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GST impact on economy: Five things to watch out for

India Inc will have to reorganise their businesses as the country switches to the GST regime, which will bring in more small companies into the tax net.

business Updated: Jul 08, 2017 18:46 IST
Raj Kumar Ray
Finance minister Arun Jaitley and revenue secretary Hasmukh Adhia at a conference.
Finance minister Arun Jaitley and revenue secretary Hasmukh Adhia at a conference.(HT photo)

While the lower Goods and Services Tax (GST) rates may lead to a decline in inflation, economic growth may not improve significantly in the short term even though it will benefit both India Inc and the government in the medium term, experts say.

Most economists forecast inflation to come down as GST rates for most goods have been fixed at a lower rate.

India Inc will have to reorganise their businesses as the country switches to the GST regime, which will bring in more small companies into the tax net.

“It’s not optimal, but let the best not be the enemy of the good. Even with its imperfections, it could usher in significant benefits, especially through a quantum leap in transaction trails and logistical efficiencies,” DK Joshi, chief economist of Crisil, wrote in a report.

But most say the Reserve Bank of India is unlikely to cut policy interest rates at the next policy review on June 6-7, as it will assess the monsoon situation as well as the way the new tax regime pans out, says Sunil Sinha, chief economist of India Ratings.

Here are five impacts GST will have in the near term:

1.Shaking up corporate operations

The new tax regime will force many companies to restructure their operations.

Companies will now insist vendors and suppliers to furnish invoices as GST will make it impossible for firms to evade taxes.

Big companies stand to benefit as they have a supply chain in order and can offset taxes paid on inputs.

Smaller firms may end up spending more as compliance cost will rise.

“While the impact on companies varies following existence of production units in the excise exempted zones, implementation of GST should result in cost savings in the supply chain network and expedite a shift from unorganized to organized trade,” foreign brokerage firm Jefferies said in a note.

2.Passing on the benefit of lower tax

While the GST Council, headed by finance minister Arun Jaitley, will keep a close vigil on whether companies are passing on the benefit of lower taxes to consumers, experts expressed doubt on the implementation of anti-profiteering norm.

“We believe that while corporates would pass on the direct benefits of GST (like a lower tax rate), they would aim to retain partly (if not fully) the indirect benefits from the saving in logistics costs, streamlining of business processes and the seamless flow of input credits,” Nomura said in a report.

While GST laws include anti-profiteering measures—the benefits of the reduction in the tax rate and input credit shall be passed on by a commensurate reduction in prices—such measures are difficult to implement and would be a retrograde step, similar to price controls, if implemented in haste, Nomura added.

Companies may use the savings from tax outgo under the GST regime to improve profit margin to some extent and invest the rest in building new capacities.

3.Inflation may remain low

Analysts have no doubt that inflation will remain low as GST rates on essential goods such as food grain, household consumer items and essential services have been either exempt or kept lower.

However, assuming that GST does have the intended effect of increasing tax compliance, the tax burden would increase, Morgan Stanley said in a note. This could lead companies to pass the costs of higher tax compliance on to the consumer at a later stage, it said.

Most of the services are not accounted in the consumer price CPI inflation basket and hence the higher GST rates may not get reflected on the retail price movement as measured by the government data.

“Services sector component in CPI is around 20%, whereas they account for almost 50% of the total consumption basket in the economy,” says Soumya Kanti Ghosh, chief economic adviser at State Bank of India.

There are services like health, education, miscellaneous segment, transportation are outside the ambit of GST. “Hence, GST implementation on CPI impact will be minimal. We estimate that GST will have neutral impact on headline CPI,” he said forecasting the average inflation at 4-4.5% during 2017-18.

4.RBI may not cut rates in June

While inflation is expected to ease further with GST rollout from a record low of 3% in April, analysts expect RBI may not immediately lower policy interest rates.

“RBI will watch out for the monsoon progress as also how the GST pans out,” said Sinha of India Ratings.

In the last policy review, RBI had flagged concerns that the “one-off” impact GST may be inflationary. The central left policy rates unchanged in April.

SBI’s Ghosh says the RBI will most probably pause on June policy review.

5.Economic growth may not jump immediately

Economists are not sure of the immediate impact of GST and some even say it may impeded growth in the short term as big companies reorganise their businesses and as small firms lose revenue.

“The GST implementation will be disruptive as there will be a major change in the supply chain,” India Ratings’ Sinha said but added the tax reform will be beneficial to the economy in the medium to long term.

Most analysts forecast the economy to grow close to 7.4% in 2017-18, the first year of GST rollout, which is slightly higher than 7.1% in 2016-17, but lower than 7.9% of 2015-16.

While GST is unlikely to be a “positive” for economic growth in the short term, Crisil’s Joshi said the reform will improve the ease of doing business, bolster investor sentiment and lure more foreign investment in coming years.