Economic Analysis - GST Optimisation To Help Spur Growth Acceleration - JAN 2018

BMI View : T he GST Council ' s decision to reduce taxes on more commonly used goods and services demonstrates the government ' s commitment to optimising the tax system in order to support growth, and we continue to expect economic activity to pick up in H2FY2017/18 (April-March).

The decision by the GST Council to reduce taxes on commonly used goods and services reflects the ongoing efforts by the government to improve the GST framework, which will be supportive of growth over the coming months, and we continue to forecast a pickup in growth in the remainder of the fiscal year, which will see India's GDP grow by 6.4% in FY2017/18. While the recent revisions to GST tax rates across several goods are expected to cost around INR200bn according to the finance ministry, we believe that higher GST receipts stemming from improving economic conditions and direct tax revenues will likely help to offset the losses from the revisions to GST rates, and accordingly, we maintain our forecast for India's deficit to come in at 3.3% of GDP for FY2017/18.

Tax Optimisation Will Help Encourage Economic Growth
India - Real GDP Growth Breakdown, % chg y-o-y
BMI, Bloomberg

At its November 6 meeting, the GST Council removed most mass consumption goods from the highest 28% tax band, and reduced taxes on services commonly provided by small and medium enterprises (SME) such as food preparation and jewellery-making. These measures were aimed at reducing the cost burden on consumers and at providing support to the SME sector. In our view, this is likely to encourage a pickup in consumption and manufacturing, both of which slowed during the lead up to and after the implementation of GST in July, and contributed to an economic slowdown in H1FY2017/18.

Select Approved GST Reductions - GST Council November 6 Meeting
Item/Service New Rate Previous Rate
BMI, GST Council
Mass consumption goods (washing detergent, chocolate, toiletries, etc.) 18% 28%
Food and food products services 5% 18%
Jewellery production 5% 18%

Lower Taxes On Essential Goods Likely To Encourage Consumer Spending

Lower taxes on essentials and mass consumption goods paint a more-constructive outlook for the consumer industry as lower taxes on essentials and commonly used items will likely spur a recovery in consumer spending, which slumped after the imposition of GST in July. The GST Council reduced the number of items in the highest 28% tax bracket from 227 to 52, and mass consumption goods such as toiletries, detergent and dried food now fall under the 18% bracket, while 'demerit' and luxury goods such as tobacco and leather apparel will continue to be taxed at the highest rate.

Furthermore, lower taxes on food, which is an important component of the consumer price index (CPI) basket, should also help lower food costs and keep inflation (3.3% y-o-y in September) in check, and mitigate any upside risks to interest rates that might weigh on growth. Additionally, increased consumer spending will likely help spur a pickup in manufacturing activity, which was adversely affected by slower consumer spending as retailers halted new orders in order to clear existing inventories.

Manufacturing And Services Recovering From July Slump
India - PMI Breakdown
BMI, Bloomberg

Lower Tax Rates On Services Bode Well For The SME Sector

The council also lowered services taxes, which is likely to provide further relief for SME manufacturers and service providers, which were hit hard by the introduction of GST. This round of GST reductions follows the council's decision at its previous meeting in October to reduce taxes for other sectors such as textiles, which had rates slashed to between 0% and 5% from up to 12% previously. A recovery in the SME sector, which contributes to around 37% of economic output and employs around 10% of the working-age population according to UN and Indian government data, is likely to help expedite India's economic recovery.

Risk To Outlook

Ongoing teething issues with the GST Network (GSTN), the electronic filing system, have yet to be resolved and are likely to continue weighing on tax administration and revenue collection. Indeed, GST revenues in September came in at INR921.5bn, which despite being an improvement from August, still lag behind July's INR950.0bn. Additionally, certain commonly used goods such as washing machines, paint and cement are still being taxed at the highest rate of 28%, suggesting that production and consumption in these sectors are likely to remain slow.