New indirect tax regime

AFTER MONTHS of deliberation, the Goods and Services Tax (GST) Council finalised the tax rates to be levied under the new indirect tax regime. As such, there will be four tax slabs corresponding to 5, 12, 18 and 28 per cent, respectively. While taxes on white goods and telecom have been bumped up to 28 per cent and 18 per cent, respectively, those on items such as soap and toothpaste have been lowered as shown in Chart 1.

Some are concerned that the shift to the GST is likely to increase firms’ working capital requirements. A study by India Ratings and Research suggests that even if a fourth of the firm inventory is procured locally, the aggregate input credit lock-up is likely to be roughly ~1 lakh crore (Chart 2). Even if half of this “is not available for set off during the transition phase, it would result in blockage of ~50,000 crore of input credit for about two month”. This could impact the liquidity in the system.

The rates have allayed fears that the GST would be inflationary in the short term. As Chart 3 shows, higher taxes on services are likely to be offset by lower taxes on food and beverages, limiting the impact on headline inflation. But it ultimately depends on the extent of pass through and the availability of input tax credit. According to HSBC Global Research, full pass through of lower taxes into prices, coupled with the full availability of input tax credit, would reduce the CPI by 0.8 per cent. But if there is no pass through and only partial input tax credit then the CPI could rise by 1.2 per cent as seen in Chart 4.

With a plethora of rates, as opposed to the original proposal of a single rate, the impact of the GST on growth, in its current form, is likely to be lower. HSBC estimates while an ideal GST structure would have boosted growth by 130 basis points, in its current form, the impact is likely to be lower, around 40 basis points (Chart 5).