GDP faces GST hiccups, say economists

Inflation may be largely unaffected

The goods and services tax (GST) might adversely affect economic growth in the initial part of 2017-18, before providing a boost from the fourth quarter, economists said.

They added retail price inflation would largely remain unaffected but inflationary expectations would persist, as prices would rise for services such as premium air travel and air-conditioned hotels as well as goods such as aerated drinks, hybrid cars and fertilisers. These items have negligible weights in the consumer price index (CPI).

Rigid inflationary expectations would not allow inflation to decline significantly, though taxes paid on inputs would be reimbursed, which would have a damping effect on inflation, some economists said.

Also, the wholesale price indexbased inflation will not be affected by the GST due to a new way of calculating price rise that does not take into account indirect taxes.

“The GDP will be negatively impacted for at least two quarters by the GST as there will be transitional problems and people will be adjusting to the new tax regime,” said DK Srivastava ofEY. Hesaideconomicgrowthcould be affected by up to 0.5 percentage points during this period. He pegs GDP growth at 7 per cent in 2017-18, a shade lower than 7.1 per cent in 2016-17.

GDP growth in April-June would be weak due to the effects of demonetisation, he added.

Srivastava said the effects of demonetisation on economic growth could dissipate in the second and third quarters of 2017-18, but the economy could come under pressure from the transition to the GST.

“The second and third quarters are likely to witness some adjustment as assessees become accustomed to new compliance procedures and higher working capital requirements. The positive effect of the GST on economic activity is likely to be visible from the fourth quarter,” said Aditi Nayar, principal economist with ratings firm Icra.

She said a broad-based revival of private sector investment was likely in 2018-19 after businesses had successfully made the switch to the GST. Earlier, Finance Minister Arun Jaitley had said the GST has a potential to raise the GDP growth by 1-2 percentage points. The GST would boost the GDP through efficiency gains as compliance improved, said Devendra Pant, chief economist with India Ratings. “But this will play out over the medium to long term. In the immediate future, the impact on government revenues cannot be ruled out,” he added.

Soumya Kanti Ghosh, chief economist with the State Bank of India group, said the GST had the potential to add at least 1 percentage point to India’s GDP. “This will lead to creation of more employment and increases in productivity,” he added.

Madan Sabnavis, chief economist at CARE Ratings, said gains to GDP growth would come from the accounting side and not from any improvements in efficiency. He said the unorganised sector would be more accurately captured once the GST came intoeffect. Hedidnotexpectpricesto fall significantly enough to push demand and did not rule out the possibility of an upward pressure on prices in the short run until all players adjusted to the new tax. However, Srivastava said the GST might reduce CPI inflation. Nayar said the effective tax rate after adjusting for input tax credit and removal of cascading taxes was intended to be reduced on most items in the GST regime. Moreover, a large portion of goods and some services in the CPI basket were in the exempt category, she added.

Food items constitute 45 per cent of the CPI and agriculture produce is exempt from the GST. However, packaged food will attract the GST. According to some economists, 32 per cent of the CPI will be unaffected by the GST and the remaining 13 per cent among food items will be affected.

However, decisions pending on areabased exemptions and export promotion schemes could affect output prices for some companies and exporters, Nayar said. She added the standard rate for services had been kept at 18 per cent and some were to be taxed at 28 per cent, which was not expected as this was higher than the existing levy of 15 per cent, inclusive of various cesses. However, the availability of input tax credit may soften the impact of the GST on services inflation.