GST launch should pave way for repo rate cut

The RBI could wait for CPI inflation to settle and then reduce the repo rates. Or it could take a calculated risk by cutting the rates immediately

In the meeting held on June 7, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) decided not to cut the repo rate. The lone dissenting voice was that of IIMA professor Ravindra Dholakia, who wanted the repo rate to be reduced by at least 50 basis points from the present 6.25 per cent. The RBI, too, has reasons to abstain from a repo rate cut. After signing the new Monetary Policy Framework Agreement with the Union government in February 2015, the responsibility of maintaining Consumer Price Index (CPI) inflation becomes the only factor in deciding the repo rate. As per the agreement, it is mandatory for the RBI to maintain CPI inflation at four per cent, plus or minus two per cent, from FY 2017-18 onwards. However, the track record of the Indian economy shows that in the last 20 years average CPI inflation was about 6.7 per cent. Given this trend, the RBI’s apprehension that a repo rate cut would make it impossible for it to maintain CPI inflation within the mandatory range is understandable.

However, much water has flown under the bridge between June 7 and now. Despite doubts and reservations, the goods and services tax (GST) was launched on July 1 by the Union government. As expected, some services and goods may cost more now than they did in the pre-GST regime. However, most of the essential goods that form the CPI basket are charged either a nil rate or five per cent in the GST regime. There is rumour-mongering by some to cause panic among people by comparing taxes on a few goods and services prior to GST with that after GST and claim that prices would be higher in the post-GST period. Most of these attempts compare the state value-added (VAT) tax with GST and claim that GST rates are higher than pre-GST rates. The GST is a single tax that subsumed central excise duty (Cenvat), additional excise duties, excise duty levied under the Medicinal and Toilet Preparations (Excise Duties) Act 1955, service tax, additional customs duty (known as countervailing duty or CVD), special additional duty (SAD) of customs (four per cent), surcharges and cesses, VAT or sales tax, luxury tax, Octroi and entry tax, purchase tax and state cesses and surcharges.

It is true that every commodity or service does not entail all the central and state taxes, but most goods do pass through more than one tax. For instance, for a biscuit packet, all taxes put together (central excise is eight per cent and sales tax or VAT is 8-16 per cent by various state governments), the consumer paid about 16-24 per cent as tax in the pre-GST regime. In the GST regime, he will pay 18 per cent. The basket that constituted about 50 per cent of items considered for CPI calculations are kept out of the tax net or levied at five per cent in GST. Therefore, there is little scope for CPI inflation to increase in the post-GST period compared to that in the pre-GST period.

However, the benefit of GST in reducing CPI inflation goes beyond the reduced tax on essential items. The additional benefit from GST would emanate from the expected reduction in logistics cost. The cost of logistics is about 14-15 per cent of total gross domestic product in India, whereas it is only seven-eight per cent in mature markets. Despite more than 26,000 km of four-lane roads in India at present, trucks have been travelling only about 280 km per day due to the wait at checkposts of state boundaries. With GST, trucks are expected to travel 460 km per day, barging through state boundaries. The GST, which makes trucks waiting at checkposts of state boundaries redundant, should ideally reduce the cost of logistics from the current 14-15 per cent to 9-10 per cent. This means the cost of goods and services should reduce. Moreover, the logistics cost constitutes about 25 per cent of the total cost paid by the consumer in the case of agricultural produce. Given the perishable nature of agriculture produce, the price of agricultural produce, which has about 50 per cent weightage in CPI, should also reduce with faster movement of goods. However, there is a caveat. Reduction in prices can happen only if all stakeholders in the supply chain, whose costs have reduced with the introduction of the GST, cut prices of products and services in proportion to the decreased logistics costs and tax rates. The GST law has an anti-profiteering provision that makes it mandatory to pass on the benefit due to reduction in tax rate or from input tax credit to the customer. There is, however, a big question mark over how the Union government and state governments would be able to ensure that savings in cost due to GST are passed on to the customer.

By all these accounts, it looks as if there is every possibility that CPI inflation would decrease to four per cent or less at least in the last two quarters of FY 2017-18 and thereon. The right environment to boost GDP growth has arrived with the introduction of the GST. However, the repo rate cut is indispensable to add momentum to India’s GDP growth rate. Unlike dearness allowance, which is revised based on inflation in the immediate past, the RBI speculates the inflation for the next one year and devises its monetary policy accordingly. The RBI in its policy review made an inflation forecast of 2-3.5 per cent during the first two quarters and 3.5-4.5 per cent during the third and fourth quarters of FY 2017-18. It is not known whether the forecast of inflation included the comprehensive positive impact of the GST such as reduction in taxes and cost of logistics. If the positive impact of the GST was accounted for by the RBI in the forecast of inflation, there is a case for a repo rate cut of, say, at least 25 basis points. If it was not considered, there is a very strong case for a repo rate cut of 50 to 100 basis points, as GST may even reduce inflation to less than two per cent.

The RBI has two options. It could wait for inflation to settle down to four per cent or less due to the positive impact of the GST and then introduce repo rate cuts. The rate cuts cannot immediately boost the economy as repo rate cut and borrowing take time to bring about the change. So, if the RBI goes for a waitand-watch approach, it may not augur well for boosting GDP growth in FY 201718. The second option for the RBI is to introduce an immediate repo cut of at least 25 basis points for each quarter in the next three quarters of FY 2017-18 and add momentum to the GDP growth rate. The first option represents conservatism, which is not bad by itself. But given the need to boost the GDP growth rate in the last two years of this government, the calculated risk of reducing the repo rate is not bad either. It is to be seen whether the RBI chooses conservatism by not touching the repo rates or takes a calculated risk by cutting them.