GST will test investors’ patience

Markets will not be happy if GST implementation remains an issue

The textile industry in Surat went on strike as the goods and services tax (GST) was implemented. So did the fireworks and match industry in Sivakasi. Both have strong connects to the informal economy and both will lack offsets for the unorganised elements in their respective value chains. The tax incidence for these will rise with GST.

Any business which has a large number of unorganised inputs will see a rise in tax incidence. The business must pay out for GST, without corresponding offsets for the informal parts of the chain. The service sector will be affected by this issue, as well as the manufacturing sector.

Almost all service businesses have informal inputs. Ideally, all these will become formalised and file compliance reports thrice a month. But, it’s hard to envisage a smooth progression for this, since 25 per cent of India is functionally illiterate and there aren’t enough accountants to go around. This system of 36 compliance reports a year (with another 12 being auto-generated) could turn ‘ease of doing business’ into a bad joke.

Also, the anti-profiteering clause gives taxmen leeway to ask why any business is charging whatever it does charge. This is an absurd law. It could hurt all businesses. It can hit the services sector harder than manufacturing.

First, there’s a matter of principle. No government agency, like the proposed National Anti-Profiteering Authority, should mandate profit margins in competitive markets. Only fanatical communists believed in this type of price-setting and it’s one reason why communism failed.

As the law stands, say a manufacturing business was charging ~100 for its product and paying ~35 as indirect taxes, prior to GST. After GST, the tax incidence drops to ~30. If the company doesn’t cut prices to pass on the benefits, the taxman may ask awkward questions. It implies profit margins will be frozen at pre-GST levels. It also begs the question as to what happens to loss-making businesses.

GST tax benefits can be relatively easily quantified in manufacturing. A services sector business could find it harder to quantify inputs. The pricing in services industries goes by the rationale of charging what the market will bear. Say, two hairdressing saloons charge different tariffs while having similar indirect tax incidence on shampoo, blades, shaving foam, etc. These businesses receive similar GST benefits. Will both be ordered to reduce tariffs to reflect tax savings? Will the one that’s more expensive be ordered to stop charging more? Ditto for advertising agencies, architects, sportspersons with endorsements, etc. There aren’t clear answers and the more corrupt members of the bureaucracy are the guaranteed beneficiaries of such ambiguous and discretionary laws.

The GST will coerce people working in the informal economy to become formal businesses. The informal sector currently offers employment to 80-85 per cent of India’s workforce. It will be a painful and chaotic transition. There could be a capacity issue due to the shortage of chartered accountants, data entry operators, etc. Manufacturers cut back production in July as GST was launched. It’s also likely that people will ease off personal consumption and bigticket expenditure until the transition is complete.

A few businesses are GST-ready. Others, by their very nature, have more informal inputs and will therefore take longer to make a transition. Until then, there will be chaos, and many sectors will take a hit.

We have already seen warnings about this from segments which are expected to eventually benefit. Analysts of the fast moving consumer goods and automobile industry, for example, say there will be an adverse short-term impact, and so do analysts tracking automobiles.

A big question is the transition timeline. What is short term and what is long term? It took West European nations, with small informal components in their economies, honest bureaucracies, 100 per cent literacy, no anti-profiteering clauses, simpler GST structures and easier compliance systems, two years on average to make the transition to this type of system. It could take India longer.

For the past two years, money has flowed into the stock market in the hopes of a sharp future acceleration in earnings. Investors are discounting an adverse impact from GST for the next couple of quarters, though some are assuming a negative impact of perhaps a year. Longer than that will start to stretch the patience of most investors.