The GST 2.0 regime will be effective from September 22 and has been timed really well. This would be the start of the festival season, where typically Indian households buy consumer goods and book homes. These are auspicious times, and households have held back purchases ever since it was announced on Independence Day that there was a rationalised scale to be announced in September.
The timing is significant for two reasons. First, a common lament from FMCG companies was that urban demand was down due to high inflation in the past. With GST rates being rationalised in the downward direction, this will be the cure for sure. There should be an immediate fall in prices that should spur demand. In fact, savings on FMCG products across the board should release significant resources for households to spend on other goods. Second, the tariff issue has reached a dead end with the 50 per cent rate now a reality. With several inputs now having lower GST rates, the exporters will get some relief on the cost side, which can aid in removing a part of the tariff disadvantage.
How do prospects for consumption look? The government has announced that the overall revenue loss would be Rs 48,000 crore. This is not as large as has been estimated by analysts. There is a gross revenue foregone of Rs 93,000 crore, of which Rs 45,000 crore is being recouped by higher duties on a set of luxury items. Any revenue foregone is a gain for the consumers
The way the GST council has segregated goods is interesting. All necessities go at a lower rate of 5 per cent or are exempt from the tax. Comforts, which include consumer goods, go at a lower rate of 18 per cent, while luxuries, including sin goods, go with a higher rate of 40 per cent. This is probably the most equitable way of rationalising rates. Demand for necessities and comforts should go up. In fact, for consumer goods, including auto, it is a major boost as costs come down substantially. An entry-level car of Rs 5 lakhs will save Rs 50,000 as GST, which is a big gain. The same holds for two-wheelers and tractors. For sin goods and luxuries, the GST does not matter as demand is inelastic. There could not have been a better reclassification.
Will government fiscal balances be affected? The revenue foregone of Rs 48,000 crore can be absorbed in the budget, given that other revenue has been buoyant and the RBI transfer of surplus was higher than expected. Therefore, in the absence of any slippages, the fiscal deficit number can be maintained at 4.4 per cent. The compensation part for states has not yet been announced. But given the intrinsic buoyancy in the economy, there should not be a major challenge. In fact, higher spending by households should generate a secondary chain of GST revenue for the Centre and states. Bond yields have reacted positively, which vindicates this position.
How about GDP growth? Prima facie, consumption should increase immediately, and if the pent-up demand for the last two years is clubbed with tax cuts as well as the income tax relief given by the budget, we can expect a big jump in spending. This, in turn, should also help the industry as capacity utilisation improves and companies go in for fresh investment at the secondary stage. This could materialise towards the end of the year, depending on how good the spending is. Therefore, the two major engines of consumption and investment should be positive during the second half of the year, which will add to GDP growth.
The biggest impact will be on inflation as consumer prices come down. The government will have to ensure that companies do not hold back these gains, and the anti-profiteering clause needs to be implemented with alacrity. The core inflation part will see a decline, which will have a soothing effect on headline inflation. The advantage is that this benefit will flow over a period of a year, as lower prices will get reflected over higher base numbers in the last 12 months. This can help in moderating the inflation projections of the RBI in FY27, too.
Will this impact credit policy outcomes? Here, there is a shoulder shrug. Lower inflation will prevail in the coming months, which will bring down projections for sure, providing more room to the RBI when it comes to rate cuts. On the other hand, growth prospects look better after this announcement, and the rate of 6.5 per cent does look very much on the cards. If so, then it will be a subjective call to take on rates as inflation will trend lower while growth will hold up. A pause for the time being looks more likely.
The GST council, however, has not included fuel products, which presently have the highest effective taxes when excise and VAT are combined. This will probably be the last frontier that has to be addressed at some point in time, as the rates are way above those of other goods and services.
The GST has been one major success story in the process of reforms, which has withstood several challenges, including Covid, where revenue ground to a halt, thus affecting overall collections. This made compensating states a challenge. This was overcome quite successfully and the system has reverted to normal to enable the council to bring about this rationalisation. Growth in collections is a direct function of overall growth, which has to tick to enable the same. The present dispensation rationalises rates as well as corrects inverted duty structures where inputs are taxed at higher rates than the final output.
Hence, the government and RBI have set the right preconditions for growth: The former through the fiscal incentives on income tax and GST and the latter on interest rates. Theoretically, this should work well, and the final result will be known in the next two quarters.
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