Special Update on India’s Goods and Services Tax
Unified Market, Significant Efficiency Gains and an Estimated 1-2% Rise in GDP
Earlier this month, the Indian Parliament passed the Goods and Services Tax (GST) Bill, a move widely hailed as one of the most significant economic reforms in the history of independent India. The bill will transform India’s taxation system by harmonising its myriad central and state levies into a single, national sales tax. This is expected to create a unified market that allows for the seamless transfer of goods and services across the country, significantly reducing the cost and complexity of doing business in India, and potentially increasing India’s GDP growth rate to 8.5% to 10%. Importantly, the passage of this reform also adds further credibility to the BJP-led NDA government’s ambitious reform agenda, and sends a signal to both international and domestic investors that Prime Minister Modi is pro-business and committed to the broader reform agenda, which is critical to India’s long-term growth ambitions. This note provides a brief overview on GST, its expected impact on the Indian economy, and the implications for investing in India.
Key Highlights of GST
- A Tax Reform More than a Decade in the Making Passed, Indicating Political Breakthrough. The Congress Party-led UPA government first proposed the idea of single indirect tax rate in India in 2004. Subsequent attempts by different governments to implement this reform faced stiff opposition from regional political parties. The incumbent NDA government’s success in finally getting the GST Bill passed into law comes after adopting a strategy, which included both incentivising state governments to come on board with the legislation, while simultaneously isolating political parties that remained opposed to the bill (a relatively novel approach within the context of this legislation)
- India’s Most Important Tax Reform Since Independence. GST is estimated to add between 1 and 2 percentage points to India’s GDP growth rate (translating into US$250bn–US$500bn in incremental GDP over 10 years), and the passage of the GST bill has been widely hailed as independent India’s most important tax reform, with its benefits expected to be far-reaching. By eliminating multiple indirect taxes across India, and creating a unified market to do business in the country, GST is expected to not only simplify taxation, but also increase government tax revenues, improve tax compliance and make Indian exports more competitive
- Ease of Doing Business in India Expected to Improve Significantly. Transporting goods across states in India has traditionally been a cumbersome process. For example, a truck carrying goods across state borders in India is estimated to spend 48 hours on average at each state checkpoint, as it clears various excise and state taxation related requirements. Bottlenecks such as these are expected to be eliminated post the implementation of the GST Bill, and the cost and time savings associated with this change and the improvement in logistics and supply chains they create should serve as a huge boost to the government’s flagship “Make in India” campaign, that looks to accelerate manufacturing activity in the country
- Significant Internationalisation Opportunity. India’s Ministry of Finance estimates that the rollout of GST should boost India’s exports by 14%. The key drivers of this growth are an expected 10–12% decrease in important production costs such as transportation, warehousing and inventory management, which will make Indian goods and services more price competitive in international markets and drive demand accordingly. The last decade has seen a number of Indian firms leverage relatively lower cost structures to exploit more profitable international markets (particularly in sectors like pharmaceuticals, chemicals and automobile components manufacturing), and the advent of GST is likely to both deepen and widen this trend, increasing competitiveness levels across a wide range of industries.
- An Important Step Towards the Creation of a Stable Taxation Framework. Foreign capital has a critical role to play in India’s economic growth prospects, and the creation of an investor-friendly taxation framework that is fair, transparent and consistent, provides an important element of an attractive investor story. Many investors have watched closely to see if the Modi government could introduce this key reform. The passage of the GST Bill is a key step in this regard, and should further bolster international investor confidence in the Indian economy
- The BJP Displays its Political Acumen. As highlighted earlier, the successful passage of the GST Bill through the upper house of parliament was driven by a nationwide consensus-building exercise by the BJP that involved bringing regional parties and state governments on board, while isolating political parties, such as the leading opposition party, the Indian National Congress, that continued to oppose the proposed legislation. These tactics highlight the political dexterity shown by Mr. Modi’s government and could potentially serve as a blueprint for getting other important reforms (such as amendments to existing land acquisition and labour laws) passed
Implications for Investing in India
From an immediate investment point of view, the passage of this legislation bodes particularly well for India’s manufacturing sector, which has longer supply chains, and involves the transport of inventory across long distances (including state lines). Within the manufacturing industry, profitability margins of export-driven industries like pharmaceuticals, textiles, automobile components and chemicals should improve by 7–8% and these sectors are likely to see increased investment activity over the next 6–12 months.
By creating a uniform and transparent tax base, GST is also expected to bridge the cost gap between the organised and unorganised sectors in India (on account of most unorganised sector players avoiding tax obligations); this should positively impact sectors like logistics and fast moving consumer goods (FMCG), where there is a particularly large unorganised sector presence.
As highlighted in GPC’s June Sign of the Times, the BJP government has made significant progress across a number of key reform areas, and the GST Bill is undoubtedly its most important economic reform to date. There are of course, important challenges that lie ahead for the government, and the passage of other big-ticket reforms may prove to be more complicated. However, by passing the GST Bill, the BJP government has demonstrated its political acumen, and more importantly, its commitment towards economic reforms, and this can only serve as a catalyst for setting India on an economic path to become one of the major powers of the 21st century.