GST – One Nation, One Tax

Touted as the biggest tax reform since Independence, the GST bill has finally been cleared by both houses of parliament after several months of struggle. A question then arises – what is all the hype about?

For a moment, imagine that you came up with an idea to manufacture and sell a product P. For procuring the raw materials, you would be asked to pay the price that includes taxes (Excise Duty). Also, as the product P is manufactured, there is value addition by the manufacturer, hence the Value Added Tax (VAT) will be charged. As the product P transfers from manufacturer to the wholesaler to the retailer, each entity adds the margin and add the corresponding taxes (sales tax, entry tax) to the price of the product P. At each stage, there is no way to offset the new tax with an already paid tax, for example, the initial VAT on the product P was charged on the price that already included the Excise Duty; there is no way to exclude the Excise duty already paid from the VAT computation. Thus, the consumers not only end up paying multiple taxes on the same product but also pay tax on tax! The problems are exacerbated by the huge tax compliance cost due to stringent norms and difficult procedures.

In summary, the current system suffers from various issues such as multiple indirect taxes with an assortment of taxable events, multilayered and varied taxation rates throughout the country, multiple agencies collecting taxes, and last but not the least – cascading effect of taxes with inability to claim credit under one tax to set off liability against another.

So how will the GST help and why is it termed as a game changing reform for not only the Indian taxation regime but also the economy as a whole?

What is GST?

GST is a destination based, single indirect tax for the whole nation which will make India one unified market. GST will follow the Destination Principle meaning that the tax will go the state in which the final consumption of the goods or services will take place.

It is a comprehensive tax covering all stages including manufacturing, sales and consumption. Many indirect taxes levied by the center & state will be subsumed (excise duty, service tax, value-added tax) thereby reducing the distortionary effects. Credits of input taxes paid at each stage, from manufacturer to the retailer/distributor will be available in the subsequent stage of value addition, which makes GST essentially a tax only on value addition at each stage.

Three categories of GST will be introduced- Central GST, Integrated GST and State GST

The final consumer will bear only the GST charged by the last dealer in the supply chain, with set-off benefits at all the previous stages. This would eliminate cascading and distortionary effects of the current multitude of indirect taxes, reducing the cost of production and giving businesses an opportunity to evaluate pricing policies.

Impact on Economy

The GST regime should result in production efficiencies that could raise global competitiveness, improve profitability and increase GDP. It will generate a third party paper trail and prevent tax evasion or black money circulation. Doing business in the country will be tax neutral irrespective of the place of doing business.  GST would mitigate huge compliance cost incurred by the companies on complying with various different indirect tax laws, administrative cost incurred by the Government, capture value addition and widen the tax base; it would generate a third party paper trail and prevent tax evasion or black money circulation; and it would boost exports by making them zero rated.

Exports

Currently, Indian manufacturing companies have modified their supply chains into complex transaction structures to adapt to the multitude of indirect taxes which make the exports uncompetitive. Foreign companies are sceptical of committing large capital investment in India. They have turned to China –More attractive SEZs and export zones. GST is expected to reduce cost of production, thereby boosting exports (3-6% gain expected). GST will create a seamless market and broaden the tax base. (Boost of 0.9-1.7% to GDP)

FDI

India continues to have 7%+ growth rate, making it an attractive destination for global capital. However, a confusing and burdensome tax structure has posed several challenges.  Introduction of GST will help in rationalisation of the tax structure & transform India into a truly integrated single economy. A certain and uniform tax regime will boost foreign investor confidence reinforcing the fact that India is committed to structural reforms. This reform is expected to bring in a manufacturing revolution, ushering ‘Make in India’ and creating millions of job opportunities.

Inflation

In the short term, GST is expected to create inflationary pressures (up to 60 bps).

However, price benefits due to increased efficiencies in production & distribution, avoidance of double taxation & proposed revenue neutrality are expected to bring down inflation in the long term.

Roadmap of GST

The path to GST starts more than 15 years ago. In 2000, the Vajpayee Government started discussion on GST by setting up an empowered committee, headed by Asim Dasgupta, (Finance Minister, Government of West Bengal). The committee was given the task of designing the GST model and overseeing the IT back-end preparedness for its rollout.

Later in 2006, the then Union Finance Minister P. Chidambaram moved towards GST in his Budget, and proposed to introduce it by 1st April, 2010. However, the Empowered Committee of State Finance Ministers (EC) released its First Discussion Paper (FDP) on the GST in November, 2009. Multiple debates have taken place regarding the bill pertaining to the proposed tax rate, the agreement from the states especially the manufacturing states (the states losing the revenue), and the inclusion of petroleum products and liquor under the purview of GST.

Inability to reach a consensus with respect to these issues compounded by the rivalry at the national level politics delayed the implementation bill significantly until Aug 3, 2016. The bill was finally passed in both the houses of parliament through extensive negotiations from the Modi Government with all stakeholders. The bill will have to be ratified by minimum of 15 states in their respective assemblies before going to President for approval. The GST Network (GSTN), the IT backbone will be launched and the states will be required to frame their GST legislations so that the bill comes into effect starting Apr 1, 2017.

Archana Maganti, Maithili  Kalelkar, Madhur Bajpai & Shreya Aggarwal

Disclaimer – All the views expressed are opinions of Networth – IIMB Finance Club – members. Networth declines any responsibility for eventual losses you may incur implementing all or part of the ideas contained in this website.

Managing Market Expectations in Monetary Policy

The markets expected Developed Economy policy makers (Japan and UK in this case) to be dovish and they were. In Japan, while the Bank of Japan (BoJ) left policy rates unchanged, there was a fiscal stimulus package worth ¥28.1 trillion (to help give loans to SMEs that may suffer from Brexit); whereas in the UK, the Bank of England (BoE) cut the policy rate and proclaimed to purchase corporate bonds.

An important question here is whether they met market expectations and how did the policy announcements impact different asset classes?

 BoJ and BoE Market Expectations

Before their respective meetings, the market participants had the following expectations:

BoJ’s Policy Announcement

Shinzo Abe propounded the three arrows of Abenomics – fiscal stimulus, monetary stimulus and structural reforms – to revive the Japanese economy from the two-decades of recession. The initial hype resulted in a positive reaction from the markets (currency depreciation and rise in equity prices). Although the inflation target of 2% was not achieved, the modest inflation was an improvement compared to Japan’s deflationary past. However, Abenomics failed to live up to the initial hype. (Click here to know more)

In April 2014, a consumption tax increase led to fiscal tightening (deviation from the stated arrows of Abenomics). This adversely impacted household spending and private investments. The modest recovery soon degraded into another round of economic recession. (Click here to read more about Deflation in Japan)

BoJ announced the following steps in the meeting to address the recession:

• No rate cut & maintained its Quantitative Easing of ¥80 trillion.
• Increased the scale of a program to buy exchange-traded funds (ETFs) to ¥6 trillion a year from ¥3.3 trillion. (BoJ Policy Statement).

 BoE’s Policy Announcement

The uncertain implications of Brexit was the major cause for status quo in the previous meeting of the BoE. However, the significant policy easing in the latest meeting clearly indicates that the BoE wanted more clarity on Brexit’s economic implications before committing to a major policy announcement. (Click here to read more about implication of Brexit on UK)

 The Monetary Policy Committee (MPC) decided to take the following steps to provide additional support after the Brexit poll and to reach its target inflation of 2%.

• Cut the bank rate by 25 basis points to 0.25% – 322 Year low!!
• Introduced Term Funding Scheme (TFS) in order to pass-over the lower rates to the customers.
• Purchase of £10 billion of the UK corporate bonds over a period of 18 months and expansion of sovereign quantitative easing by £60 billion (buying UK Government Bonds over a period of 6 months) (Click Here to know more about BOE measures)

Impact on Markets

Immediately after the announcement:

• Currency – Yen appreciated by 1% whereas the pound crashed by 1.6 %. It was the biggest fall of pound since Brexit Referendum.
• Bond Yields – 10-year JGB Yields rose to -0.2% from -0.3% whereas 10-year UK bond yields fell to a record low of 0.639%.
• Stock Index – The Nikkei Average tumbled by 2% as BoJ’s policy statement fell short of expectations whereas the UK FTSE climbed by 1.6% led by financial shares.

Opinion on BoJ’s action – Expectations not met on monetary policy front

In its policy statement, the BoJ mentioned that it eased monetary policy to cope with growing uncertainties in overseas economies and a rise in the global financial market volatility owing to Brexit vote and slowdown in EMs. The main objective of the actions was to help prevent these uncertainties from leading to loss in investor and business confidence.

However, contrary to market expectations, the BoJ did not cut the policy rate. The probable reason is that the BoJ wanted to get some more time to build consensus especially as banks and other financial firms have opposed BoJ’s JGB purchases and negative interest rate policy. In fact, there wasn’t any specific mention about inflation in its Monetary Policy Report and its downside risks. Given the government actions, it seems that government believes that monetary policy has become less of an effective tool to boost GDP and induce spending.The announcement of fiscal stimulus suggests a move towards the original Abenomics principles to kick start the Japanese economy.

Opinion on BoE’s action – Exceeded expectations

Given that Brexit implications are still unclear, the BoE’s stance indicates a front-loading of easing to effectively communicate that the BoE is in control of the situation. Even though BoE chose to cut rate by 25bps, it exceeded market expectations on several other fronts –

• The term Funding Scheme – lending up to £100 billion to banks at a generous rate, close to the bank rate for four years –  will ensure that base rate cut is passed through to households and companies. Click here to Know More
• Buying the UK corporate bonds, starting September, would further drive down borrowing costs for companies, helping inculcate credit growth.

Future Expectations

• The BoJ announced that there will be a comprehensive review of its policy framework at the next meeting on September 20-21. The main intention is to do a comprehensive assessment of developments in economic activity and prices under Quantitative Easing with Negative Interest Rates. The report will form the base for a concrete interest rate decision on rates in the September or November meeting.

• As stated in the BoE report, it is expected that they might further cut rates. Majority of members are expected to support a further rate cut and provide more easing measures at one of MPCs forthcoming meetings during the course of year..

Things to look out for

We will give some interesting trade ideas based on the above policies and market actions. Please keep a look out in this space in the coming few days.

Rishi Vora, Dinkar Mohta and Punit Parekh

Disclaimer – All the views expressed are opinions of Networth – IIMB Finance Club – members. Networth declines any responsibility for eventual losses you may incur implementing all or part of the ideas contained in this website.