GST cuts help but India must raise its game

GST rate simplification was long overdue. Rates had been absurdly high and fiendishly convoluted. An identifiable part of a single finished product could have a different rate from the rest of the product, resulting in several memes on social media. In some sectors like textiles, there was even a ‘tax inversion,’ meaning that the GST rate on inputs in that sector was lower than the rate on output.

First, the good news. The overall blended rate of GST, at an estimated 9.5%, will decline by about 2% from last year and about 5% from its peak in 2017. This will directly find its way to household and corporate savings, stimulating consumption.

For households, this is an unambiguous positive. For corporations that could not utilize all their input credit, this will be a moderate positive. For exporters, who are not subject to GST on export goods, this will reduce the burden of waiting for a refund on input GST paid. Some sectors like textiles will appreciate that tax inversion has been eliminated. For instance, rates on synthetic fibre and yarn will now be the same as that on garments up to ₹2,500, whereas earlier they were taxed at a higher rate than garments.

Now for the other side. What we needed was full-fledged GST reform, not merely a reduction in rates accompanied by a few process changes. This would include not only a strict reduction to one or two slab rates, but a complete elimination of indirect cess (this accrues only to the central government and not states), a dramatic simplification of the process of submitting GST returns and a meaningful pull-back of enforcement overreach.

For want of more comprehensive GST reforms, the contribution of indirect taxes to coffers is only 4.9% of GDP, below its peak. While the contribution of all taxes, including direct levies, has regained its peak of about 11.9% (a level last achieved in 2008), most of the increase has come from direct taxes.

The complexity of rates and processes for GST is almost entirely the cause of this underperformance. India’s tax-to-GDP ratio is significantly below that of peers like China (17%) and Brazil (30% including payroll taxes), and also below the OECD average (33%). The opportunity for really impactful reform has not been taken.

Combining GST reduction with a decline in the rupee’s exchange rate against the dollar (3% this year) and some careful cost-cutting by firms can reduce their export costs by about 15-20%, helping them regain some lost competitiveness against rival products going to the US market that are subject to varying tariffs of 10% or more.

Beyond GST reform, India can take additional steps to combat the reduction in GDP that might arise from the prohibitively high US tariffs on Indian goods. Wherever India has a competitive domestic industry with affordable products that are readily substitutable with others, we should drop import duties to zero. For instance, India charges an import duty of 30% on motorcycles. While this was reduced in the latest budget from 50%, there is no reason for it to be so high. Similarly, we collect an ‘agriculture cess’ of 40% on imported cars. These methods of pure revenue enhancement should be eliminated.

Wherever a foreign product would easily substitute an Indian product, we must carefully evaluate all steps to localize and/or become more competitive. For instance, neither Apple nor Dell as yet makes laptops in India, Samsung does. Samsung pays 10-22% import duties on chipsets, printed circuit boards, cameras, display panels, etc. Tack on an 18% GST and laptops in India are 25-30% more expensive than elsewhere. This sector needs a grand reduction in duties to go with incentives to localize production.

Another way to play defence is to diversify the countries we export to. Australia is a shining example of how to do this.

After China gave it a cold shoulder in 2021-23, Australia forged several new bilateral and regional trade agreements. The country now has deals with the US (10% tariff), Japan, Singapore, South Korea, Thailand, Indonesia, Malaysia, India and the UK, as well as with the Asean group of nations and two broad Asia-Pacific agreements.

While this will take time and effort to replicate, it is something that India must do.

On the offensive side, India can make it difficult for the US to obtain those goods that are not readily substitutable there.

While India has fewer aces up its sleeve than China does, we can still play hardball with pharmaceuticals. India supplies a third of all pills that Americans consume every year. By my estimate, India supplies 100 billion out a total 300 billion pills consumed in America annually. For argument’s sake, if we impose a ‘licensing regime’ on these pills (like China did with rare earths) for a while, the US government would take notice. We could up the ante further if we impose a ‘reverse reciprocal tariff’ of 50% on pharma products alone. The US would suffer a sky-rocketing price impact.

This is a poor way to conduct policy, but in a school yard of bullies, we may have little choice.

P.S: “There is no friendship without self-interest. That is the bitter truth,” said Chanakya.

The author is chairman, InKlude Labs. Read Narayan’s Mint columns at www.livemint.com/avisiblehand