GST: Lower Inflation In Theory, Not In Practice, Says Nomura

Published on 30 May 2017 by Team

The Goods and Services Tax (GST) rates are expected to lower inflation by 2 percentage points, according to government estimates. While this may be true on in theory, things may differ in practice, a recent Nomura report said.

The report measured the mathematical impact of the GST rates on 196 items, which form about 87 percent of the consumer price index by weight.

It found that the direct reduction in tax incidence could lower CPI inflation by around 33 basis points. The reduction would be mainly due to a 60-basis-point decline in food price inflation. However, core inflation is expected to rise 60 basis points due to increased taxes on several services, Nomura said in its global markets research report on Friday.

The chart here shows how the GST rates will impact goods and services in the CPI basket.

Why An Actual Decline In Prices May Not Happen

While the statistical analysis shows a decline in headline inflation in the near term, from a practical perspective, the report notes more than one reasons on why the actual decline may not materialise.

Asymmetric Price Transmission

Asymmetric price transmission is when companies pass on higher tax costs to consumers, but do not lower prices when tax rates decline. It is not a given that all direct benefits will be passed on, Nomura’s report explained.

This is because the competitive intensity in a particular sector and demand conditions will also play a role.  

Nomura Global Markets Research

It expects consumer sectors such as automobiles and consumer non-durables to pass on the tax benefit to consumers. But, service providers may not pass the benefits because of robust demand conditions, the report added.

Indirect Tax Benefits May Be Retained

Indirect benefits such as the ability to claim input tax credit and lower logistics costs are even more less likely to be passed on to consumers, Nomura predicts.

This is because it is difficult to isolate the profits that come from GST indirectly, and the uncertainty about the tax refund process during the transition period, the report said. Amid uncertainty and confusion, prices will be left unchanged, it added.

Anti-Profiteering

The government has included a clause in the GST law to set up an anti-profiteering body to ensure that the benefits are passed on to consumers.

The enforcement of the anti-profiteering clause would be difficult as there are many small firms across India, and there are many factors outside taxes which could drive cost changes, the report said. Even within the same sector, different firms could get different tax benefits depending on production processes and sourcing, which adds to the difficulty of pegging if the benefits are being passed on, the report added.

Also, if the government becomes strict in enforcing this, then it would also hurt their own goal of widening the tax base as it will discourage firms from moving to the formal economy, the report said.

Malaysia’s experience in 2015 on this front is pertinent. Malaysian authorities more strictly enforced anti-profiteering mechanisms to curb potential profiteering that could arise in the guise of the GST. This veiled threat deterred firms from increasing prices immediately.  

Nomura Global Markets Research

Benefits Could Be Used In Other Forms

Firms benefiting from GST may decide to use those gains in other forms such as higher marketing spends, or higher volume per package, and not necessarily lower prices, Nomura said.

News Source- BloombergQuint


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