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India Strategy - GST rates cut: Positive for consumption and domestic manufacturing

Recently announced GST rate rationalizations (tax rate cuts across categories) bode well for domestic manufacturing (especially consumer goods), SMEs and rural/social sectors. We also expect a boost to consumption demand in the economy, propelled by a fall in prices across products. Key changes announced were a) a cut in consumption goods tax rate across products, b) cut in rurally/socially-focused services tax rate and c) ease in compliance procedure for small players. Consequently, we see further support for growth in consumer goods IIP series, which has been holding strong for last few months on receding consumption imports with domestic manufacturing fulfilling the demand (Exhibit 4, 5). Also on the expected lines, the GST Council has announced service tax exemption mostly in rural and social sectors, as this is a pre-election year. This move further supports the two themes we have been highlighting: a) strength in domestic manufacturing and b) rural consumption (details in our note on “What’s moving on the ground”). Consequently, we expect paint companies (Outperformer (OP) on Asian Paints and Kansai), P&G hygiene (Unrated), footwear manufacturers (OP on Khadim), Whirlpool (Unrated), Dixon (OP), Havells (OP), Voltas (OP) and select hotels to be key beneficiaries.

Fiscal impact of the move: According to various media sources, the recent tax cuts could result in Rs100-150bn tax loss (fiscal deficit for FY19BE is ~Rs6trn). We believe while this announcement alone would not put much pressure on the fiscal math, but clubbed with MSP hikes, difficulty in achieving disinvestment target could mean a small fiscal slippage at end of the year. However, its too early to draw a trend on this front. Hence, we will be monitoring this space closely. Also, we expect the tax rate reduction to fuel consumption demand and compliance, which would aid tax collections and growth with a lag (probably 9-12 months).

Sectors which saw tax rate cut have a big share of unorganised players - this move should help them come under tax net and simultaneously benefit from increased demand (provided tax leakage gets plugged): Most products targeted, especially in white goods (coolers, mixer grinders, electric iron, etc) have a big share of unorganised players. Tax rationalization and compliance easing here will help achieve 3  things: a) unorganised players will be encouraged to be more tax compliant and move to the organised sector (instead of existing organized players eating into market share of small players). Though we expect it to be a slow process, b) reduced prices across the board will help fuel consumption demand, c) organised players will benefit more from uptick in volumes (as prices go down) rather than cannibalization of business from unorganized (we expect this to take effect with a lag).

Major challenge that have been faced by government so far is some form of tax evasion especially before e-way bill got implemented. If government is able to address loop holes there, this move would certainly help in achieving higher compliance, which we expect to take full effect from FY20 onwards.

An incremental support for domestic manufacturing growth: Easing compliance procedures and tax rationalisation should help micro/small manufacturers. These manufacturers saw improved performance with GST implementation settling down in late 2017. Consequently, we saw sustained pick up in domestic consumer goods manufacturing and receding consumer goods imports (implies consumption demand was met through domestic manufacturing instead of imports, Exhibit 4, 5). We thus believe rationalisation would bode well for domestic manufacturers, IIP and GDP growth.

Most services tax rate cuts in rurally/socially-focused segments: The service tax rate rationalisation is focused more on rural and social sectors, as this is a pre-election year. The focus areas have been animal husbandry sub-segments, tube-well set up, administrative fees on PF, reinsurers for Ayushman Bharat (government’s flagship health insurance scheme).  Also, we expect clear announcements on Ayushman Bharat scheme over next few months, given the limited time at hand in the run up to the elections.

 The changes would be applicable from 27th July and the impact on stocks in trade is yet to be seen.