GST to negatively impact growth and inflation in short run: Nomura

But will lead to increase in tax collections, says the financial holding company

While the passage of the constitutional amendment to the goods and services tax (GST) Bill is being greeted with much fanfare, in the short term it may well end up negatively impacting growth and push core inflation up by 10-40 basis points (bps), says Nomura in a report. On the fiscal front, gains are likely to be felt in the short term through an increase in tax collections, it adds.

The implementation of GST, from the next financial year, will lead to an increase in the service tax rate, which is currently 15 per cent. As the services sector accounts for 60 per cent of the gross domestic product (GDP), Nomura expects this increase to negatively impact consumption of discretionary services and, in turn, affect growth.

On the flip side though, consumption of goods could get a boost, as taxes on goods are likely to be lowered from the current rates. This could boost manufacturing as well. But, as manufacturing accounts for only 17 per cent of GDP, the overall impact in the short term would be weaker consumption.

Read our full coverage on the GST Bill and its impact

However, the long-term impact on growth is positive. The new indirect tax architecture, as Nomura points out, would reduce inefficiencies in inter-state trade, lower logistical costs, boost investments and reduce black money, thereby, boosting productivity and growth in the long run.

On inflation, Nomura expects GST will be “mildly inflationary” in the short term, pushing up core Consumer Price Index (CPI)-based inflation by 10-40 bps. However, if the GST rate is higher than 22 per cent, the CPI impact would be around 0.7 per cent. The increase in inflation is likely to last around a year, until the efficiency gains, in the form of lower logistical costs and a lower tax burden, structurally reduce inflation.

On the fiscal front, Nomura expects gains to be made in the short term as well on account of an increase in tax collections. Though a revenue neutral rate would be “fiscally neutral” for both the Centre and states, Nomura expects tax revenues to rise, as the GST architecture will “push the black economy into the formal one”, facilitate easier tax administration and boost firm profits by lower logistical costs and tax efficiencies.

While the report suggests that post GST, the Centre’s tax share in overall tax collections could rise at the expense of states, the actual extent of the decline in the states’ share will ultimately depend on the compensation that the Centre agrees to pay to the states to compensate for the losses. In the long term, the new architecture would increase indirect tax buoyancy which will benefit both central and state governments.