Given the noise Brexit had created, someone looking at the markets’ subsequent reaction would consider it a non-event, a minor blip at best. Global and Indian markets have taken the UK referendum in their stride. However, global markets have been moving much ahead of Indian markets. Over the last one month Nifty has moved by just over 7% while NASDAQ has increased by 11.87%, Hang Sang increased by 9.63%, German DAX by 11.27% and the UK’s FTSE by 12.39%.
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Though Indian markets had tailwinds of good monsoon helping it forward, it has not been able to surpass global leaders. One of the reasons for the relative non-performance is on account of higher than average valuations, with money moving in the mid- and small-cap space rather than the frontline stocks. But the other pertinent reason is the mystery surrounding Goods and Service Tax (GST). Buoyancy is visible when there is some positive news of GST getting cleared.So why is the market so fascinated about the GST? Will it really be a game changer? More importantly, how will it impact listed companies?
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Broking firm Nomura points explains that currently under the constitution, while the Union government is constrained from levying taxes on goods beyond the point of manufacturing, state governments cannot levy taxes on services. Thus, to simplify and unify the current indirect tax structure, an amendment to the current constitution is needed. The implementation of a unified and simplified GST through constitutional amendment could overhaul the current indirect tax system of India.
GST is a consumption tax that is collected on sale of manufactured goods and services. Since it is a consumption tax it is passed on until the last stage, wherein the customer bears the tax, just like excise duty is imposed currently.
What makes GST an important tax reform is it simplifies the tax structure, increases tax compliance, increases government revenue and integrates states. Morgan Stanley says that the current taxation system creates borders within borders in the country, as the system is unable to provide tax credits for interstate transactions, and this leads to distortions in the allocation of resources. In this context, one of the most important benefits of implementing the GST is that it would integrate the economy and provide for a common national market. Corporate sectors’ decisions to set up production operations would be influenced not by tax benefits but on core business efficiency.
What will be the impact of GST on the economy? Analysts say that after an initial increase in inflation, which will be transitory in nature, growth should kick in. Broking firm Nomura estimates that the GST would drive up headline CPI inflation by 20-70 basis points in the first year due to higher prices of electricity, clothing & footwear, health/medicine, and education after accounting for input taxes and potential asymmetric pricing behaviour by firms where tax increases may be quickly passed on to output prices, while firms refrain from fully passing-on tax savings to consumers. However, in the long term, lower tax and logistic costs, productivity gains and higher investments under the GST should structurally reduce inflation.
Market is betting on growth that GST is expected to bring in. Morgan Stanley points out that the overall impact of better allocation of resources, improving efficiency of domestic production and exports is likely to improve overall growth. As per estimates from the National Council of Applied Economic Research (NCAER), growth could increase by 0.9% to 1.7%.
Which sectors and companies will gain the most if GST gets implemented? Morgan Stanley analysts say four of the ten sectors they have evaluated would benefit from GST implementation. Consumption (warehousing consolidation), logistics (more movement of heavy vehicles), house building materials (lower duties), and industrial manufacturing would likely experience a positive impact; oil & gas could see a negative impact, while cigarettes could see a negative impact only if overall tax incidence goes up, which may be a low-probability event. The remaining sectors would likely see a neutral impact.
As the general impact of GST on the economy is positive, market naturally is pricing better days ahead.