The GST Fire

An exhibition of tanks by DRDO coincided with
the passage of the GST BIll in Rajya Sabha

The Goods & Services Tax which India has voted to bring in from April next year,  may while uniting the fragmented Indian market to the delight of India Inc., also exacerbate that `Elephant in the Room’ which the country’s economy has been grappling with for decades now – Inflation.

Global experience has shown that GST brings in its wake a rise in prices all around for at least a year before, prices settle down and even decline. Knowing India, and the way our businesses work, one cannot doubt that it would indeed be a small miracle if prices come down after rising. India Inc., is obviously happy with the tax as it means a uniform tax regime all over the country and an end to the hassles of delayed shipments due to Octroi queues at state borders. However, those who will have to bear the burden of the tax may not be as happy despite the news media trumpeting how the tax structure will make India more competitive.

That dreaded word which every retiree living on a fixed income and every salary earner whose increment is slower than the rate of price rise fears, is inflation. Will this fear which if and when proven true,  turn voter ire into a raging resentment around the time of the 2019 General Election ?

Are we already paying too high a price ?

Malaysia which adopted GST in 2015, saw an increase in retail inflation despite careful planning and leaving out many essential products from the taxation altogether. Australia’s John Howard Government almost lost the general elections after bringing in GST.

Canadian Conservative Prime Minister Kim Campbell actually lost the 1993 elections after the electorate protested price spikes induced by her predecessor Brian Mulroney introduction of the GST.   The Indian example is nearest to Canada with its two stage GST rate – one levied by the state and one by the Centre.

The Congress while demanding a cap on the nation-wide GST tax’s median rate, is possibly taking a leaf out of economic history and trying to position itself for the next General Elections, when it may well look to channel protests against  the initial bout of inflation which GST may usher in.

Former Finance Minister P Chidambaram has already made it clear that the Congress will campaign throughout the country demanding a low GST median rate. In case, (and it looks like they will), the Government chooses a higher median rate  and an even higher rate for luxury and sin goods, rest assured the Congress and other political parties who would include the BJP’s own allies, will lose no time in pillorying the ruling  party for its folly in unleashing the Inflationary monster.   

Goldman Sachs in a research note found that Asian countries which brought in GST between 1977 and 2015, all reported an average increase in inflation of 1.1 %  higher on average in the year of its implementation. Sachs also estimated, based on cross-country evidence and the evidence from state VAT implementation, that retail inflation in India could rise 0.9 percentage points if the GST rate were to be 20 per cent.

With retail food inflation having built up over the years, any further increase in inflation is likely to prove to be an incremental burden on the populace. Consumer price index was just shy of the 6% mark in June. Even more worryingly, Retail inflation in rural areas has consistently outpaced urban areas in the past 18 months, hitting 6.20 per cent in June, well above 5.26 per cent in cities such as Mumbai.

Reserve Bank of India Governor Raghuram Rajan’s harsh inflation targeting, which often led him to refuse to bow down to pressures to ease interest rates had put him at odds with successive finance ministers looking to pep up Indian growth suffering from a global industrial slowdown.

As a response to that `Nay-saying ' by Rajan, a new mechanism which the Government is ushering in may give the Finance Ministry a larger say in setting interest rates. Not so judicious decisions lowering interest rates to unleash growth may well upset the battle against rising prices and with GST fueling the price spiral, it would not give rise to just another academic Growth Vs Price Rise debate but perhaps another political Tsunami which would have the potential to shake not merely Mr Narendra Modi's government but also upset other apple-carts in forthcoming state elections to a number of key states.