The impact of GST on inflation is nebulous. This is so because, whenever a tax regime changes, there are myriad tax rates which undergo a change, and it is hard to figure out whether or not the consumer of a product or service is better off or not. There are always extraneous factors at work which would be affecting prices, and with the spread of globalisation, it becomes more complex. Therefore, it is interesting to try and figure out whether inflation has gone up or not since GST was introduced July last year. The government has been open to adjusting these rates which was done on a broader scale twice, based on feedback received from the market.
Normally, we tend to look at the headline inflation number and then conclude there has actually not been much change in inflation and that things are more or less neutral. The fact that both the headline CPI and WPI numbers have been at the lower end has been an argument used for claiming that GST has not impacted prices significantly. In fact, this was a convincing argument put forward regularly to call for rate cuts through the year. To the extent inflation has gone up, it is attributed to the price of fuel or food products which are called supply-side shocks over which GST has little control. But, in the period following GST, the food basket has benefited from successive good harvests which have also helped to bring down the overall inflation rates. Also, fuel prices have been stable, which, combined with a stronger rupee, has kept cost-push inflation down.
The accompanying graph provides information on the trend in inflation rates on both the relevant components of the WPI and CPI, which excludes the impact of food and fuel. The WPI is essentially a producers’ price index and excludes services, and the manufacturing index is the one most influenced by GST. Fuel is excluded as it has been deliberately kept out of the new tax system while agriculture is also out of this tax scheme by definition. The CPI is representative of the consumer basket and excludes items that do not figure in this scheme—like machines, metals, and chemicals. To get a fair idea of GST, the food products category needs to be excluded as it was stated upfront that less than half of the CPI would not be affected on account of GST.
What is interesting is that both these indices moved upwards from July onwards. Almost one year after the imposition of GST, the core CPI index, which has a weight of around 54%, increased by around 200 bps. While it would be difficult to ascribe this increase completely to GST, as there were other factors at work such as HRA, the fact that all the non-food components rose indicates that there was an upward bias. Also, the fact that services generally were under the higher tax bracket of 18% or 28%, up from the previous 15%, added to inflation. This was a period also when GDP growth, which can be a proxy for overall economic demand in the country, had slowed down from 7.1% to 6.7%. It broadly means that demand pull forces would have had a limited impact.
The WPI manufacturing index witnessed a sharper increase of 130-140 bps during this period. While an increase in global metal prices would be a contributing factor, the GST impact cannot be ignored fully. Therefore, there is some reason to believe that in net terms, the GST may have had an inflationary push.
Interestingly, the fuel index had declined almost continuously during this period which opens up the question on whether or not this complex needs to be included in the GST. The argument is that it would soon become necessary to ensure that the nation is protected against high inflation in case global oil prices shoot up, which is possible at any time. A compromise could be a special rate for fuel which would be higher than 28%, but fixed.
The GST was premised on being generally revenue and price neutral and while it is impossible to arrive at this result, efforts have been made along the way to fine tune the rates—especially in the downward direction to ensure that inflation impact is minimised. The fact that the overall environment was congenial did help, to a large extent, to keep the inflation numbers in check, even to the extent that GST has increased prices of some goods. It also can’t be said for certain if the companies had lowered prices where the net tax rate had come down as, on the consumer end, this is not too visible. For example, in restaurants, the bills have come down as the GST is now 5% compared to a double digit rate in various states. While the government earns less revenue, none of the menu cards have lowered the prices even in cases where costs came down due to a lower GST. The government, too, has expressed concern on the anti-profiteering clause which can be used to ensure that lower taxes do reach the consumer in the form of lower prices. It may be assumed that clarity on this subject will be attained in the course of time.
Implementing GST was always going to be challenging given the breadth and depth of the economy. The information provided on the GST collections has been encouraging and, notwithstanding the operational issues, especially for the SMEs, the process has been quite smooth. The major achievement has been in assimilating the unorganised segment progressively into the formal economy, which would be mutually beneficial in due course of time. There have been no serious complaints from the state on revenue shortfalls in the last year and the Union Budget was finally well balanced on the tax side. Therefore, it has been a fair enough success story.
The price effect will play out more clearly this year when the economy really picks up momentum and the larger part of the economy gets covered in this system. Given the complexity in the production processes and the varied impact of the GST on various raw materials, as well as the final product, the net impact is difficult to fathom at the ground level. It has been noticed already that companies are gradually regaining pricing power which is going to work towards keeping prices elevated. The challenge will be to keep them under control in this environment.