Herald the GST Era, Stage set for a larger formal economy.

BY GAURAV KULSHRESHTHA | 03 JULY 2017

At the stroke of the midnight hour of June 30th–July 1st, as India stood at the cusp of a new era of “One Nation One Tax”, the stage seems to be set for a more formal economy.

• With around 92% of employment in informal sector and approx. 50% of GDP coming from the unorganized sector, Indian economy is considerably unorganized and informal given its size and stage of development. This has been a drag not only on productivity and growth of the economy but additionally has also hindered government finances and labor welfare.
• GST intends to reduce cascading of taxes and introduce an input tax credit chain, thereby boosting returns from economies of scale in manufacturing and also lowering of logistics cost. Citi analysts believe that this would make formal units more competitive vs. informal units that escape the tax net.
• GST, coupled with other structural changes like progression towards a less cash economy, growth of e-commerce, direct tax compliance etc. suggest that the stars are now aligned for a larger formal economy.

Economies of scale are hard to get



Source: Citi Research, FiveThirtyEight, China Business Council for Sustainable Development, Prowess

• Formalization may become a game changer for sectors like Consumer Staples, Jewellery, Paints, Auto- Parts, Pharma/Hospitals /Diagnostics and also Agrochemicals.
• With this accelerated push towards formalization, new companies would emerge and lead productivity gains, higher tax compliance will enable more public spending, productivity gains will lead to better allocation of resources-all this setting off a virtuous growth cycle. This will enable better access to lower cost capital, and by virtue of longer term growth prospects, lead to more job creation in the formal sector.
• However, in the near term, GSTs input tax credit mechanism could be disruptive as larger/formal companies would not be able to avail input tax credit until the related supply chain pays their due taxes, and in process may refuse to do business with informal sector. There is also a risk of informal jobs loss not being directly offset by formal job gains in the near term. The focus on compliance and greater filing requirements may also pose some challenges to MSMEs.