Kotak Institutional Equities (KIE) - GST reforms: More tax cuts to support flagging consumption

The government's proposal to rationalize GST rates could potentially boost demand for certain consumption items with low fiscal impact. The impact of potential lower GST rates on demand of goods or profitability of companies will depend on the extent of pass-through by companies. Previous such tax cuts to boost consumption or investment have not had the desired outcomes.

Central government has proposed significant reforms in GST

The next phase of GST reforms (see Exhibit 1) is based on three key pillars of (1) structural reforms, (2) rate rationalization and (3) ease of living. The proposal has been submitted to the Group of Ministers (GoM) within the GST Council for review. Unconfirmed media reports indicate a shift to two rates of 5% and 18%, with goods taxed at 12% and 28% likely to be redistributed to the new slabs of 5% and 18%. A select few items may continue to attract special rates, presumably equivalent to the current GST rate plus compensation cess.

New rates may provide a Rs1.3 tn boost, benefiting mostly autos and durables

Exhibit 2 outlines the current GST rates for select goods and services along with estimated GST collections. Mass consumption and aspirational goods will likely move to lower rates, resulting in rate reduction for select autos, cement, consumer durables and staples. This could translate to an estimated economic boost of around Rs1.3 tn to select sectors; quantum may be higher if entire 12% slab gets subsumed in 5% (see Exhibit 3). Cement sector may see limited benefit given low price elasticity; the share of cement in overall real estate price is not very high given the predominance of land cost in overall real estate prices.

Fiscal impact could be mitigated through certain measures

We believe the central government could offset the revenue shortfall by utilizing (1) compensation cess collections and cess fund by amending/repealing the GST (Compensation to States) Act in Parliament, post consultation with GST Council, or through the Finance Bill, and/or (2) the surplus marketing margins of OMCs through higher excise duties while keeping retail prices unchanged (see Exhibits 4-5), and/or (3) funds from select schemes such as for R&D, AI projects, etc. States may have limited room to absorb SGST losses unless the center shares gains from these measures (see Exhibit 6).

Risks of staggered or incomplete pass-through of benefits by companies

The impact on demand of goods and profitability of companies could depend on (1) market dynamics of a sector and (2) government action. The GST Act requires complete pass-through of lower rates to consumers by companies through lower prices. However, companies may take (1) price hikes before the anticipated GST rate cuts in 2HFY26 or (2) aggressive price hikes in FY2027. We note that most of the potential beneficiary sectors/companies of lower GST rates enjoy high profitability/return ratios anyway (see Exhibits 7-8). Previous attempts by the government to boost consumption demand or investment through tax cuts (income tax cut in FY2026 budget, corporate tax cut in September 2019) have not had the intended outcomes.

Source : Equity Bulls

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KotakInstitutionalEquities KIE GSTReforms