Economy

THEMATIC August 20, 2015

Exhibit A: The introduction of GST did

GST - Overhyped and misunderstood NOT boost GDP growth in other
countries but did lower inflation
With Parliament seemingly headed for a special session on the Goods After
New Thail
introductio Canada Australia
and Services Tax (GST), we try to delineate the economic impact of this Zealand and
n of GST
misunderstood tax. GST, at the revenue neutral rate (RNR) of 18%, will
Did GDP
benefit most goods, as currently most goods pay tax at ~24%. However, growth No No No No
an 18% GST is unlikely to boost GDP growth. In contrast, a GST rate of increase?
25% will adversely impact consumption (of Goods & Services) but will Did inflation
Yes Yes Yes Yes
boost Government revenues, which will in turn aid economic growth if fall?
the extra revenue is spent on capex. The final layer of complication Did the tax-
arises from the 1% inter-state tax payable to producer states; if to-GDP ratio Yes Yes Yes Yes
increase?
charged, this will reduce the benefits of a uniform GST.
Source: Ambit Capital research
Evidence suggests that GST has a mixed economic impact
Cross-country evidence suggests that the introduction of GST has no correlation
with GDP growth. Although the introduction of a single GST limits inefficiencies
created by a heterogeneous taxation system, there is little evidence that it helps
boost economic activity. However, the introduction of GST helps in reducing
inflation by removing the problem of dual taxation and thereby reducing the
cost of doing business. It also helps in boosting the tax:GDP ratio, provided the
GST is introduced at a high enough rate i.e., higher than the revenue neutral
rate (RNR), which in India seems to around 18%.

The structure of GST will determine the impact on the economy

Whilst the introduction of GST will undoubtedly remove inefficiencies (such as
the problem of double taxation) and simplify the existing indirect tax structure,
its impact on economic growth is ambiguous. At the RNR of 18%, the
Government’s revenue will remain unaffected and hence the Government
cannot increase expenditure to stimulate growth; however, at a GST of 25%,
India’s tax:GDP ratio (which at 11% is significantly lower than other emerging
Asian economies’ >20%) will increase by as much by 1-2% points. If the
Government spends these increased revenues of around $20-40bn on capex,
then GDP growth will be positively impacted, especially as the fiscal multiplier
(around 2.45x for India) comes into play.
A further complication is the mooted 1% inter-state tax, which is supposed to be
given to producing states; if levied, this can significantly reduce the benefits of
moving to a harmonised GST. Note further that given the sheer amount of
legislative and logistical work that remains to be done, it is highly unlikely that
GST will be implemented before April 2017.

Services stand to lose the most with the implementation of GST

If GST is set at the RNR of 18%, most goods which currently pay an effective tax
rate of ~24% will benefit. Sectors such as automobiles, FMCG and home
building materials in particular will be positively affected. At a rate of 25%,
however, most goods will be negatively impacted; however, at this rate
Analyst Details
Government revenue and, hopefully, Government spend on hard asset creation
Saurabh Mukherjea, CFA
will receive a boost and thus drive GDP growth.
Tel: +91 22 30433174
However, at both rates – 18% and 25% – Services will be negatively impacted, saurabhmukherjea@ambitcapital.com
as Services are currently taxed at 14%. In the context of listed stocks, the Ritika Mankar Mukherjee, CFA
Services sectors that will be most acutely impacted are aviation, media, Tel: +91 22 30433175
telecommunication and to some extent Banking & Financial Services. ritikamankar@ambitcapital.com
Sumit Shekhar
Tel: +91 22 30433229
sumitshekhar@ambitcapital.com

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
 Economy

The creation of a brave new world with

GST in play
The GST Bill that will change the face of India’s indirect taxation system is a
constitutional amendment. Hence, for it to come into law, it has to be passed by both
Houses of Parliament with a two-third majority. The bill has been passed by the lower
house of Parliament i.e. the Lok Sabha in May 2015 but it still needs to be passed by
the upper house i.e. the Rajya Sabha.
The passage of the GST Bill is likely to be postponed to a special session of
Parliament (or to a Winter Session in a worst-case scenario); however, its eventual
passage, followed by the states then enacting the relevant legislation, is likely to
entail the creation of a brave new world in India, given the vast differences between
the current indirect tax regime prevalent (see Exhibit 1) and the one envisaged by the
first rendition of GST that India will implement (see Exhibit 2 below).
Exhibit 1: The current indirect tax regime in India
Head Description
 The Constitution provides for the division of taxation powers between the Centre and states.
Constitutional provisions for  Indirect taxes levied include excise duty (levied by Central Government), service tax (levied by Central
indirect taxation Government), customs duty (levied by Central Government), sales tax (levied by State Governments), octroi
(levied by State Governments), and Value Added Tax (levied by both Central and state Governments).
 The concept of Value Added Tax (VAT) was introduced for central excise duty in 1986 (first as MODVAT and
then as CENVAT).
First bout of indirect tax
reform - Introduction of Value  Prior to this, excise duty was levied on both inputs used and the output produced. This “tax on tax” led to
Added Tax (VAT) in CY86 cascading of taxes. This problem was sought to be addressed by the VAT regime under which tax paid on the
inputs is deducted from the tax payable on the output produced. Similarly, sales tax also had a cascading
effect through the distribution chain. All states have now adopted the concept of VAT for state sales tax.
 The issue of cascading taxation was partly addressed through the VAT regime. However, certain problems
remained. For example, several Central and state taxes are excluded from VAT. Sectors such as real
estate, oil and gas production, etc., are exempt from VAT. Furthermore, goods and services are taxed
Need for Goods and Services differently, thereby making the taxation of products complex. Some of these challenges are sought to be
Tax (GST) overcome with the introduction of GST.
 The GST regime intends to subsume most indirect taxes under a single taxation regime. GST is a value-
added tax levied across goods and services. This is expected to help broaden the tax base, increase tax
compliance and reduce economic distortions caused by inter-state variations in taxes.
 In 2011, the Constitution (115th Amendment) Bill, 2011 was introduced in Parliament to enable the levy of
GST. However, the Bill lapsed with the dissolution of the 15th Lok Sabha.
GST (Constitution
Amendment) bill  Subsequently, in December 2014, the Constitution (122nd Amendment) Bill, 2014 was introduced in the Lok
Sabha. The Bill was passed by the Lok Sabha in May 2015 and referred to a Select Committee of the Rajya
Sabha for examination in the same month.
Source: Media reports, PRS Legislative research, Ambit Capital research.

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Exhibit 2: The first rendition of the GST regime that is likely to be implemented in India
Head Description
 GST will be applicable on the supply of goods or services.
 Alcoholic liquor for human consumption will be exempted from GST.
Scope of GST  Initially, GST will not apply to: (a) petroleum crude, (b) high speed diesel, (c) motor spirit (petrol), (d) natural gas, and (e)
aviation turbine fuel. The GST Council will decide when GST will be levied on them.
 Tobacco and tobacco products will be subject to GST. The Centre may also impose excise duty on tobacco.
 Both, Parliament and state legislatures will have the power to make laws on the taxation of goods and services. A law
made by the Parliament in relation to GST will not override a state law on GST.
Levy of GST
 The Central government will have the exclusive power to levy and collect GST in the course of inter-state trade or
commerce, or imports. This will be known as Integrated GST (IGST).
 A Central law will prescribe the manner in which the IGST will be shared between the Centre and states, based
on the recommendations of the GST Council.
One of two scenarios are likely with respect to the rate of GST, namely:
GST rate  Scenario 1: 18% (with or without 1% additional inter-state tax)
 Scenario 2: 25% (with or without 1% additional inter-state tax)
Indirect taxes to be The following major taxes will be subsumed by GST:
subsumed by GST  Value added tax (12.5%)
 Central sales tax (2%)
Note: Figures in  Service tax (14%)
parentheses indicate  Excise duty (~12%)
the current rate for  Customs duty (ranges from 0% to 150% with the average rate being 12%)
Central taxes  Central value added tax (ranges from 8% to 20%)
 An additional tax of up to 1% on the supply of goods will be levied by the Centre in the course of inter-state trade or
commerce. The tax will be collected by the Centre and directly assigned to the states from where the supply originates.
 This tax will be levied for two years, or for a longer period, as recommended by the GST Council. The Central
Government may exempt certain goods from such additional tax.
Additional tax on
supply of goods  The principles for determining the place of origin from where the supply of such goods takes place will be formulated by
a law of Parliament.
 This extra tax has been mooted as GST is a “destination” based tax and hence states which are large manufacturers
rather than larger consumers believe that they could be short-changed. This 1% tax on inter-state trade at the source of
supply is meant to compensate such states.
 The GST Council will consist of: (a) the Union Finance Minister (as Chairman), (b) the Union Minister of State in charge
of Revenue or Finance, and (c) the Minister in charge of Finance or Taxation or any other Minister, nominated by each
state government. All decisions of the GST Council will be made by three-fourth majority of the votes cast; the Centre
shall have one-third of the votes cast, and the states together shall have two-third of the votes cast.
GST council
 The GST Council will make recommendations on: (a) taxes, cesses, and surcharges to be subsumed under the GST; (b)
goods and services which may be subject to, or exempt from GST; (c) the threshold limit of turnover for application of
GST; (d) rates of GST; (e) model GST laws, principles of levy, apportionment of IGST and principles related to place of
supply; (f) special provisions with respect to the eight north eastern states, Himachal Pradesh, Jammu and Kashmir, and
Uttarakhand; and (g) related matters.
 The GST Council may decide the mechanism for resolving disputes arising out of its recommendations.
Compensation to
 Parliament may, by law, provide for compensation to states for revenue “losses” arising out of the implementation of
GST, based on the recommendations of the GST Council. Such compensation will be paid for five years. These losses will
States
be estimated by taking current indirect tax collections by the States as the base.
Source: PRS legislative research, Media reports, Ambit Capital research
The GST (122nd Constitutional amendment bill) was passed by the Lok Sabha in May
2015 but could not be taken up for discussion in the Rajya Sabha in the recently
concluded Monsoon Session due to disruption by the Opposition parties. Press reports
suggest that the Government is planning to call a Special Session of Parliament to try
to get the GST bill passed. However, such a session will only be called once the
Government is sure that it will be able to secure a two-third majority in the Rajya
Sabha (source: http://goo.gl/z9zdyX). Note that the Rajya Sabha has 245 members,
out of which the NDA accounts for only 64. Note further that given the sheer amount
of logistical work that will have to be done post GST being approved by the
Parliament, it is unlikely that GST will be implemented before April 2017.
The subsequent note is divided into the following sections:
Section 1 focusses on capturing cross-country experience on GST implementation.
Given the unique contours of the first rendition of the GST that India will implement,
in Section 2, we quantify the likely impact of GST implementation in India. Section 3
finally focusses on investment implications of the ushering in of the GST regime in
India.

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Section 1: Cross-country experience on GST

implementation
Various countries have introduced a single GST. However, given the magnitude of Given the magnitude of change
change entailed by a GST regime, the GST has typically been implemented in a entailed by a GST regime, the
phased manner, whereby an ideal GST structure is created over time. For instance, implementation has typically been
New Zealand implemented the GST in two phases spanning three years cumulatively in a phased manner
whilst Canada implemented the same in three phases spanning 17 years
cumulatively. However, Australia and Thailand implemented the GST in a single
phase (see the exhibit below).
Exhibit 3: GST rates in New Zealand and Canada were revised over time
Case Study 1 : New Zealand Case Study 2 : Australia Case Study 3 : Canada Case Study 4: Thailand
Introduced in July 2000 all at once at 10% replacing
Introduced in January 1991 at
the wholesale sales tax entirely. The single phase
7% to replace the
Introduced in October 1986 at implementation In Australia was possible mainly Introduced in 1991 all at once
Manufacturers’ Sales tax
10% and then hiked to 12.5% because there was not much opposition from the replacing all indirect taxes at
(MST); was reduced to 6% by
by 1989. provinces. All the taxes are collected by the federal 7%.
2006 and eventually to 5% by
Government but the entire amount is distributed to the
July 2008.
provinces (less administrative charges).
Source: Ambit Capital research

In the subsequent sub-sections we analyse these countries’ experience with GST

implementation and its impact on key macro variables.
Cross-country experience points to no direct correlation between indirect tax
reform and GDP growth
Cross-country evidence suggests
Whilst it is difficult to assess the impact of GST on economic growth (as GDP growth is that there is no clear evidence that
affected by a range of variables), cross-country evidence suggests that there is no the introduction of GST necessarily
clear evidence that the introduction of GST necessarily leads to higher GDP growth. leads to higher GDP growth
Although the introduction of a single GST limits inefficiencies created by a
heterogeneous taxation system, there is little evidence that it helps boost GDP growth
rates.
Whilst GDP growth in New Zealand was higher post GST implementation, in the case
of Canada, Australia as well as Thailand, GDP growth was lower post GST
implementation (see the exhibits below).

Exhibit 4: New Zealand - GDP growth in New Zealand Exhibit 5: Canada – However, GDP growth slowed down in
increased post GST administration… Canada post GST implementation

3% GST hiked in 4% GST introduced

CY89 in CY91 GST lowered in
(Avg. over specified period)

CY06
(YoY change, in %)
Real GDP growth rate

Real GDP growth

3%
2% GST introduced GST further
in CY86 lowered in CY08
2%

1%
1%

0% 0%
Pre GST (CY81-85) CY86-89 Post GST (CY90- Pre GST CY91-06 CY06-08 Post GST
95) (CY86-90) (CY08-13)

Source: IMF, Ambit Capital research Source: IMF, Ambit Capital research

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Exhibit 6: Australia – GDP growth slowed down in Australia Exhibit 7: Thailand – GDP growth slowed down in Thailand
as well also

4.0% 3.9% 12% 11%

(Avg. over the specified period)

Real GDP growth rate

10%

Real GDP growth rate

(YoY change, in %)

8%
8%

3.5% 6%
3.4%
4%

2%

3.0% 0%
Pre GST (CY95-00) Post GST (2001-05) Pre GST (CY87-91) Post GST (CY92-96)

Source: IMF, Ambit Capital research Source: IMF, Ambit Capital research

A survey of available research also suggests that the impact of indirect tax reforms on
GDP growth is ambiguous (see the exhibit below).
Exhibit 8: Research suggests that the impact of indirect tax reforms on GDP growth is ambiguous
Title of the paper Key relevant finding Source and Year
Consumption taxes should not in theory affect savings and investment decisions since future and
current consumption are treated equally, and they remain neutral with respect to various sources
The tax system in India: of income. Empirical evidence is mixed; however, some studies suggest that such taxes indeed IMF working paper,
Could reform spur growth? have no impact on employment and growth, but others find that – like income taxes, although to April, 2006
a lesser extent – they have a negative impact on growth by distorting the choice between labour
and leisure and also could depress savings.
Moving to Goods and
Services Tax in India: Impact Implementation of a comprehensive GST across goods and services is expected, ceteris paribus, NCAER,
on India’s Growth and to provide gains to India’s GDP somewhere within a range of 0.9-1.7%. December, 2009
International Trade
Source: Various academic publications, Ambit Capital research

In the Indian context, of particular relevance is the oft quoted 2009 NCAER study
titled “Moving to Goods and Services Tax in India: Impact on India’s Growth and
International Trade” where the authors claim that the implementation of GST will
provide gains to India’s GDP somewhere between 0.9% and 1.7%. However, the
study assumes a flawless GST with no exemptions and no extra inter-state taxes. The
GST which has been planned is far from ideal, with exemptions and inter-state taxes.
Therefore, it is difficult to comment upon the impact of GST on GDP growth unless we
have a clear picture on the structure of rates and other distortions such as the
exemptions and the inter-state tax.

Cross-country evidence suggests that GST implementation lowers inflation

Cross-country evidence suggests that the introduction of GST helps reduce inflation Cross-country evidence suggests
by removing the problem of dual taxation and thereby reducing the cost of doing that the introduction of GST helps
business. reduce inflation by removing the
Whilst the introduction of a single GST helped reduce inflation in New Zealand as problem of dual taxation
well as Canada, inflation rose moderately in Australia and Thailand. However, the
increase in inflation in Australia as well as Thailand was driven by unique factors such
as domestic supply constraints. After adjusting for these factors, inflation in these two
countries too was lower post GST implementation.

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Exhibit 9: New Zealand - Inflation rates were lower in New Exhibit 10: Canada – Inflation rates were lower in Canada
Zealand post GST implementation… as well

16% GST introduced

5% GST introduced
in CY91
in CY86
12%

(YoY change, in %)
4%
(YoY change, in %)

12% 10% GST hiked in GST lowered in GST further

CY89 3% CY06 lowered in CY08

CPI
8%
CPI

2%

4% 3% 1%

0% 0%
Pre GST (CY81- CY86-89 Post GST (CY90- Pre GST CY91-06 CY06-08 Post GST
85) 95) (CY86-90) (CY08-13)

Source: IMF, Ambit Capital research Source: IMF, Ambit Capital research

Exhibit 11: Australia - Adjusting for domestic supply Exhibit 12: Thailand - Adjusting for domestic supply
constraints, inflation rates were lower in Australia post GST constraints, inflation rates were lower in Thailand post GST
implementation implementation

4% 6%

3%
(YoY change, in %)

(YoY change, in %)

3% 5% 5%
5%
CPI inflation

2%
CPI

2% 4%

1% 3%

0% 2%
Pre GST (CY95-00) Post GST (2001-05) Pre GST (CY87-91) Post GST (CY92-96)

Source: IMF, Ambit Capital research Source: IMF, Ambit Capital research

GST implementation boosts a country’s tax-to-GDP ratio

Cross-country evidence suggests that the introduction of GST boosts the tax-to-GDP Cross-country evidence suggests
ratio by 1-2% points. In Canada, the tax-to-GDP ratio increased marginally after GST that the introduction of GST boosts
was introduced but decreased as GST rates were lowered from 7% in 1991 to 5% in the tax to GDP ratio by 1-2% points
2008.

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Exhibit 13: New Zealand - GST increased the tax-to-GDP Exhibit 14: Canada – The tax-to-GDP ratio first increased
ratio in New Zealand and then decreased in Canada when rates were raised

36% 36% 36%

34% 34%
Tax-to-GDP ratio

34%

Tax-to-GDP ratio
34%
(in %)

32%

(in %)
32% 32%
31% 31%

30%

28% 28%
Pre GST (CY81- CY86-89 Post GST Pre GST CY91-06 CY06-08 Post GST
85) (CY90-95) (CY86-90) (CY08-13)

Source: OECD, Ambit Capital research Source: OECD, Ambit Capital research

Exhibit 15: Australia - The tax-to-GDP ratio in Australia Exhibit 16: Thailand – The tax-to-GDP ratio also increased
also increased after implementing GST… in Thailand

30% 11%
30% 11%
Tax to GDP ratio

Tax to GDP ratio

10%
(in %)

(in %)

29% 29%
9%
9%

28% 8%
Pre GST (CY95-00) Post GST (2001-05) Pre GST (CY87-91) Post GST (CY92-96)

Source: OECD, Ambit Capital research Source: CEIC, Ambit Capital research

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Section 2: Impact of GST implementation

in India
Insights based on the combination of cross-country experience and the unique
nuances related to GST system suggest that a single unified GST in India is likely to
impact key macro variables in the following manner:
 The introduction of a single GST is unlikely to boost GDP growth in the short run.
Its ability to add to GDP growth in the long to medium term will depend on
nuances like the structure of rates and exemptions.
 The introduction of a single GST could lower inflation in India given that goods
account for more than 70% of the CPI basket and goods in India currently attract
an effective tax rate in excess of 25% i.e., more than the GST rate that India is
likely to opt for.
 The introduction of a single GST is highly likely to boost India’s indirect tax
to GDP ratio, as GST will bring the unorganised sector (which accounts for 59%
of India’s economy) under the purview of taxation.
 The introduction of a single GST is likely to compress India’s CAD by boosting
export growth.
 Furthermore, GST implementation is also likely to increase direct tax
collections, as: (1) GST payments by tax-payers will be linked to their respective
Permanent Account Number (PAN); and (2) the National Securities Depository
Limited (NSDL) which maintains the Tax information System (TIN) will also look
after the GST database. This integration of the indirect tax system with the direct
tax system will enable authorities to triangulate information, thereby
automatically leading to improved tax buoyancy.
GDP growth
Whilst an oft-quoted paper by the National Council for Applied Economic Research Post GST implementation, GDP
(NCAER), “Moving to Goods and Services Tax in India: Impact on India’s Growth and growth would be unaffected
International Trade,” claims that “Implementation of a comprehensive GST across
goods and services is expected, ceteris paribus, to increase India’s GDP somewhere
within a range of 0.9% to 1.7%”, the range of imperfections that India’s GST is likely
to have are likely to mean that GDP growth will be unaffected in the short run.
To be more specific, the imperfections with India’s likely GST regime are: exclusion of
alcohol and petroleum products from the purview of GST, and additional 1% inter-
state tax to compensate the producing states (click here to access the NCAER paper
http://goo.gl/IdXADx).
In fact, there is a risk that GDP growth may be affected adversely in the short run by
the 1% inter-state tax. This 1% additional inter-state tax, which has been
recommended to compensate the producing states, is likely to result in distortions
that have the potential of eating into the small gains created by a unified GST in the
early years.
In the medium term (beyond FY17), the impact of GST on GDP growth will depend
upon the structure of the tax rate:
 A GST of 18%: At this rate of GST (which is also the revenue neutral rate), there An 18% GST will not result in any
will be no incremental gain in tax revenues for the Government. Also, a GST of incremental gain in tax revenues
18% will be positive for goods, as currently the effective tax rate on most goods is for the Government.
approximately 24%. However, it will negatively hurt services consumption, as
currently the service tax rate is 14%. Therefore, at the revenue neutral rate of
18%, the GST is unlikely to have a material impact on GDP growth, as there will
be no incremental gain in tax revenues, which could spur capital expenditure by
the Government and hence boost the GDP growth rate.

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 A GST of 25%: At this rate, the Government’s tax-to-GDP ratio will receive a 1-
2% point boost (see the exhibit below). Assuming that the incremental tax
revenue is expended on capex, this will have a positive impact on GDP growth.
The incremental Government expenditure will be magnified through the fiscal
multiplier for capital expenditure which in India’s case is roughly 2.45 (source:
NIPFP), implying that every additional rupee spent by the Government will have a
2.45x multiplier effect on spurring further spending.
Exhibit 17: At GST of 25%, the total tax-to-GDP ratio could jump by 2% points
In ` trillion
Total indirect tax Total direct tax Total tax to GDP Change in
collections (Centre collections (Centre ratio (Centre total tax to
+ States) + States) + States) GDP ratio
Current 13.5 6.8 17.8% Not applicable
At RNR of 18% 13.5 6.8 17.8% 0%
At 25% 16.4 6.8 19.7% 1.9%
Source: Indian Public Finance Statistics, NIPFP, Ambit Capital research; Note: The data pertains to FY14
Note that demand for Services will suffer under both the scenarios, given that the
current Service Tax rate of 14% is lower than the GST rate in both the scenarios.
Inflation
Inflation in India could be lowered if the GST rate is lower than the effective tax rate
Inflation in India could be lowered
payable currently on Goods.
if the GST rate is lower than the
Currently, the effective tax rate for goods in India works out to be ~24% after effective tax rate payable currently
accounting for all the indirect taxes taken cumulatively (see the exhibit below). The on goods
effective tax rate for services currently stands at 14%.
Exhibit 18: Currently, the effective tax rate for most goods comes to ~24%
Sector CENVAT VAT CST Effective tax rate
Automobiles 8-20% 12.5% 2% 24 - 38%
Cement 8% 12.5% 2% 24%
FMCG 8% 12.5% 2% 24%
Source: Ambit Capital research
A GST rate of 18% (with or without the 1% additional inter-state tax) is therefore likely However, a GST rate of 25% will
to help bring down overall inflation, as most goods pay an effective tax rate of 24% in be inflationary
the current set-up. However, a GST rate of 25% (with or without the 1% additional
inter-state tax) will increase the cost of most goods in India and therefore will be
inflationary.
Tax-to-GDP ratio
India’s tax-to-GDP ratio has been rangebound between 8% and 12% over the past
two decades (see the exhibit below). Furthermore, a comparison with peers as well as
with developed countries like the UK points to the vast tax-revenue-generating
potential in India.

Exhibit 19: India’s tax-to-GDP ratio remains abysmally low Exhibit 20: India’s tax-to-GDP ratio is lower than that of
at 11% as per FY15 Budget Estimates most its emerging market peers
14% 30%
India's tax revenue

12%
(as a % of GDP)

25%
10%
(as % of GDP)

Brazil
Tax revenue

8% 20%
India
6%
15% Russia
4%
2% 10% South Africa
0% 5% Thailand
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015

Malaysia
0%
2005
2006

2007
2008
2009
2010

2011
2012

Gross tax revenue Net tax revenue

Source: CEIC, Ambit Capital research, Note: Data is presented on financial Source: World Bank, Ambit Capital research, Note: Data is presented on
year basis calendar year basis.

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The Central tax-to-GDP ratio looks likely to rise by 1-2% points (if the GST rate is
higher than the revenue neutral rate):
1) India’s current indirect tax-to-GDP ratio (Centre + States) and the likely GST will boost the Government’s
boost due to GST: GST will boost the Government’s revenue by increasing the revenue by increasing the tax base,
tax base, as the Indian unorganised sector will come under the purview of the as the Indian unorganised sector
GST. Given that 59% of the total output in India is produced in the unorganised will come under the purview of the
sector, this can boost the Government’s revenue to a considerable extent if GST is GST
able to bring even a part of the unorganised sector under its ambit.
2) India’s current direct-tax-to-GDP ratio (Centre only) and the likely boost
due to GST: One of the leading GST experts in India highlights that GST
implementation is likely to result in lifting direct tax collections, as: (1) GST
payments by tax-payers will be linked to their respective Permanent Account
Number (PAN); and (2) the National Securities Depository Limited (NSDL) which
maintains the Tax information System (TIN) will also look after the GST database.
This integration of the indirect tax system with the direct tax system will enable
authorities to triangulate information, thereby automatically leading to improved
tax buoyancy.

As explained in the previous section, a GST rate of 25% (which is substantially higher
than the revenue neutral rate) will boost the Government’s tax-to-GDP ratio and if
this amount is spent on capex, this is likely to have a positive impact on GDP growth.

GST implementation could help compress India’s CAD

India’s manufactured exports could receive a boost under GST, as the introduction of India’s manufactured exports could
GST will remove inefficiencies (e.g. double taxation and complex structure) in the receive a boost under GST
system by replacing a range of taxes by one single tax. This will increase India’s
export competitiveness and hence will help reduce Current Account Deficit (CAD).
However, inefficiencies in the system such as 1% extra inter-state tax could reverse
some of the gains which could be potentially achieved through GST.
The increase in exports could have a positive impact on GDP growth, as exports of
Goods and Services constitute around 25% of GDP. The introduction of GST will make
Indian exports more competitive and hence will help in boosting exports.

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 Economy

Section 3: Investment implications

With a single GST rate applicable to Goods and Services across sectors, intuitively the
impact will be negative for sectors where the current tax rate is relatively low and
positive for those where the current effective tax rates are relatively high (relative to
the likely GST rate).
 Broadly speaking, Services are going to lose regardless of what the GST rate is
Broadly speaking, Services are
(given that it will be higher than the current Service Tax rate of 14%) and Goods
going to lose regardless of what
can benefit if the GST rate is around the RNR of 18%. Services sectors which are
the GST rate is
large in the context of the listed market and which look likely to suffer are
Aviation, Media and Telecommunications.
 The Goods sectors which look likely to materially benefit assuming that the GST is
set at around the RNR of 18% are Automobile, Cement and FMCG.
 The unorganised sector in India has hitherto avoided paying indirect taxes on
inputs and outputs and hence has had cost advantages of around 13-30%
relative to its organised counterpart. If GST is able to capture the unorganised
sector in the tax net, then this competitive advantage for this sector will be
eroded. As a result, in Goods sectors in which unorganised accounts for the
majority of the market share (e.g. light electricals, paints, pipes and
plyboards), the organised players stand to be benefit regardless of the rate at
which GST is introduced.
 However, for the overall economy to benefit, GST needs to be set at around 25%
so that it can materially augment the tax-to-GDP ratio and thus give the
Government the funds required to boost GDP through capital expenditure.
Exhibit 21: Goods will benefit the most if the GST is implemented at 18%
Sector Current effective tax rate (%) Impact of GST
CENVAT/ Effective tax
VAT CST At 18% At 25%
Service tax rate
Automobiles 8-20% 12.5% 2% 24 - 38% Positive Mixed/Positive
Cement 8% 12.5% 2% 24% Positive Negative
FMCG 8% 12.5% 2% 24% Positive Negative
Services 14% 14% Negative Negative
Source: Ambit Capital research

Automobiles
Currently, majority of inputs used for manufacturing auto components are subject to Under GST, increased taxes on
4% VAT, whereas auto components and automobiles are subject to 12.5% VAT
these inputs will be available as set
(except 4% applicable to tractors). Under GST, increased taxes on these inputs will be
off, which is not the case currently.
available as set off, which is not the case currently.

The effective tax rate applicable on small cars (engine capacity of less than or equal
to 1999 cc) is ~24%, whilst for luxury cars (engine capacity of more than 1999 cc) it is
~38%. Post GST implementation, the sector seems likely to have lower effective taxes
which should help reduce the sticker price for consumers.

Cement
The major inputs for the sector include limestone, gypsum, coal, and fly ash. The
facilities are usually located near limestone mines; gypsum/coal is purchased either
locally or through inter-state transactions. As per the prevalent tax structure, inputs
are subject to ~4% VAT; however, cement bags are taxed at 12.5% VAT. Under GST,
increased taxes on these inputs will be available as set off, which is not the case
currently.

Furthermore, on inter-state transactions, CST is levied, the credit of which is not

available to be set off against the excise/VAT liability of the company, thus, adding to
the cascading impact of taxation.

August 20, 2015 Ambit Capital Pvt. Ltd. Page 11

 Economy

The aggregate effective indirect tax in the industry is ~24%. With GST in place, the
effective rate will be lowered, thus lowering the price of cement for the end
consumer.

FMCG
The main inputs for this sector, excluding cigarettes and alcohol, are edibles (wheat,
flour, and sugar), palm oil, caustic soda, flavours and fragrances, amongst others.
Inputs in the sector are levied with an excise of ~4%, except edibles, whilst VAT on
products ranges from 4.0% to 12.5%. Under GST, increased taxes on these inputs will
be available as set off, which is not the case currently.

As various products are involved in the manufacturing of FMCG products,

procurement of inputs is generally an inter-state transaction, leading to CST levy,
which, in turn, results in a cascading impact in taxation, thereby sharply increasing
input costs.

In aggregate, the effective tax rate on these products comes to ~24%. With a low-
rate GST, the sector will benefit from reduced price of the final product.

Reduced cost advantage for unorganised goods manufacturers

GST is likely to increase market share gain of the organised segment, as the
unorganised segment stands to lose under the new world of GST. This will happen,
as:
 GST will bring scale economies in distribution logistics and help players with
greater financial strength.
 The unorganised sector will become less competitive under the GST, as input
taxes will be available for set off and the price differential between organised and
unorganised will decrease (see the exhibit below).
Exhibit 22: Product pricing divergence between organised/unorganized
*Price
Market Organised Organised difference
Home Price difference explained by
size share market size (organised vs
building
unorganised)
segments
Productio Labour A&P/
(` bn) (%) (` bn) (%) **Taxes
n costs payments others
Light
379 67% 254 30% 9% 8% 6% 7%
Electricals
Paints 314 65% 204 13% 1% 3% 1% 8%
Tiles 210 40% 84 30% 8% 6% 5% 11%
Pipes 120 65% 78 25% 12% 10% 0% 3%
Plyboards 150 30% 45 25% 5% 12% 4% 4%
Sanitaryware 30 48% 14 20% 4% 9% 3% 4%
Source: Ambit Capital research, management meetings, Note: * As a percentage of market prices of organised
players, ** Most important component of the price difference is excise duties

Services
The service sector will be negatively impacted by the increase in the effective tax rate
from the current 14%. The tax base for Services is also likely to increase
significantly, as GST will be levied on a much larger base of goods and services
(against the current practice of levying tax only on the Services explicitly specified).

The extent of levy of service tax on the Banking & Financial Services sector however is
restricted to fee income and charges. Fees and charges collected account for 1-
1.5%% of the assets of listed lenders and GST will have a negative impact on the
sector by eating into this. Other services such as aviation, media and telecom too will
be negatively affected by GST.

August 20, 2015 Ambit Capital Pvt. Ltd. Page 12

 Economy

Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 saurabhmukherjea@ambitcapital.com
Research
Analysts Industry Sectors Desk-Phone E-mail
Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 nitinbhasin@ambitcapital.com
Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 aadeshmehta@ambitcapital.com
Abhishek Ranganathan, CFA Midcaps (022) 30433085 abhishekr@ambitcapital.com
Achint Bhagat, CFA Cement / Infrastructure (022) 30433178 achintbhagat@ambitcapital.com
Aditya Bagul Consumer (022) 30433264 adityabagul@ambitcapital.com
Aditya Khemka Healthcare (022) 30433272 adityakhemka@ambitcapital.com
Ashvin Shetty, CFA Automobile (022) 30433285 ashvinshetty@ambitcapital.com
Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 bhargavbuddhadev@ambitcapital.com
Deepesh Agarwal Power Utilities / Capital Goods (022) 30433275 deepeshagarwal@ambitcapital.com
Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 gauravmehta@ambitcapital.com
Karan Khanna Strategy (022) 30433251 karankhanna@ambitcapital.com
Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 pankajagarwal@ambitcapital.com
Paresh Dave, CFA Healthcare (022) 30433212 pareshdave@ambitcapital.com
Parita Ashar, CFA Metals & Mining / Oil & Gas (022) 30433223 paritaashar@ambitcapital.com
Prashant Mittal, CFA Derivatives (022) 30433218 prashantmittal@ambitcapital.com
Rakshit Ranjan, CFA Consumer / Retail (022) 30433201 rakshitranjan@ambitcapital.com
Ravi Singh Banking / Financial Services (022) 30433181 ravisingh@ambitcapital.com
Ritesh Gupta, CFA Midcaps – Chemical / Retail (022) 30433242 riteshgupta@ambitcapital.com
Ritesh Vaidya, CFA Consumer (022) 30433246 riteshvaidya@ambitcapital.com
Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 ritikamankar@ambitcapital.com
Ritu Modi Automobile (022) 30433292 ritumodi@ambitcapital.com
Sagar Rastogi Technology (022) 30433291 sagarrastogi@ambitcapital.com
Sumit Shekhar Economy / Strategy (022) 30433229 sumitshekhar@ambitcapital.com
Utsav Mehta, CFA Technology (022) 30433209 utsavmehta@ambitcapital.com
Sales
Name Regions Desk-Phone E-mail
Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 sarojini@panmure.com
Dharmen Shah India / Asia (022) 30433289 dharmenshah@ambitcapital.com
Dipti Mehta India / USA (022) 30433053 diptimehta@ambitcapital.com
Hitakshi Mehra India (022) 30433204 hitakshimehra@ambitcapital.com
Krishnan V India / Asia (022) 30433295 krishnanv@ambitcapital.com
Nityam Shah, CFA USA / Europe (022) 30433259 nityamshah@ambitcapital.com
Parees Purohit, CFA UK / USA (022) 30433169 pareespurohit@ambitcapital.com
Praveena Pattabiraman India / Asia (022) 30433268 praveenapattabiraman@ambitcapital.com
Shaleen Silori India (022) 30433256 shaleensilori@ambitcapital.com
Singapore
Pramod Gubbi, CFA – Director Singapore +65 8606 6476 pramodgubbi@ambitpte.com
Shashank Abhisheik Singapore +65 6536 1935 shashankabhisheik@ambitpte.com
USA / Canada
Ravilochan Pola - CEO Americas +1(646) 361 3107 ravipola@ambitpte.com
Production
Sajid Merchant Production (022) 30433247 sajidmerchant@ambitcapital.com
Sharoz G Hussain Production (022) 30433183 sharozghussain@ambitcapital.com
Joel Pereira Editor (022) 30433284 joelpereira@ambitcapital.com
Nikhil Pillai Database (022) 30433265 nikhilpillai@ambitcapital.com
E&C = Engineering & Construction

August 20, 2015 Ambit Capital Pvt. Ltd. Page 13

 Economy

Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%
NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events
NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock
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