June 13, 2017 / 2:15 AM / 2 months ago

BREAKINGVIEWS- Modi’s India can ride out giant tax reform

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

By Una Galani

MUMBAI, June 13 (Reuters Breakingviews) - India is heading down a bumpy road. The country is under-prepared for the July 1 nationwide rollout of a complex new goods and services tax which will create a single customs union, replacing a myriad of charges levied across 29 states. But for all the shortcomings, the reform smoothes the way toward a more efficient, less corrupt economy.

The overhaul is far from the ideal of single flat rate. India’s GST will instead have bands of 5, 12, 18, and 28 percent, plus an additional levy for certain items like chewing tobacco, fizzy drinks, and luxury cars. Petroleum products, alcohol, and electricity are among the exempt items.

The hope is that a tiered system will avoid a rise in consumer price inflation that typically results from the rollout of simpler structures, as most recently seen in Malaysia. That’s an important feature as Prime Minister Narendra Modi is due for re-election in 2019.

The downside of the complexity is a lower boost to growth. Economists at HSBC now expect a medium-term GDP uplift of 40 basis points after the change, half their original forecast before the details were agreed. Meanwhile, ambiguity over how all sorts of things are categorised will inevitably lead to rent-seeking from some tax officials.

Graphic: India's fiddly GST is designed to avoid a jump in inflation: reut.rs/2rUpCU3

The long-term benefits could be profound, however. The process requires companies to electronically upload reams of invoices and reconcile them with vendors. That will allow taxpayers to use their invoicing history to secure better borrowing terms, and make it harder for company owners to understate their personal income. Enterprises, like logistics firms, will be able to pick the most geographically logical location for new warehouses, instead of hunting for the state with the lowest taxes.

The big unknown is how much disruption the transition will unleash. Tax experts and company executives expect longer working capital cycles, and general uncertainty for up to one year. Indeed, most small and medium-sized companies are still coming to grips with basic concepts like input credits. New Delhi may well have to grant them a period of clemency.

Yet Modi’s masterful political spin last year on his radical "demonetisation" experiment, in which he cancelled most of the country's bank notes by value, suggests he can manage any teething pains. Unlike that unorthodox reform, this one enjoys near-unanimous political support.

On Twitter twitter.com/ugalani

CONTEXT NEWS

- India's new Goods and Services Tax (GST) will come into effect from July 1. It is seen as the country's most significant tax reform since independence.

- The GST will harmonise the variable tax rates currently in effect throughout India's 29 states and create a single customs union.

- The destination-based tax will apply rates of 5, 12, 18, and 28 percent to different categories of goods and services. There will be an extra levy added to the top rate for specific luxury items.

- Alcohol, electricity, real estate and petroleum are exempt.

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Editing by Pete Sweeney and Nicolle Liu

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