Is GST likely to be inflationary in India?
There has been a general belief that GST will add to inflation in the initial years. While the quantum of the impact of inflation cannot be predicted, the global experience is that the inflation rate does creep up by 0.5% to 1% annually in the first couple of years from implementation. Why does this happen and what are the global experiences?
Why GST could be inflationary…
In the Indian context, the most obvious reason will be service tax. Currently, the services are taxed at 15% and this could move up to 18% or above. This could easily impute higher collateral inflation to a variety of products that get impacted. Secondly, GST will broaden and deepen the tax compliance in India. Millions of small businesses that are currently not subject to excise duty will have to pay GST as the threshold limit for GST exemption is likely to be drastically reduced. This will also add to inflation. Lastly, while the system will change, the entire national infrastructure and company level supply chain design will take some time to adjust. During this adjustment period, inflation will tend to move higher. Of course, over a period of 3-5 years, the efficiency gains will outweigh the higher tax incidence and thus reduce inflation.
What’s the global experience?
Emerging markets like the Philippines and China saw an increase in the inflation rate after GST implementation. But in case of Thailand and Indonesia the inflation actually fell in the year of GST implementation and the subsequent year. Thus there seems to be no clear global trend. The one critical factor for India could be higher service tax which could fuel inflation. Otherwise, it could be more a food inflation worry!