Proposed GST reforms are aimed at giving some relief to textiles exporters

New reduced rates for industries are taking care of impact of Trump’s tariffs

By Dr. Nilanjan Banik

One measure that will surely provide some respite to middle-class budgets is Prime Minister Modi’s proposal to the GST Council to reduce goods and services (GST) slab rates from the current four-tier structure of 5%, 12%, 18%, and 28% to a simplified two-tier system of 5% and 18%.

There will be another special tax rate for ‘sin’ goods, which is already in place. Many developed countries, such as Australia, Canada, New Zealand, and Japan, have a single GST rate, typically ranging between 5 per cent and 15 per cent. Higher multi-layered GST slabs always have the unintended consequence of dampening consumption and negatively impacting businesses. Reforms in the GST framework are a welcome move, as the goods and services tax on items of daily consumption is likely to come down, if and when the GST Council okays the proposal.

According to the specifics of the proposal that have been circulated unofficially to sections of the media, most items such as textiles and apparel, agricultural machinery, automotive components, healthcare and insurance products, and Fast-Moving Consumer Goods (FMCG) and retail sectors are likely to come down.

A lower GST will have a subsequent multiplier effect because of lower reduced logistics costs and simplified compliance. Most items under consideration are price elastic in nature, and a lowering of prices will increase demand and create employment. More importantly, when Trump’s tariffs are creating disruptions in global trade, it will make India’s exports more competitive.

Let us examine the impact of reduced GST rates on two important sectors, namely textiles and automotive components. India is the largest producer of cotton in the world, and the textile and apparel industry is crucial for job creation and exports. This industry employs around 40 million people.

As of now, apparel items below Rs 1,000 attract a GST of 5 per cent. For apparel items exceeding Rs 1,000, the GST rate is 12 per cent. Even this low indirect tax can be detrimental to export competitiveness. For any manufacturer in the textile industry, they also need to invest in value added services such as marketing, warehouse rentals, logistics, courier, and other product fulfilment costs. However, these additional activities attract on average a GST rate of 18 per cent.

This amounts to an inverted duty structure, as the tax on input is higher than the tax on final output. The table below demonstrates how a higher GST rate can increase prices by up to 7 per cent. For example, from Table 1, we find, courier costs, packaging costs, payment gateway costs, marketing costs, warehousing manpower costs add up to Rs 36. A 12 per cent GST on Rs 36 is Rs 4.32, which is Rs 2.52 (or 7 percentage points) more than if the GST rate were fixed at a lower 5 per cent.  The result is the same whether we consider apparel products less than Rs 1,000 (5% GST) and/or more than Rs 1,000 (12% GST).

How GST makes Apparel Industry Uncompetitive

Costs of Goods Sold (COGS) is how much it costs to produce goods and includes direct material and labour expenses that go into production of each apparel. COGS does not include indirect costs such as overheads and marketing. For the apparel products, the higher GST rate of 18 per cent as opposed to 5 per cent on value added services (such as marketing) have an effect on increasing the net sale price by 4.4 per cent.

For example, for the apparel product priced at Rs 1,200, the corresponding figures for tax payment are Rs 144 (with 12% GST) and Rs 60 (with 5% GST), respectively.

Additionally, the apparel industry which is into exports also suffers from refund of input tax credit. Since, March 2019, the government introduced Rebate of State and Central Taxes and Levies (RoSCTL) to refund the input tax. However, apparel industry owners still complain of an inability to get this refund on account of lack of coordination between the Ministry of Finance and Ministry of Textiles.

When one includes interest costs, delayed payments, and COGS, a higher GST rate of 18% translates to an additional cost of 8%, which will certainly make our apparel items uncompetitive.

The story holds for manufacturers of aluminium automotive components. Aluminium automotive parts are finished products which are made with raw aluminium. The government of India has protected the raw aluminium industry (aluminium articles and thereof: Chapter 76) by imposing a custom duty in excess of 7.5%. If one were to add the ad valorem and special duties, the figure goes beyond 10%, which makes Indian manufacturers producing final aluminium products such as automotive components and agricultural machinery less competitive in the global market.

Additionally, the GST rate on aluminium automotive products is 28%, which is the highest GST slab rate. The high GST structure lowers the trade margin for the makers of aluminium automotive products. This makes the business unsustainable even in the domestic market. For example, Chinese governments give 16 per cent subsidy to manufacturers of final aluminium automotive products, making the Chinese firms competitive in the world market.

The proposed reforms in the GST framework are a welcome move. Even for sectors such as health insurance, this will bring down the cost. India has a 40 crore population that is not covered by health insurance. Most lower and middle-income households will also get respite as prices of FMCG items fall. The GST reform can boost the economy as well as exports.

(The author is Professor, Mahindra University, Hyderabad)