Modi’s tax cuts will give India a festive spending boost

Starting Monday, the daily economic burdens of millions of Indians could ease slightly.

Staples like milk and bread, life and medical insurance and life-saving drugs will become tax-free. Consumption tax on small cars, television sets and air conditioners will drop from 28% to 18%. And other common goods like hair oil, toilet soap and shampoo will be taxed at a marginal 5% instead of 12% or 18%.

The sweeping cuts are part of Prime Minister Narendra Modi’s major overhaul of India’s complex goods and services tax (GST) regime announced earlier this month.

This is expected to both simplify the tax code and give flagging household consumption – which makes up over half of India’s gross domestic product (GDP) – a much-needed fillip.

The timing couldn’t be more opportune.

Lower GST rates coincide with the beginning of a long festive season when Indians typically open their purse strings to buy everything from new cars to clothes.

This four-month period also brings in a bulk of yearly sales for consumer goods companies such as packaged food makers and apparel manufacturers.

The hope is, reduced taxes will mitigate some of the impact of the US’s bruising 50% tariffs on India, leave people with more money to spend and spruce up the domestic economy.

The cuts come off the back of a $12bn income tax giveaway announced in February and lower interest rates from India’s central bank, all of which bode well for a consumption pick-up.

Companies, including Reliance, consumer staples giant HUL, and automaker Mahindra & Mahindra will pass on lower taxes to consumers to boost demand.

Carmakers are banking on the cuts, with share prices up 6-17% since Modi’s August announcement, while dealerships report rising enquiries amid unsold inventory.

At a Mumbai showroom of Hero Motocorp, India’s largest motorbike manufacturer, a dealer told the BBC that he expected sales to jump 30–40% over the next two months compared to last year.

“Easing the cost burden of first-time owners has increased enquiries and footfall,” Ashutosh Varma, Hero India’s chief business officer, told the BBC. This is especially so for “cheaper variants”, he said, where price sensitivity is the highest.

Vishal Pawar, a software developer who was at the showroom, said he’s considering upgrading to a 200cc bike this year.

“The best time to buy is when festival discounts and tax cuts overlap. I’ll make the purchase during the Dussehra festival,” Mr Pawar said.

Companies that make consumer goods are also upbeat about a pick-up in demand.

Sabyasachi Gupta of Godrej Enterprises said the tax cuts coupled with a good harvest could go some way in expanding the market for discretionary goods like air-conditioners beyond the metro cities.

But the changes have led to a last-minute scramble among companies like his – right from reprinting labels to reflect new prices and balancing production with uncertain demand.

“We’re keeping old and new labels side by side so consumers can see their savings,” Mr Gupta told the BBC.

Among smaller brands and shopkeepers, news of the tax changes is slow to reach, and many say they lack the capacity to adjust pricing and packaging on short notice.

In Mumbai’s iconic Crawford Market, the city’s biggest wholesale and retail hub where everything from spices to sequins are sold, few shopkeepers were aware of changes to GST slabs.

Those who knew about it were confused.

Sheikh Rehman, who owns a crockery store, said he was still negotiating with his suppliers on how to manage taxes on the inventory he had already purchased.

Next door, at a bridal showroom there was disappointment. The government has cut GST on garments costing less than $29 (£21.2) to 5%, but items priced above that figure now face a higher levy of 18%.

Wedding outfits rarely cost less than $29, meaning nearly every ensemble in Naresh G’s store will attract a higher tax. This could have a cascading impact across the supply chain from craftsmen to designers and retailers.

“Indians spend a lot on wedding clothes and the season is just about to start, the tax hikes may take away some of the shine,” Mr Naresh said.

At a net level though, the impact of the GST cuts is expected to be largely positive.

According to ratings agency Crisil, lower taxes will benefit a third of an average consumer’s monthly expenditure basket and improve the middle class’s purchasing power.

The extent of the impact will depend on “the degree to which producers pass the rate cuts to consumers”, Crisil said in a report, adding that the impact will play out over this and the next financial year.

The cuts, of course, come at a cost.

The government predicts they could lead to a revenue loss of around $5.4bn this year. But independent experts and rating agencies like Moody’s expect the figure to be higher, with the strain on the exchequer “even more pronounced” in the coming years.

These losses add to a bleak macro picture: federal tax revenues have barely grown in the first four months, compared with a 20% jump last year, while spending is already up more than 20%.

With Delhi intent on keeping its fiscal deficit – the gap between revenue and expenditure – in check, the Modi government may have to hit the brakes on the big-ticket road and port spending that has driven India’s growth over the past five years.

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