Investors beware: Stock markets are not prepared for GST disruption

Short-to-medium term pain has not been accounted for; compliance may be burdensome

With the July 1 Goods and Services Tax (GST) roll-out in place, a critical area from the government’s perspective is the readiness of the Goods and Services Tax Network as compliance to the new regime is entirely dependent on the efficacy of the service providers. 

The government has to ensure that smaller businesses in Tier-2 and -3 cities are ready as this community is, by and large, clueless, while at the same time, their awareness is critical for GST's success. 

The organised sector will have to get their processes and information technology (IT) systems aligned. Also, we have a huge unorganised sector, which recently got rattled by demonetisation, which is now expected to embrace the GST system. Compliance under GST will be burdensome and the outcome would be binary. Either you are compliant or you are not since there cannot be any intervening period that is termed as a "migration period".

Every manufacturing process would finally boil down to a GST chain with various entities or individuals playing out their part. As the adage goes, "The chain is as strong as it’s weakest link." And there could be a number of weak links, especially among the small & medium scale units that supply various critical components across manufacturing chains. This could cause physical disruption in the manufacturing process.

We could, in fact, witness disruption even before the July 1 roll-out date, as various establishments move to clear their inventory at steep discounts and manufacturing is stopped to avoid building up inventory. This will lead to a jump in sales at the cost of margins in the month of June, while a slackening in demand will follow in the ensuing months. 

Another important element of GST is that the government has put in place laws that have a provision of anti-profiteering so that the benefits accrued are passed on in the value chain. The corporates would most likely pass on the direct benefits of GST but are likely to retain the indirect benefits from savings in logistics costs, streamlining of business procedures and so on. It remains to be seen how this would be implemented. The industry will closely monitor this from the pricing perspective. However, the fear of ‘control raj’ will continue to play out till proven otherwise.

The increase in tax compliance obligations will be another critical area that will be realised soon. Today, a service provider with operations in 25 states can obtain a single centralised service tax registration, whereas, under GST, separate registrations may have to be obtained in each of the 25 states. 

Currently, while one has to file only three service tax returns a year, after GST, one will have to file four or five returns per state per month, which amounts to more than 100 returns per month. The same issue will be faced by manufacturers having operations in multiple states as they will have to file multiple returns on a monthly basis. Thus, the industry needs to be ready with appropriate enterprise resource planning systems and processes that are GST-ready. One can still understand that large corporates would be ready for the roll-out but can we expect everyone to be running at the same speed? It may be a field day for the service providers but cumbersome for small & medium enterprises. 

Lessons from various countries that have implemented GST suggest that there has been strong discontentment in the general public, businesses, and firms. In fact, some countries like France and the UK had to reduce their initial rates. Given that India is much larger and diverse than other countries where GST has been implemented, the problems arising here may not have a precedence. Another important aspect that countries implementing GST have come across is that the regime has had an inflationary impact, especially where the rates were higher than before. Although the government is suggesting that GST will not have an inflationary impact in India, we need to see how it plays out over the next few months.

Although I believe that GST would ensure a wider net of compliance in the longer run, resulting in much higher tax collection, the short-to-medium term pain has not been accounted for. The markets have been gung-ho about GST but the disruption it can cause hasn’t yet been discounted. It could overwhelm market participants when we are in the middle of implementation. Finally, when we gauge the government’s track record on implementation, there has always been a gap between the noble intent and its execution. Thus, I would suggest "investors beware". The author is an independent market analyst.