Ind-Ra's sample set of corporates showed that the task is humongous and can be gauged by the size of closing inventory of around INR11.2 trillion as at FY16, which are at various stages of production process and includes other inventory procured at various dates from different sources including CST, VAT and exempt purchases. The average excise duty of the sample set works out to around 5.5%. Further assuming that 25% of the over-all inventory is procured locally and is subject to an average VAT rate of 14%, the over-all input credit lock up will be around INR1 trillion for this sample and would be higher on an over-all basis. Even if 50% of this is not available for set-off during the transition phase, it would result in blockage of INR500 billion of input credit for about two months (although may not necessarily be used during the first two months). Moreover, service tax rates are likely to increase by a flat 3% to 18% as against 15%. These factors may put stress on the short term working capital requirement for businesses.
Ind-Ra believes that even if businesses are able to achieve this seemingly mammoth task and the amounts are credited to the electronic ledger on a provisional basis, it will be subject to variations in the near term as there could be litigations on eligibility and availability under the existing laws and under the GST regime which may lead to disruption of working capital for businesses. The impact on individual companies could however vary widely and Ind-Ra's study suggests that around 85% of the blocked input credit will be with companies with greater than INR5 billion revenues. Ind-Ra believes larger companies whose credit profiles are relatively stronger will tide over the short term working capital disruption relatively easily as compared to the ones which have weaker credit profiles.
Focusing on the liquidity conditions, the system liquidity remained abundant- reflected in the liquidity adjustment facility (LAF) provided by Reserve Bank of India (RBI). On an average in May 2017 banks are parking over INR3 trillion (3% of net demand and time liabilities) under the LAF window, comparted to above INR5 trillion in March 2017. Currently, the high liquidity situation is owing to the lower amount of currency in circulation and a surge in foreign portfolio investments (FPI). The currency in circulation has now restored to INR14.5 trillion, compared to INR18 trillion, prior to November 2016. Additionally, net FPI investment in equity and debt has crossed INR1 trillion since the starting of 2017, an exogenous money creation.
The sloshing system liquidity has become a cause for concern, as it impacts the monetary policy objective and practices. The objective of monetary policy is to keep the overnight rate (O/N) and the shortest end of the yield curve anchored to policy rate (i.e. repo rate). During the months of March -April 2017, O/N rates were substantially lower than the policy rates and similarly short term yields were below the policy rate. To tackle such anomalies the RBI in its April 2017 monetary policy spelt out a detailed course of actions. And in line with the monetary policy communication, RBI has sterilised INR1 trillion of liquidity through Treasury bills (T- Bills) under the market stabilisation scheme. As a result, the O/N rates and short term rates have now realigned to RBI's objective, i.e. anchored to repo rates.
The ongoing dilemma is now, how RBI will tackle this sloshing liquidity surplus, or whether it is even necessary to sterilise such liquidity. Ind-Ra believes that such liquidity surplus need not be sterilised. The RBI's objective is to keep O/N rates close to policy rate, where liquidity is one of the tools. After issuances of T-Bills under the market stabilisation scheme at higher yield, overnight rates have now recalibrated to policy rate. And as more importantly, as per Ind-Ra's prognosis the system liquidity should be at ease during the transition phase of GST. Thus in order to minimise the magnitude of such disruption at the earliest and to absorb the sudden changes in requirement of short term finance, easy system liquidity is necessary. However some fine tuning will be needed to maintain O/N rates closer to policy rates.
Thus Ind-Ra believes the changes of both fund flow and cash flow cycle may cause abrupt volatility in the working capital requirements during the initial phase of GST transition. The actual manifestation is expected to be visible in the volatility of system liquidity and short term rates. To tackle such a disruption with ease and so as to ring-fence short term fiancmarket from a market failure, the easy financing option is critical. Thus an easy system level liquidity is essential to pursue these objectives. Since the overall credit offtakes is low and banking system liquidity is at its high level, banks will also be in a position to tackle any unanticipated volatility in fund requirements.
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