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S&P Global Ratings has allayed fears about the government’s proposed reform of the Goods and Services Tax (GST) regime, dismissing concerns about New Delhi’s finances due to potentially lower indirect tax rates.
Days after the agency upgraded its rating on India, Yee Farn Phua, director of sovereign and international public finance ratings at S&P, said on Tuesday in a webinar that while the initial reaction to the government’s proposal would be that tax rates would come down and hurt revenues, it might not necessarily be the case.
“If you look at the current GST regime, it is quite a complex one – four different rates, which make accounting and implementation sometimes quite difficult. With the proposed two-rate system now being looked at, though the effective rate could be somewhat lower, but actually because of easier implementation and fairer accounting processes, there actually could be a boost to fiscal revenues in the longer term,” Yee Farn Phua said.
On August 14, S&P upgraded its rating on India to BBB from BBB-, saying the country is “among the best performing economies in the world”. A day later, on August 15, Prime Minister Narendra Modi announced a host of reforms in his Independence Day speech, including one that would see the GST move to a two-slab system of 5 per cent and 18 per cent by the end of 2025. In addition to the two slabs, a special 40 per cent category has been proposed for sin and demerit goods. This higher tax rate is expected to be imposed on only 5-7 items.
“It’s still very early days to see the actual fiscal impact, but we don’t think that the government would reform this system to the point that it would hit fiscal revenues for them. After all, in the past five to six years, GST reform has proven (to be) a driver of and a very important and major component of the government’s fiscal revenues. So, we think that story will continue to play out… Overall, we don’t think it would be a major drag on fiscal revenue,” Yee Farn Phua said, adding that S&P is “monitoring” this new development.
S&P’s assessment is broadly in line with that of other economists, who see higher consumption from lower indirect tax rates aiding the government’s tax collections in the long term, although the short run could see a fiscal hit. According to Morgan Stanley economists Upasana Chachra and Bani Gambhir, while the fiscal balances of the central and state governments will likely come under pressure due to revenue losses, it could be “partly offset by higher GDP growth improving direct and indirect tax collection”.
“All else being equal, a loss in GST revenues could put upward pressure on the consolidated fiscal balance, but we believe that as growth picks up, the net effect will potentially be limited. Further, specifically for 2025-26, the impact on central government deficit should be less than 0.1 per cent of GDP, assuming no offsetting impact,” Chachra and Gambhir wrote in a note on August 17.
State governments, however, are wary, with The Indian Express reporting this week that multiple states have expressed concerns over substantial losses in their share of GST revenues due to lower indirect tax rates. Annually, top officials from state governments said, the revenue loss could be Rs 7,000-9,000 crore for most major states.
Over the years, GST rates have gradually come down due to tweaks made by the GST Council. As per an RBI study from September 2019, the weighted average effective GST rate had decreased from 14.4 per cent at the time of the new indirect regime’s launch in mid-2017 to 11.6 per cent by mid-2019, with higher buoyancy “achieved by widening the tax base and removing distortions”.
According to S&P’s forecasts, made prior to the GST reforms announced by Modi, the combined fiscal deficit of the central and state governments is seen at 7.3 per cent of GDP in 2025-26, which it expects to decline to 6.6 per cent by 2028-29. In terms of debt, S&P expects India’s net central plus state debt to decline to 78 per cent of GDP by 2028-29 from 83 per cent in 2024-25, bringing it closer to pre-pandemic levels.
The Centre has targeted a reduction in its debt-to-GDP ratio to 49-51 per cent by 2030-31 from 57.1 per cent in 2024-25. States do not have a debt target. Rating agencies view government debt on a consolidated basis – Centre plus states.
At the webinar on Tuesday, when asked if the rating upgrade was “too little, too late” considering India’s performance, Yee Farn Phua laughed, saying he had seen Indian media headlines which said ‘S&P upgrades India after 18 years’.
“My response to that is that we generally take a long-term view to these sorts of things. If you look at India’s performance as an economy over the past 10-20 years, there have been up-cycles and down-cycles. Economic growth has sort of chugged along, but fiscal numbers have spiked up and down.”
