In a cautionary note, analysts at Oxford Economics have warned that, given the lingering structural issues plaguing the economy, GST rate cuts alone will not sustainably boost growth prospects in the long run and will likely have only temporary effects on select sectors.
“Existing structural issues mean the GST reforms alone cannot sustainably raise growth prospects over the long run,” said Senior Economist at Oxford Economics.
The comments are notable as the government and many pro-government economists have hailed the recently implemented GST rate cuts as a major reform expected to spur demand and consumption, which in turn could revive private capital expenditure—a key missing component in the economy for more than a decade.
“Poor infrastructure, governance weaknesses, and policy uncertainty constrain domestic investment as well as FDI inflows. Declining national savings rates also mean domestic funding sources are limited,” he added.
The positive impact of the rate cuts, Tsuchiya noted, will likely be concentrated in the durables sector, primarily automobiles. “Non-durables will likely see a smaller boost, while investment-facing sectors may receive indirect support from higher production demand down the line.”
The analysis is based on Oxford Economics’ global economic and industry models, which were used to simulate a reduction in economy-wide effective expenditure tax rates. “In this demand-driven framework, we found that durable goods will be among the main beneficiaries,” he explained.
At a more granular level, varying tax rate reductions mean some goods and services will receive a bigger boost than others. However, the pace and extent of pass-through to consumers—which differs by product—will also determine the effectiveness of the tax cut.
Effective September 22, the government reduced the number of GST brackets and lowered the peak rate from 28% to 18%. The slabs were simplified to just two—5% and 18%—and all existing cesses were removed from the earlier four slabs of 5%, 12%, 18%, and 28%. The government also exempted most essential items from tax while introducing a new 40% rate for sin and luxury goods, aiming to streamline existing taxes. As a result, the effective tax rate will remain largely the same, if not slightly lower in some cases.
The new framework addresses many of these issues while retaining the benefits of a progressive tax system through differentiated rates and targeted exemptions.
Sectors most responsive to consumer spending and investment demand are expected to benefit the most. Among these, consumer and capital goods sectors are poised to outperform, while upstream sectors such as industrial goods and materials will benefit relatively less.
Consumer goods are direct beneficiaries of lower tax rates, as lower prices allow households to buy more with the same income. Capital goods receive indirect support through higher investment, as firms are incentivized to expand production capacity in response to stronger consumer demand.
He noted, “Higher consumption is undoubtedly positive for the economy, but for the policy to generate a significant boost, it is important to evaluate the extent of spillovers to other parts of the economy.”
As demand for end-products rises, firms would typically increase production capacity to meet it. However, with uncertainty remaining high due to U.S. trade policy, firms may opt to utilize existing capacity before making new investments. Industrial surveys indicate that fewer firms have been optimistic since the start of the tariff war.
He outlined several structural issues that continue to constrain the economy. While the GST rate cuts may add momentum to growth, sustained improvement will require addressing these deeper challenges.
“Uncertainty around policy and regulation has been holding back private sector investment. A volatile policy environment makes it difficult to predict returns reliably, deterring firms from actively investing,” he said.
The effect of policy uncertainty is even greater for FDI than for domestic investment, leading to underperformance in attracting foreign capital. The lack of sufficient foreign capital places the burden of financing on domestic sources, which are constrained by declining national savings rates since 2010—a trend expected to continue as private consumption remains a key driver of the economy.
Nevertheless, the GST rate cuts come at an opportune time to bolster domestic demand, especially as the external sector faces challenges from U.S. tariffs. Domestic demand is particularly important, as private consumption and investment together account for around 90% of GDP, compared to 80% for the regional average.
“But the uncertain extent of pass-through to consumers, limited spillovers to other sectors, and structural hurdles mean that GST reform alone will not be strong enough to significantly lift the growth trajectory,” he concluded.
Source #ET
