With lower GST rates kicking in this week, and auto majors like Maruti and Hyundai reporting record one-day sales ever, the excitement around GST rate cuts is palpable. The first-day effect was clearly a result of pent-up demand, with consumers waiting until the lower GST rates kicked in, but the broader question is whether this marks the start of a lasting private consumption boom and what costs are we paying to sustain this consumption boost?
Let’s first decode arguments in favour of the GST rate revamp. First, simplifying the GST slab structure was long overdue. With over 90 per cent of items now taxed at either 5 per cent or 18 per cent, compliance becomes simpler. The rate revamp also corrected for duty inversion in specific sectors, particularly in the fertilizer industry.
Second, the move extends the government’s middle-class relief efforts, following last year’s income tax reform that made income up to ₹12 lakh tax-free. Crucially, GST cuts reach the bottom of the pyramid more effectively than income tax relief.
Third, after years of robust government capital spending — now at 4.1 per cent of GDP, up from 1.7 per cent in 2013 — and with sluggish private consumption (growing at 6 per cent) and tepid private capex, one could argue it was time to shift resources from the state to consumers.
Fourth, lower rates offer relief to leveraged households, potentially improving repayment capacity and easing stress for microfinance lenders.
Lastly, it provides sectoral impetus to some of the struggling sectors such as the two- and four-wheeler sales, which have been tepid for few months now.
Transfer of resources
Yet, it is worth recalling what any fiscal policy really is: a transfer of resources from government to households, a zero-sum game — at least in the short run. While consumers’ purchasing power rises, government revenue and hence spending fall unless the government borrows more. But higher borrowing is no panacea: more debt today is just kicking the can down the road as it implies lower spending or higher taxes in the future. And with government debt already at 81 per cent of GDP and bond yields elevated, India cannot risk fiscal slippage so soon after an S&P’s rating upgrade. And then there are lost complementarities between public and private spending: lower GST on cement matters less if the government’s spending on Awas Yojna falls.
Thus, while private consumption rises, overall consumption — public plus private — may not. In fact, as consumers spend only 45-60 per cent of their additional income, while governments spend every rupee, the total consumption might fall in the very short term. And the multiplier effect argument is not unique to private spending. Government spending multipliers, especially on capex, are larger (greater than 2) than those observed on private consumption. Overall, it is not straightforward to conclude that the GST rate cuts will boost GDP growth, either in the short term or the long term.
GDP pass-through
And coming to GST pass-through, while auto companies have substantially passed on GST benefits to the consumers, whether FMCG firms will do the same remains to be seen, especially given that FMCG sector is reeling from 15 per cent year-over-year rise in input costs for the June 2025 quarter, and with a benign inflation scenario, may view tax cuts as an opportunity to restore margins rather than lower prices. This speculation is consistent with IMF research on Eurozone documenting that pass-through for non-durables is almost half that of for durables.
Even if prices of durable goods drop substantially, is it desirable for already leveraged household sector to borrow more to purchase durables, with household debt at 41 per cent of GDP — up from 36 per cent in 2021, and net financial savings at 5.1 per cent — half that of 2021?
One clear benefit of GST rate cuts is that with 10-15 per cent of the goods in India’s CPI basket attracting lower GST rates, it will lower the inflation anywhere between 0.50-1 percentage points. However, what the popular commentary subtly ignores is that this is a one-time price and inflation shock — once the pass-through is complete, we are back to the original inflation dynamics.
In summary, GST 2.0 will boost private consumption and sentiment, simplify taxation, and extend relief to lower-income households. However, the fiscal trade-off is real: with India’s spending on education (4.1 per cent of GDP) and health (1.9 per cent) still well below that of its peers and targets, there is no substitute for sustained government investment in human capital and infrastructure over the next decade.
The writer is Chief Economist, Muthoot FinCorp Ltd
Source from: https://www.thehindubusinessline.com/opinion/will-gst-20-boost-overall-consumption/article70167351.ece
