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GST cut may not push up companies’ profit margins

The recent reduction in GST (Goods and Services Tax) rates has been hailed by analysts as being positive for markets and for sectors whose tax rates have been reduced. However, a closer inspection of facts indicates that ground realities may not turn out to be as rosy as the street would hope for from the GST cut.
“The GST rationalisation is being viewed by markets as a positive surprise,” said Jagannadham Thunuguntla, senior vice-president and head of research (wealth), Centrum Broking.
“As the tax rates on more than 100 products have been reduced, (equity) markets were positive of the news,” explained V K Vijayakumar, chief investment strategist at Geojit Financial Services, on why markets viewed the tax cuts in a positive light.
The GST Council, in their 28th meeting on July 21, 2018 had made changes to the tax framework, pruning tax rates, easing the compliance rates for Small and Medium Enterprises and providing input credit refund to the textile sector.
After the recent GST rationalisation, only 35 goods are in the highest tax bracket of 28% GST. When GST was implemented on July 1, 2017, there were 226 goods in the 28% category, which means about 191 goods have seen reduction in the GST rate, which is a huge relief for consumers.
Sectors that will benefit from GST cut
There are some specific sectors that will benefit from the GST rate reduction. Consumer sector (paints and varnish), light electrical (refrigerators, freezers, vacuum cleaners, and TV upto 68 cms), auto, fertilizers, sugar, textiles and footwear and hotels. “Companies in these sectors saw a positive reaction in their stock prices,” said Hemang Jani, head – advisory, Sharekhan by BNP Paribas, about the street’s specific reaction to the sectors benefiting from this move.
Sectors that will not benefit from GST cut
Equally, too, there are sectors that will not benefit from the move. Air conditioners, digital cameras, dish washing machines and TVs above 68 cms will not benefit from the tax rate reduction.
Concerns from GST reduction
In fact, if one were to dig just a little deeper, there are several points of concern from the GST reduction. Both from the economic, as well as, sectoral point of view.
The recent move could result in a revenue loss of Rs 10,000 – 15,000 crore (to the exchequer), said analysts.
“The fall in tax revenues due to the tax cuts, is an area of concern,” said Vijayakumar.
“Most companies would be passing on the GST reduction (that is, the reduction in taxes to consumers,” said Jani, “Thus where would be the improvement in profit margins profits,” he asks.
Even if the beneficiary companies pass on the tax cuts to consumers in the form of reduced prices, this may not necessarily be a good thing. “The higher demand (due to reduced rates) can build inflationary pressures and with the risk of a higher fiscal deficit, can push up interest rates in the economy quicker than expected,” said Suman Chowdhury, President-ratings at Acuité Ratings and Research.
Such macroeconomic headwinds need to be observed carefully as they can impact the profitability of mid- and small-caps over the next few quarters despite the strong buoyancy in demand. In fact, besides macro economic woes from India, the beneficiary companies will have other concerns that may affect any paybacks from the GST cuts.
Take textiles for example. The industry has gone on record that they will reduce prices by 5% from August. “But we have to factor in competition. The (textile) industry in Vietnam and Bangladesh are doing better than their counterparts in India,” said Vijayakumar. China is slowly ceding space due to higher costs caused by rising wages. Rupee depreciation is beneficial to textile exporters. But these factors will take a long time to play out.
Besides, most of the beneficiary sectors are in the mid- and small-cap sectors, where traditionally variables like crude oil and other input prices are major challenges.
“The average price of crude, this year, is higher than it was last year,” said Jani. Also, though some commodity input prices like palm oil and copra have corrected it’s still early days to factor in their impact.
According to Dhananjay Sinha, head of research, economist & strageist, Emkay Global Financial Services, there are several economic hurdles that may yet affect these companies. These hurdles include, hardening interest rates, higher inflation, and eventually an increase in taxes. “The concern is that some of these negative symptoms are already visible,” he said.
So what are the takeaways from the perspective of the equity markets vis-à-vis the GST reduction? Tax revenues, time and some global factors are the key.
“Markets will be watching the GST collection figures for the coming three to four, till the festive time, quite closely to assess the real impact of GST rationalisation,” said Thunuguntla. The equity markets are tracking whether the average GST collection would cross Rs 1 lakh crore per month, a key trigger.
“Overall, markets can still remain volatile, given global developments of trade conflicts and narrowing excess liquidity and tightening domestic liquidity, which have collectively caused meltdown in the broader market,” said Sinha.