Should you invest in funds which can benefit from the implementation of GST?

By Vidya BalaFundsIndia.com

The Goods and Services Tax (GST) will be a reality in India from July 1. GST can be a game changer in the way India does business in the long-term. But, it may be writ with chaos in the way it is implemented in the short-term.

Will GST really impact sectors, markets and the economy and if so what should you do about it? Read on.

GST and its intent

Before we move on to the possible impacts of GST, what exactly is GST and what does it set out to do? GST is a comprehensive tax system on the manufacturing, sale and consumption of goods and services in the country.

That means it is a single tax system within the Indian boundaries. It is passed on through the last stage when the consumer consumes the product or service.

GST was proposed with the idea of:
• simplifying tax structures and reducing the multiplicity of taxes
• integrating state economies by providing a tax credit for inter-state movement of goods
• improving tax compliance and tax revenue
• Improving overall efficiency in the use of resources to produce goods and deliver services

In its present form, GST does not check all the points above. Its tax structure with 4 rate slabs cannot boast of simplicity. However, on the other points, GST can, if implemented and followed up well, deliver in the long term.

Rate change largely sector neutral

According to the government, nearly 81 percent of items fall below the 18 percent slab and only the remaining are taxed above this slab.

Since the average current rates of most goods were slightly lower or around the GST rate and service tax rates were marginally lower than the GST rate, it is not expected to be inflationary in nature nor is it expected to negatively impact companies.

And remember, companies could not earlier take credit for many of the services they paid and could not offset it against what they produced. It would now be possible to do that as there is one tax for goods and services.

The slab rates for different sectors have largely remained close to their earlier rates or gone up/gone down marginally. When you read reports that GST is positive for pharma, or media distribution or somewhat positive for cement, consumer goods (partly) and auto and auto ancillaries and industrials, it means that these sectors will now enjoy lower taxes from the unification.

On the other hand, the slab rate goes up for sectors such as telecom, agri-inputs and chemicals, consumer electricals and build materials (partly) and real estate (impact varies across states).

The change does not impact sectors such as infrastructure, utilities, oil & gas and metals. That basically means a few positive, a few negative and then a largely neutral tax stance.

That said, we do not think sector impacts based on rates really matter. This is because GST is a consumption tax; the end consumer will mostly bear the impact of the hike or the fall.

The anti-profiteering clause (whether for good or bad) is likely to ensure that lower rates are mostly passed on to consumers.

This is one reason why we say it is sector neutral to the extent of the slab rate change. And since most GST rates of goods hover around their current level of taxes, it is now being widely accepted that GST is unlikely to be inflationary in nature.

One quick move of the market on this is the smart 20 basis point rally (fall in yields) in 10-year gilts. Fear of inflationary pressure from GST was one of the reasons that had kept yields at higher levels since February 2017.

Then how are companies and the economy as a whole likely to benefit from GST? It will likely happen in the following ways:

- GST, if implemented stringently and followed up relentlessly by the tax department, can result in the unorganised sector coming into the formal tax system. This means they lose their pricing edge and probably their market share to organised players (for our purpose, listed companies). It also means that the government gets an additional source of revenue that was hitherto outside its net.

- Companies that were not able to take credit of many of the taxes they paid would now be able to; eventually leading to the efficient outgo of cash flows on taxes for them. For example, a consumer company would be able to take credit for the tax they were paying on advertisement expenses (which was service tax earlier) - an expense that accounts for a chunk of their cost outgo.

- Next, even while companies may not directly benefit from any lower slab rate, there can be efficiencies kicking in from a single tax regime - inter-state goods transfer may no longer be inefficient and the cost of logistics/transport can drop.

This may provide indirect benefits to companies. We think it is this benefit that can have a lasting impact on companies. But this is not one to accrue in the short term.

In the short to medium term though, there could be enough challenges:

- There is confusion aplenty on the quantum of input credit on the goods lying in inventory in the supply chain during the period of transition. Reports state that this could lead to significant de-stocking by goods sold through intermediaries and result in lower sales for a month or so.

- There would be a surge in working capital requirement especially by mid-sized companies for the following reasons: One, the entire tax is to be paid on the manufacturing of goods, as opposed to just excise duty earlier. Two, transfer of goods (within the company) between states will require tax payment and then claim credit. Three, the tax must be paid before the exemption can be claimed in case of manufacturing units that enjoy exemption benefits.

What should you do?

While we will be watching fund managers take calls in sectors, there are unlikely to be sectors that a fund manager is positive on, merely on account of GST.

For example, while pharma may benefit from GST, the current issues troubling the sector may leave very few stock choices for a fund manager to pick from. To this extent, we think investors too should avoid taking bets on sectors that they believe will simply benefit from GST.

The right thing, in our view, is to stick to good quality funds that will invest in quality stocks that will, in addition, gain from economies of GST.

In the near term, one can expect some volatility, especially in the mid-to small-cap space. The market has already been hitting at the heady valuations of this space for reasons more than GST in the past few weeks.

We think any market turbulence on account of sluggish quarterly numbers in the September and December quarter could be opportunities to average, other things remaining the same.

In the debt space, we will not be surprised if short-term debt funds offer superior yields for a while as the tight working capital requirement of companies may be partly met by the issue of bonds to mutual funds.

In all, we think GST should not be viewed in isolation in terms of its impact on the market. We had mentioned about a series of events that will impact the market in our outlook earlier this year and believe all of these have together been anchoring the market thus far.

FundsIndia’s Research team has, to the best of its ability, taken into account various factors – both quantitative measures and qualitative assessments, in an unbiased manner, while choosing the fund(s) mentioned above.

However, they carry unknown risks and uncertainties linked to broad markets, as well as analysts’ expectations about future events. They should not, therefore, be the sole basis for investment decisions.

Disclaimer: The author is Head – Mutual Fund Research, FundsIndia.com. The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.