GST 2.0: The Fiscal Trade-Off on Consumption

GST 2.0: The Fiscal Trade-Off on Consumption

The GST 2.0 rate rationalization is expected to provide a boost to private consumption and market sentiment in the short term, but it is not straightforward to conclude that it will increase overall consumption (public plus private) or GDP growth due to significant fiscal trade-offs.

Arguments Favoring Consumption Boost

• Stimulus for Durables and Sentiment: The rate cuts, particularly on higher-ticket items like automobiles and electronics, immediately translated pent-up demand into higher sales (e.g., auto majors reporting record one-day sales). This positive sentiment encourages further spending.
• Aids Lower Income Households: GST cuts, unlike income tax relief, are argued to reach the bottom of the pyramid more effectively, extending genuine price relief on a wider basket of essential goods.
• Correcting Duty Inversion: The simplification and rate adjustments corrected duty inversion in specific struggling sectors, such as the fertilizer industry, which improves the cost structure for manufacturers.
• Lower Inflation: The rate cuts are expected to lower CPI inflation by approximately 0.5 to 1 percentage point, improving the real purchasing power of consumers.

Fiscal Trade-Offs and Negative Factors

• Government Revenue Reduction (Zero-Sum Game): GST cuts represent a transfer of resources from the government to households. In the short run, the resulting fall in government revenue implies either lower public spending (on infrastructure, education, and health) or higher government borrowing.
• Total Consumption May Not Rise: Since consumers typically spend only 45-60% of their additional income, while governments spend every rupee allocated to schemes like capital expenditure (which has a higher economic multiplier, often greater than 2), total consumption (public + private) may not rise significantly and could even fall in the very short term.
• Risk to FMCG Margins: The full price benefit transmission for FMCG non-durables is uncertain. With the FMCG sector facing rising input costs, companies may use the tax cuts as an opportunity to restore profit margins rather than lowering consumer prices, a trend often observed internationally (the pass-through for non-durables is often half that of durables).
• Household Leverage: The price cuts may incentivize already leveraged households (with debt at 41% of GDP) to borrow more for durable purchases, which raises financial stability concerns.