A much-awaited restructuring of the goods & services tax (GST) slabs to raise the revenue-neutral rate (RNR), from a little over 11% now to 15.5%, could be delayed by a few months, as high global commodity prices have resulted in a rise in inflationary expectations among households and firms and brought the Reserve Bank of India’s (RBI) accommodative policy stance under critical review.

A delay in the GST slabs recast could have serious implications for state governments’ revenues, since a five-year compensation mechanism for their GST revenue shortfall is set to end on June 30. It could also become more difficult for the Centre to resist states’ demand for an extension of the compensation in order to avoid a revenue shock to states. States’ spending, especially revenue expenditure, surged in the last couple of years in the wake of the pandemic, even amid severe revenue constraints.

“The suggestions the group of ministers (GoM) on rate rationalisation will be vetted by the GST Council. The changes in GST slabs will be done in phases keeping in mind inflationary pressures,” a senior official told FE, acknowledging the difficulties to raise tax rates at this juncture. In the meantime, officials are banking on the continuation of the buoyancy in GST collections and anti-evasion measures to narrow the likely shortfalls in GST receipts.

The government is also conscious of the fact that raising the indirect tax rates across a wide range of products now could dampen consumption and hit economic growth in the short term.

Under the GST compensation mechanism, which is constitutionally guaranteed, state governments are assured 14% annual revenue growth for the first five years after the tax’s July 2017 launch.

The group of ministers (GoM) led by Karnataka chief minister Basavaraj Bommai could not conclude discussions on how the GST rates could be revised, leading to a delay in the submission of the report. The panel was constituted in September 2021.

Given that stakeholder consultations on the GoM report will also take time and that some key state elections such as Gujarat and Himachal Pradesh are due in 2022, a comprehensive GST rate rejig could be deferred on for a longer period.

While the council made some attempts to correct inverted duty structures across several value chains, the decision to roll back a uniform GST rate for textiles proved that it won’t be an easy option.

The council had to drop a plan to hike the GST rates for most textile products in the man-made fibre value chain from 5% to 12% in late December 2021, amid protests from the industry from Gujarat and other states. It may revisit the issue soon.

With the hardening of commodity prices after the Ukraine-Russia conflict, India’s wholesale price inflation (WPI) reversed it trajectory in February 2022 and increased to 13.11%, after coming in at 12.96% in January. Retail inflation (CPI) in February also rose marginally to 6.07% from 6.01% in the previous month, hovering over the upper bound of the RBI’s inflation target range of 2%-6%.

“It is essential to carefully consider all aspects including the possibility of inflation, before concluding on the rate rationalisation exercise. It is also necessary to ascertain views of key industry stakeholders,” said MS Mani, partner, Deloitte India.

It was envisaged that GST would produce significant incremental economic growth and improve revenue productivity. But revenues from this comprehensive destination-based consumption tax have consistently been below the government’s expectations, partly due to the pandemic. Revenues improved in recent months due to a crackdown on evasion and formalisation of the economy.

Officials are hopeful that the average monthly GST collections would improve to about Rs 1.35 lakh crore from Rs 1.23 lakh crore in FY22, thereby generating about Rs 90,000 crore in additional state GST collections in the next financial year.

There have been discussions on merger of 5% and 12% GST rate categories into a single rate of 7% or 8%, another official said. However, raising GST rates at this juncture may not be easy for commodities such as food products that attract a 5% rate.

An analyst pointed out that if the GST Council has to replace the existing structure of four rates — 5%,12%, 18% and 28% — with a three-slabs system, then the peak rate of 28% is unlikely to be touched because it covers a few luxury items. The other option is to get 5% and 12% rates merged to 7%-8% or merge the slabs of 12% and 18% to 15-16%. Again, 18% may not be changed as it is giving 70% of GST revenues. It is also possible that some items may be moved to the 18% slab from 5% or 12% now. Also, a few items in the 5% category might be exempt.

While the GST compensation mechanism is to end on June 30 this year, several states have demanded that the facility be extended, finance minister Nirmala Sitharaman told Parliament earlier this week. The Centre has however reiterated that the statutory requirement was to compensate the states for GST shortfall only for the initial five years after the GST’s launch. 

Also, it pointed out that just for servicing the loan taken to compensate the states for 2020-21 and 2021-22, the cesses will need to be in place till the end of FY26.

Following a GST Council decision, the Centre released Rs 1.1 lakh crore for 2020-21 and Rs 1.59 lakh crore for 2021-22 as back-to-back loans to make good the shortfall. The Centre has mobilised the funds through borrowings under a special window provided by the RBI.