A week of shifts in external policy and domestic taxes

Given most Indians' high propensity to consume, GST changes would result in hardly any revenue loss

Hope floats on China visit and tax cuts

When the real economy weakens, the stock market gets a high. This has been the case, ever since the excess liquidity sloshing around in the world’s financial markets converted stock prices and indices into a function more of liquidity than of underlying corporate performance. US job openings have slid to a 10-month low, although a more comprehensive jobs report is due only this Friday. But that slide was enough to convince investors that the Fed is going to cut rates this month. Lower rates mean looser liquidity, and higher stock prices. Bottoms up!

In India, the GST reforms announced by the finance minister Wednesday night has added to the exuberance. Rates have been reduced on a number of goods and services of mass consumption, even as SUVs that are longer than 4 metres, the only kind of automobiles that have been selling in decent numbers for months on end, see their GST rate go up from 28% to 40%. The GST Council has raised the cost of energy in the economy, increasing the GST on coal from 5% to 18%, and increasing the GST on transportation of crude and refined products by pipeline from 12% to 18%. The GST on job contracts associated with exploration and development of oil fields, and the production of hydrocarbons has also gone up. Since GST does not apply to either electricity or petrofuels, the increase in these tax rates will add to the cost of energy in their totality.

Prices at the fuel pump are an opaque mishmash of duties, cesses, and staggered changes that oil marketing companies make to pass on changes in global crude prices. So when the price goes up, it is not clear to the consumer why that happens. The cost of thermal power, which is the mainstay of India’s power generation, will go up thanks to the increase in GST on coal — the defence that the new 18% GST would subsume the Rs 400 a tonne compensation cess does not wash, as the compensation cess will disappear sooner rather than later, when borrowings made to pay compensation to the states are paid off, but the GST at the enhanced rate would continue. This would raise both the cost of power and the electricity duty the states levy on power prices. Consumers would, of course, feel the increase in power prices, but attribute it to the rise in electricity duty and state level decisions, rather than link it to GST changes.

In other words, the latest round of GST reforms seeks to propitiate consumers by lowering rates they can see, while raising rates they do not directly observe. Visible taxes down, invisible taxes up.

However, the consumption of goods that have turned cheaper, thanks to the rates coming down, is likely to go up. Such goods include small cars, with engine capacity up to 1,200 CC in case of petrol engines, and 1,500 cc in case of diesel engines. The consumption of more premium goods and services, which stand conflated with luxury/sin goods and face a steep tax rate of 40%, would fall. The savings on goods made cheaper by lower GST rates would also be spent, given the high marginal propensity to consume for most Indians. That expenditure would generate fresh GST revenues. The final tax giveaway is likely to be smaller than the initial estimate of Rs 48,000 crore. Stock market exuberance is not particularly irrational.

The bond market is not all that cheerful. In the US, yields on long-term government bonds touched 5%. In the UK, they crossed 5.6%. In France, the yield on 10-year bonds is 80 basis points above the euro-area average. The French prime minister Francois Bayrou has called a confidence vote in a Parliament in which centrists who would support him are a distinct minority, as he seeks to push through a budget that would cut spending to trim France’s burgeoning national debt, which has crossed 114% of GDP. President Macron probably hopes to trigger yet another round of Parliament elections, in which parties other than the hard right National Rally would put up common candidates far more coherently than they had done in the last elections, to hand the hard right a resounding defeat. That would help the centrists, come the next presidential elections.

President Trump’s tariffs have been ruled illegal by an appeals court. But he has time to move the Supreme Court before the ruling takes effect. The defunding of Harvard has also been ruled to be illegal. Trump would approach the Supreme Court on that , as well.

The Trump tariffs and the US administration’s concerted hostility towards India has made India and China stage a reconciliation of sorts. After a gap of seven years, the prime minister of India has travelled to China, and met with the Chinese president, as well as the President of the Russian Federation. The meeting of Russia’s leader Vladimir Putin with the leaders of the world’s two largest countries — one of which is the world’s second largest economy, and the other, the world’s fastest growing large economy — tells the West that it no longer sets the agenda for the rest of the world.

The SCO meet condemned terror in general and the Pahalgam attack in particular. With this concession on China’s part — in diplomacy, a concession to India can take the form of a good spanking for Pakistan — India is now in a position to relax assorted curbs on Chinese business activity in India.

PM Modi went to China via Japan. In Tokyo, India reiterated its commitment to the Quad, in which Japan, Australia and India partner with the US, ostensibly for stability in the Indo-Pacific and world peace, but in reality to contain China. This makes India one of the few countries to be truly non-aligned, or multi-aligned, if you will. The rest of the BRICS grouping would find India a useful bridge to the non-American West, say the European Union. Japan has promised to step up investments in India.

While India registered a surprise GDP growth of 7.8% in the April-June quarter, and the latest purchasing managers’ indices are all upbeat, India can do with as much investment as it can get. In this quarter of fast growth, the share of gross fixed capital formation in GDP remained stuck at 30.4%. While this is better than this crucial ratio being below 30%, it is nowhere near the 35% India needs for growth to speed up, leave alone the 45% rate that China has sustained for long.