What is GST, and how does it impact you – the trader/investor?

Blog | Trading 101

On the evening of 3th August, it was the headline you simply could not miss. The GST Bill Gets Passed!

Television pundits hailed it as a landmark bill. Social media raved over it. And the general feeling was that this was a very, very good thing for the Indian economy. 

But you're a trader/investor. You follow the markets. And if there's one golden rule in trading, it's this. The market never lies.

As this blog is being written during market hours on the day after the GST passing announcement was made (4th August), the markets have remained completely flat. The Sensex is currently hovering around 27,700. In fact, over the past 5 trading days, the Sensex has fallen close to 2%.

This begs the question: if the media is lauding the GST bill announcement, why isn't the market reciprocating the same sentiment?

What is GST?

GST stands for the Goods and Services Tax. Without getting into extreme details, the primary purpose of GST is to bring a uniform tax code to the country. The motto that the GST campaign has been running with (literally) is "One country, one tax."

Examples are usually the best way to explain anything, so let's jump right in with an example of how the current taxation system in India "works".

Suppose I own a company in Maharashtra that manufactures high end designer handbags in Mumbai but sells them to loyal customers in Delhi. From a company's perspective, I pay taxes to the central government in the form of direct taxes. GST has no bearing on direct taxes levied by the central government; therefore, the taxes I pay to the central government will not directly change with passing of GST.

All other taxes fall under the category of "indirect taxes". What are indirect taxes? Each time I manufacture a handbag, there is a tax called excise tax. This is levied upon me as soon as a handbag is manufactured and leaves the factory building. Next, the handbag crosses borders from Maharashtra all the way to Delhi. Each state has its own consumption tax. Therefore, whenever someone buys one of my handbags in Delhi, he/she is paying a consumption tax that goes to Delhi's state government. You might be aware of this tax - it's called VAT (value added tax).

A Complicated Matter

But it gets more complicated. In order to make my handbags, I need raw materials, many of which I might import from other states. Suppose I need to import cotton from Gujarat. Gujarat would levy a central excise tax and a sales tax in order for me to purchase the cotton. Then, in accordance with the consumption tax mentioned above, there would be another consumption tax levied by Maharashtra's state government if it is consumed in Maharashtra. Since my final customer is in Delhi, however, Maharashtra would levy an "export tax" on the sales cost.

If you find this confusing, you're not alone. And that's why GST is being hailed as a savior of sorts.

Under GST, there would be no excise taxes, extra consumption taxes, export taxes, state excise taxes, etc. Instead, there would be a "uniform" GST. Within GST, there would be a state GST and a central GST. But the overall "GST tax" would be capped at 18% (the exact rate is yet to be determined).

What's also important to remember is that the GST would be imposed on where the product/service is being consumed (consumption).

There are, of course, a lot more details to this; but the basic idea is that taxes such as Excise Duty taxes, Service Tax, State VAT, Central Sales Tax, Purchase/Luxury Tax, Entry Tax, and other forms of taxes would all be replace / absorbed by GST.

Isn't that wonderful? It sure sounds like it. So why doesn't the Nifty agree?

Theory #1: The Information Has Already Been Priced In

This is a popular argument, and there is a lot of merit behind it. If you simply do a quick Google Search with "GST" and "2015", you will notice that substantial talks were already underway that by mid 2016, GST would be passed. In other words, this isn't really "news".

If you simply look at the official GST India website archive from November 2015, you will notice that the wheels were already set in motion. Since then, the chatter only picked up.

Over the past 6 months, the Sensex has gone up 14%. 

It would be downright ignorant to believe that the markets had not already expected GST to be passed sometime mid 2016. Therefore, the theory that yesterday's "news" was priced in holds a lot of substance.

Alas, if only the markets were that simple to understand.

Theory #2: GST Has Been Hyped

On paper, GST sounds fantastic. From virtually every angle, it sounds like a system that is aimed at simplifying a complicated process. It eases the burdens of doing business, reduces taxes, should curb corruption, and basically benefit most citizens and companies of India.

The problem in a situation like this is that, when dealing with the stock markets, proper implementation is vital for the markets to continue to surge upwards.

Many do not know that GST has been implemented in other countries. Canada, New Zealand, the UK, Malaysia, and Singapore are a few examples. What separate the successful cases from the not-so-successful cases came down to proper implementation of GST. In the case of Singapore, the GST was originally introduced at 3% in 1994; since then, it has climbed up to 7%.

Hong Kong saw Singapore as a cause of concern. Its citizens did not want the GST rate to increase over time, and were generally wary of a tax that "penalized" consumption over saving. In 2006, the citizens of Hong Kong voted against the implementation of GST.

In both the case of Singapore and Hong Kong, the rate of GST was the driving force behind the decisions. And as it stands, the belief is that the upper cap on GST will be in the 18-20% range. It is widely acknowledged that, even after GST is implemented in its full capacity, it will take many months for the massive overhaul to truly kick in and positively impact businesses and citizens alike.

The Bottom Line

If you're looking to find out which sectors are likely to "benefit" from GST, a simple Google search will do that for you. In general, any sector where the taxation rate is higher than 20% should benefit. On the other hand, sectors where the taxation rate is generally lower than 18%, like most services based sectors, might find GST to be more of a hindrance.

But this is an oversimplification. The stock market is a wild beast to tame, and the worst mistake you can make is to oversimplify a reform like GST that will have massive repercussions in our economy.

The best thing you can do is to avoid the herd. The herd right now is oversimplifying the pros of GST without acknowledging the reality that not only has most of the information been priced in, but it will take 8 months at the earliest for any sort of concrete implementation to kick in. Until then, stick to your mode of trading and investing.

You just might find yourself stumbling upon a a great trade opportunity that others overlooked because they were looking in the wrong place.

Download IconDownload the Upstox App Today