On 15th August, India’s prime minister, Narendra Modi, used his Independence Day address to announce a sweeping simplification of the country’s goods and services tax (GST). The patchwork of four main rates—5%, 12%, 18% and 28%—will be collapsed into two: 5% and 18%. A punitive 40% levy will remain for 'sin' goods such as tobacco and alcohol. The aim, said the government, is to ease compliance, reduce distortions, and put more money in consumers’ hands. To investors and economists, the announcement sounded eerily familiar. Six years earlier, on 20 September 2019, the finance minister stunned India Inc by slashing corporate taxes from 30% to 22%, and from 25% to 15% for new manufacturers. For firms such as Hindustan Unilever, Asian Paints, Nestlé India, Bajaj Finance and HDFC Bank, the cuts meant a windfall. The BSE Sensex soared 5.3% in a single day and 2.8% the following Monday, its biggest two-day rally in years. Yet, the enthusiasm quickly faded.
The tax cuts were just a knee-jerk reaction, a desperate response to a flagging economy. Growth had slowed to 5% in the first quarter of that year—3.5% on old calculations. Exports were languishing, unemployment rising and auto sales had sunk to a two-decade low. The financial system was in crisis, with shadow banks teetering. The tax bonanza was supposed to spur companies to reinvest their savings, leading to employment. But higher retained earnings don’t drive the expansion plans of cash-rich companies; only strong secular demand does. No wonder the generous tax cuts did not translate into corporate expansion. We are still waiting for the private capital expenditure (capex) upcycle.
Instead, six years later we are getting another sharp tax cut. The economic setting in 2025 is less catastrophic, but hardly robust. India Inc's core earnings shrank 3.3% year-on-year (y-o-y) in the April—June quarter (Q1FY25-26), the second contraction in four quarters. Revenue grew 7.3% y-o-y, but excluding financial services and oil companies, growth was only 5.3%. Profit before tax fell 7.4%. The earnings of 3,051 listed firms shrank. India's core sector output grew just 2% y-o-y in July, down from 2.2% in June.
Industrial output overall dropped to a 10-month low of 1.5% in June. Slippages at Indian banks rose 26% y-o-y in the June quarter (Q1FY24-25), driven by stress in microfinance and unsecured retail portfolios. Fresh slippages reached Rs49,000 crore, up from Rs39,000 crore a year earlier. Recoveries and upgrades fell 3.4% to Rs28,000 crore, while write-offs declined marginally to Rs26,500 crore. Gross non-performing assets (GNPA) rose 6.7% to Rs4.8 lakh crore. The data suggests early signs of credit fatigue.
Foreign portfolio investors (FPIs), spooked by sluggish earnings and a sliding rupee, sold Indian equities worth Rs21,000 crore in the first half of August alone, bringing outflows to Rs1,16,000 crore in 2025. Foreign institutional investors (FIIs) sharply reduced their exposure to Indian equities in July, making India the most underweight market among emerging market portfolios. India's relative weight fell to a negative 2.9 percentage points versus the MSCI EM index. Meanwhile, China, Hong Kong and South Korea saw increased allocations.
Can GST 2.0 reverse this picture? Cutting consumption tax for the masses is different from cutting income-tax for rich corporates. The State Bank of India reckons that rationalisation could lift annual consumption by nearly Rs200,000 crore, or about 8% of household demand. In an economy where consumption contributes nearly 60% of GDP, the hope is that higher household spending will ripple through manufacturing and services, spurring growth.
But the immediate trigger is geopolitical. In a sharp escalation of tensions, Washington has branded India a prime enabler of Russia’s war effort, thanks to its purchases of cheap Russian oil. On 27th August, America will impose a 50% tariff on around US$50bn (billion) of Indian exports—more than half of its US$80bn in annual shipments to the United States. Few importers will absorb such a price hike. Unless exporters find other buyers—or some last-minute deal is struck—a large chunk of sales will vanish. This is where a lower consumption tax makes sense. Domestic consumption, courtesy of GST 2.0, is intended as a buffer. However, the mercurial US president can escalate his war by targeting Indian software exports, H1B visa, and foreign remittances which are critical to India’s balance of payments and currency stability. But until that happens, the GST 2.0 will help.
The trouble is that such tactical cuts do little to address India’s deeper weaknesses. In 2019, if tax policy had been part of a coherent growth strategy, it would have been built into the Budget, not unveiled as a bolt from the blue. The same is true today. A one-off reduction in consumption tax may cushion consumers against tariff shocks, but it does nothing to repair the structural impediments to growth.
India’s persistent failure to capture global market share is illustrative. Consider textiles, one of our top-10 exports. In 2010, China controlled 36.6% of world exports; by 2018, as wages rose, its share had slipped to 31.3%. Vietnam and Bangladesh seized the opening, doubling their shares to 6.2% and 6.4%, respectively. India’s share fell slightly, from 3.3% to 3.2%. Taxes were not the issue. Rather, it was the 'frictional costs' of doing business in India—red tape, corruption, poor logistics, and inconsistent policies—that held firms back.
The corporate tax cut of 2019 was meant to signal a pro-growth turn. Instead, it ended up as an improvised fix. GST 2.0 risks being another. There is one difference between the two situations, though. The 2019 tax cut fuelled an explosion of speculation about further Big Bang reforms coming from a reformist PM. No one is expecting that anymore.
(This article first appeared in Business Standard newspaper)
Fiercely independent and pro-consumer information on personal finance.
1-year online access to the magazine articles published during the subscription period.
Access is given for all articles published during the week (starting Monday) your subscription starts. For example, if you subscribe on Wednesday, you will have access to articles uploaded from Monday of that week.
This means access to other articles (outside the subscription period) are not included.
Articles outside the subscription period can be bought separately for a small price per article.
Fiercely independent and pro-consumer information on personal finance.
30-day online access to the magazine articles published during the subscription period.
Access is given for all articles published during the week (starting Monday) your subscription starts. For example, if you subscribe on Wednesday, you will have access to articles uploaded from Monday of that week.
This means access to other articles (outside the subscription period) are not included.
Articles outside the subscription period can be bought separately for a small price per article.
Fiercely independent and pro-consumer information on personal finance.
Complete access to Moneylife archives since inception ( till the date of your subscription )
