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India to Unify Tax: Near-Term Pain/Long-Term Gain for ETFs

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Markets in India have put up a solid show so far this year on a buoyant economy. Continuing the upbeat momentum, India is now set to launch the goods-and-services tax or GST from July 1 for the first time since independence. This tax will fill in for/unite more than a dozen of indirect taxes levied by state and central governments. The initiative is aimed at beefing up government revenues.

Why is GST So Important?

The move is expected to create seamless business transaction, lower cost of production of goods and reduce inflation – an economic issue that India normally grapples with (read: India Inflation at Record Low: ETFs in Focus).

As per the source, India presently has one of the worst tax-to-GDP ratios of 16.6% among key economies, less than half the OECD average of 34% and also below several emerging economies. But with the implementation of GST, which is one of the highest in emerging economies, India will come out of that issue.

The government estimates that companies would be able to save around $14 billion under the GST scheme as the tax system “will allow them to organize their warehouses and supply chains more efficiently.”

As per IMF, GST will drive India’s medium-term growth to above 8% while some analysts expect the implementation of GST to boost GDP by 1.5−2% over the long term (read: India ETFs: More Run Ahead?).

Is It a Near-Term Pain and Long-Term Gain?

Apart from the bullish ones, there are other views as well. Citigroup Inc.’s economists last year analyzed “that countries like Canada, Australia and New Zealand saw a one-time increase in inflation after GST implementation, which normalized in a year.” This pattern can be considered as a short-term negative (read: What GST Bill Passage Means for India ETFs).

Moreover, some weakness in the corporate earnings from GST may be noticed in the second quarter due to the rush of inventory clearances at discounted prices. As per a source, retailers are reluctant to load fresh stocks and are uncertain about getting credit for their present inventories under the GST scheme. 

Investors should note that the final two quarters of the current fiscal will decide if there is any slack in consumer demand from GST as several items like luxury hotels and telecom services will likely see higher tax rates. Some advanced consumption during the “pre-GST sale” period may be a drag on consumption in future quarters. However, certain business segments are likely to see an overall decline in tax outlays.

A source said that “tax on services that account for around 60 per cent of the GDP, is expected to increase under GST while taxes on manufactured products that make up 17 per cent of the GDP can move lower.” If this becomes be the taxation pattern in the GST era, advanced consumption will only be natural. 

UBS and credit rating agency Moody’s said that the near-term impact of GST will be moderate. However, Moody’s expects long-term benefits to “include higher productivity growth, due to efficiency gains in business operations, greater investment as interstate tax barriers are reduced, enhanced tax compliance and an expanded revenue base.”

ETFs to Buy

Against this backdrop, investors may jump on to buy India’s long-term growth story but buying large-cap ETFs seems prudent. Large-cap stocks have greater foreign exposure. Since international economies are on the mend and domestic economy may see some upheaval on the rollout of a new tax system, it is better to bet on large-cap India ETFs like iShares India 50 ETF (INDY - Free Report) ,PowerShares India Portfolio (PIN - Free Report) and iShares MSCI India Index Fund (INDA - Free Report) at the current level (see Asia-Pacific (Emerging) ETFs here).

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