India’s big leap forward

India has passed reforms paving the way for a single national rate of valued-added tax, which should give the economy a significant boost.

India's parliament has just passed "the most significant tax reform since independence", says Una Galani on The bill paving the way for a single, national rate of GST (the equivalent of VAT) on goods and services to replace a bewildering patchwork of different levies in the country's 29 states had been stuck in the legislature for years. The news shows that Prime Minister Narendra Modi can "compromise to get things done".

India is less of a single market than the EU, as Mihir Sharma points out on The states' tax systems aren't interconnected, while licensing scheme and regulations also vary. This incoherence is a key reason why India's companies tend to be smaller than their global rivals. "The moment you grow out of your home state, even if just to open a warehouse elsewhere, your paperwork increases exponentially."

Now businesses will be able to benefit from economies of scale; rather than replicate supply chains on a state-by-state basis, they can distribute products from a single warehouse, notes The Economist. Fiddly tax codes and exemptions car sales are subject to six different levies at various rates will be swept away. The efficiency gains could boost the growth rate by 1%-2% a year, economists have estimated.

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It could be some time before the benefits materialise, however. At least 15 state legislatures will need to back the measure, as it is an amendment to the constitution. It is not expected to be derailed, but important issues such as setting the actual rate, and which goods and services could be exempt, have yet to be settled by the new GST Council. In other words, it may be watered down to some extent.

There is still plenty to do on the reform front, however, says a editorial. A single market for tax should be accompanied by a single market in land and labour, for instance. Parliament should also tackle the pointlessly complicated licensing system. Still, this new tax shores up Modi's reformist credentials, says Capital Economics.

Since 2014 India has adopted an inflation target, cut fuel subsidies, and lifted limits on foreign investment in the railways, aviation and defence industries. It has hitherto been reluctant to prise open the retail and banking sectors, "the two areas of the economy in greatest need of increased competition".

For now, the reform may make the central bank more inclined to cut interest rates, reckons It will reduce supply chain inefficiencies and cut costs, thus bearing down on structural inflation. Core inflation is dropping too. The economy is already growing at a healthy clip. The longer-term outlook, meanwhile, remains compelling.

As asset managers Manning & Napier note on, it has become a "world-class hub" for IT services, consulting and business process outsourcing. Demographics also bode well, with the working-age population set to expand faster than in any other big economy. One way to gain exposure is through the Aberdeen New India investment trust (LSE: NII), which is on a discount to net asset value of 13%.

Andrew Van Sickle

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.