GST Council meet today: Narendra Modi needs to save small units, not let rivals demonise the tax reform.

Small companies are feeling the heat of the Goods and Services Tax (GST) rollout. And, this adds to the pain faced by the economy at this juncture. The simple reason is that millions of tiny entrepreneurs, commonly known as micro, small and medium enterprises (MSMEs), are a major employer in the economy giving jobs to around 8 crore people and contribute close to 40 percent of the Gross Domestic Product (GDP).

In that sense, these firms are the backbone of the economy. After the rollout of the GST, this segment is facing severe cash flow issues. This is mainly due to delayed refunds and the complexity of the compliance process in the new technology framework. Also, across industries, demand has taken a hit and there are no fresh investments. If this persists, the short-term liquidity mismatch can seriously hamper future prospects of these firms, warns India Ratings and Research, one of the rating agencies in a note.

“The short-term liquidity crisis arising from delayed input credit refunds is due to the difficulties in mapping the inventory held on the transition date with respective invoices, various GST Network-related technical issues and admissibility of these refund claims. The admissibility can depend on companies’ ability to match corresponding tax invoices with vendors’ filings,” the agency said.

In the recent monetary policy, the monetary policy committee (MPC) too had noted that even the rollout of the GST has had a temporary negative impact on the growth. “The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates,” the MPC said.

Nevertheless, GST is a great idea whose time has come in India. Being an ambitious economy, India needed to embrace the uniform indirect tax structure sooner than later. And the Narendra Modi government has done a good job in generating a political consensus to make this happen a decade after the idea was first discussed in Parliament.

It is wrong to compare the GST with Modi’s other economic moves such as demonetisation. This is a much-needed, long-awaited tax reform while note ban was a risky adventure, that later turned out to be a misadventure for the economy. Unlike this, GST is a progressive step India has taken to elevate the economy to the next orbit of development.

The government’s determination to meet the 1 July rollout date was sure to be followed by hiccups in the initial stage and needed to be corrected at the earliest. Small industrial units need to be give special care since these entities lack the clout and financial muscle enjoyed by large corporations. The GST Council should offer relaxations to these companies by making it easier to file returns (lowering the number of returns from three a month currently and a cut-off for small firms).

As India Ratings points out in its report, GST will also result in higher working capital requirements for the majority of manufacturing companies since these entities need to pay the entire tax at the point of dispatch of goods from the factory gates, and also for the movement to warehouses. The agency estimates the jump in working capital requirement at 200-450 bps of revenue for the steel industry and at about 500 bps of net value addition across the value chain for the textile industry. “The increase in working capital requirement, as a proportion of revenue, would aid bank credit growth for large corporates,” it said.

This will create demand for bank loans. But, the big question is whether the banking sector, neck-deep in bad loans, will be keen to fund this demand. Bank lending to MSMEs contracted by 3.4 percent till August this fiscal year as compared with a contraction of 4.6 percent in the year-ago period. For medium-sized companies, the contraction in credit growth has been 5.7 percent while for large companies, it was 2.3 percent this fiscal year till August. Unless the bad loan problem gets resolved, it is unlikely that banks will re-open their lending channels to small and medium companies in a big way.

But, none of this should be a reason for politicians to write-off GST comparing it with demonetisation. Clearly, the onus is on the government, which needs to urgently work out a solution to help these companies overcome the transition phase. Modi shouldn’t let the opposition demonise the GST giving an excuse of faulty rollout. As the World Bank too has noted, despite the temporary pain, GST is going to have a positive impact on the economy in the long-term. The immediate task for the government is to cushion small industrial units from the transition pain by addressing inefficiencies in the implementation while taking political consensus ahead.