Anticipated price decrease due to GST changes could allow RBI's monetary policy committee to consider lowering interest rates by 0.25 to 0.50 percentage points.
Simplified GST Rates Boost Economy, Ease Inflation
India is set to undergo a significant change in its Goods and Service Tax (GST) structure, with economists from UBS predicting that the timing of the reform is apt and could potentially stimulate the economy.
According to Venkatakrishnan Srinivasan, Founder and Managing Partner of Rockfort Fincap LLP, the proposed GST rate rationalisation is a double-edged sword for markets. On one hand, it simplifies slabs mainly to 5% and 18%, cuts rates on essential goods, and fixes inverted duty structures. On the other hand, it is projected to cause a revenue loss of approximately ₹1.1 trillion annually (~0.3% of GDP).
The government plans to abolish the 0% and 12% GST slabs, leaving only the 5%, 18%, and 40% slabs in the new GST structure. A demerit rate of 40% will be imposed on luxury items under the new structure.
Boosting Consumption and Manufacturing Competitiveness
The GST rate rationalization is expected to reduce the tax burden on goods and services, lowering prices at the point of purchase and easing input costs for businesses. This can directly lift consumption demand and improve industrial competitiveness.
Easing Inflation and Monetary Policy
Lower and simplified GST rates on essentials and mass-consumption goods reduce retail prices, which can reduce headline inflation. This is crucial given that GST accounts for a significant component of the Consumer Price Index (CPI). By fixing inverted duty structures, the reforms reduce cascading taxes, lowering costs at various supply chain points, further easing inflation.
The reduction in inflationary pressure can give the Reserve Bank of India (RBI) room to maintain or even lower the repo rate (the rate at which RBI lends to commercial banks), supporting growth. Since GST cuts help reduce inflation, the RBI might not need to tighten monetary policy aggressively.
Managing Fiscal Impact
The GST rationalization is projected to cause a revenue loss of approximately ₹1.1 trillion annually, shared between the Centre and states. However, the government expects to offset this fiscal cost with higher consumption growth, surplus cess collections, and increased dividend transfers from RBI. Improved compliance, formalization of the economy, and higher economic activity could partially compensate for revenue losses over the medium term.
Supporting Demand-Led Growth
The GST reform acts as a structural reform that supports demand-led growth, keeps inflation in check, and allows the RBI greater flexibility in setting the repo rate. UBS economists predict that household consumption is likely to increase over the next 2-3 quarters due to the GST reform, personal income tax relief, rate cuts, softer inflation, and improved credit availability.
UBS maintains that there is space for a further 25-50 bps rate cut in the rest of FY26 to support growth. The RBI's rate-setting panel has already cut the repo rate by 100 bps, from 6.50% to 5.50%.
Thus, GST rationalization acts as a structural reform that supports demand-led growth, keeps inflation in check, and allows the RBI greater flexibility in setting the repo rate, while the government manages a moderate fiscal impact with growth-oriented offsets. However, Venkatakrishnan did not discuss the impact of the GST reform on luxury items or the expected deflationary effect on the economy.
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