Will GST Change India’s Manufacturing Landscape?

GST’s impact on manufacturing and supply chain: Pains and gains

First, the bad news: Dark clouds of degrowth loom over India’s manufacturing industry.  During the first quarter of FY18, the manufacturing growth fell sharply to 1.2% from 10.7% a year ago according to Central Statistics Office (CSO) data. During the period of April-July, IIP (Index of Industrial Production) grew by 1.7 per cent, compared to 6.5 per cent of April-July last year.  In short, things look grim as they stand in the manufacturing sector.

Now some news that could bring some hope – it’d be too early to call them good news. There are some early signs of revival aided by govt initiatives, global developments such as the recent spurt growth in export volumes and the manufacturing industry’s own inbuilt resilience.

Results of the Nikkei India Manufacturing Purchasing Manager’s Index (PMI) survey released in September showed that the manufacturing activity in India rebounded in August rising to 51.2 in August from a 101-month low of 47.9 in July – good but still less than 50 which indicates expansion. “August’s PMI results showed that manufacturers in India recovered quickly from the sharp slump that followed the introduction of the GST,” said Pollyanna De Lima, an IHS Markit economist and the author of the report.

The incontestable truth that emerges from all the developments is, that the manufacturing industry needs a much greater push to become the engine of growth and provider of much-needed jobs that the economy desperately needs. More importantly, for India’s GDP to grow sustainably at 9-10 per cent per annum, it is important that the manufacturing sector must grow steadily at 14-15 per cent per annum over the next three decades.

Among all the growth enablers, the government and the industry have for long put their faith in a landmark reform – GST (Goods and Services Tax). After more than a decade of speculation and political tug of war, GST was at last introduced this year on July 1. Manufacturing industry stakeholders are hopeful that GST could be the magic pill that turns the industry around. The MD of the Indian arm of VDMA, a global Mechanical Engineering Association, Rajesh Nath says, “After 17 years of brainstorming and political deliberation and hurdles, the biggest tax reform in Independent India, the goods and services tax (GST), was finally rolled out on the 1st of July this year. This will surely send out positive signals to the world and the country is going to be seen as a unified market.” He adds that GST will further improve the ease of doing business in India, which could potentially help in making the business environment increasingly conducive. “The first indicators after implementation of GST are positive as tax collections under GST had come to over Rs 93,000 crore in the month of July. This has far exceeded the expectations as this is based on the fact that only 63% of tax assesses had filed their returns.”

Further, a joint report by ASSOCHAM-EY released in August this year stated that the introduction of GST is exFpected to have the following positive outcomes for the manufacturing sector:

Reduced production costs: The cascading effect of the taxes faced by manufacturers on purchase of raw materials and supplies will be eliminated.

Smoother supply of goods within the country: Reduced scrutiny at state border checkpoints and lighter compliance norms will lead to cost and time savings, improving supply efficiency by over 60%.

Supply chain restructuring: Prior to GST, key logistics decisions such as warehousing and storage were made in order to optimize indirect tax costs, given the arbitrage between VAT rates in different states. GST will cause these decisions to be made keeping in mind business efficiency and locational advantage.

Area-based exemptions: Area-based tax exemptions will be discontinued so that the credit chain along GST is not disturbed.

While the aforesaid points provide an encouraging overview of GST’s impact, one also needs to understand the prevailing sentiment on the shopfloor, to see how manufacturing industry stakeholders perceive its impact for the near and the long term.  To bring in that perspective, Dynamic Manufacturing India spoke with industry thought leaders about all these major implications and then some. Presenting, views from the top.

Early View

For one, GST has, without a doubt, widened the tax net and made transactions more streamlined than before. Dhiruj Sarda, Managing Director, East Coast Magnets Private Ltd, a leading maker and supplier of Magnetic Chucks and Holding magnets, says, “Things are moving smoothly than before for us – small vendors who were not inclined to register for VAT and would rather want cash transactions are also now willing to go with GST as it gives them the benefit of input credits.”

Ravi Shankar S, Manufacturing Excellence Consultant and former Managing Director DMG MORI India says: “Metal working industries and machine tool industries supply to every manufacturing sector. Hence the business continues as before; however the uniform tax rate should help the industry to perform better in the long run.”

Impact On Manufacturing Footprint

The biggest implication of a one-nation one-tax system has to be on the manufacturing footprint of the country, that is, it should enable companies to locate or relocate plants at locations which promise better quality of manufacturing in terms of labour, capital and infrastructure. Will our country’s manufacturing map see any such impact?

Industry thought leaders say that, though manufacturing locations could be relocated in the long run, in the immediate turn it doesn’t look imperative especially since many exemption benefits from the earlier tax regime continue.

Mr Ravishankar says, “The industries in the SEZs in Industrially backward states are exempt from GST and the exemption is in the form of refund. Hence those industries continue to receive the benefits. The Industry can make rational decisions for the location based on either raw-material availability or market for finished goods as the case may be.”

Mohini Kelkar, Managing Director, Grind Master Machines Pvt. Ltd says that “Shifting of manufacturing base within the state is now easier from an administrative point of view as all the units will have one GSTIN. This would save and ease further administration of maintaining separate records and compliance with government authorities. Ms Kelkar affirms that companies in the machine tools industry, including Grind Master, have benefitted post GST: “In machine tools business, centralising manufacturing facility at one place is very much important from the point of productivity. Grind Master has been benefitted post GST.”

Sharing the perspective of his industry, Mr Sarda says, “We are in the light engineering sector and hence our choice for location is based more on small vendor support and better infrastructure. This is the reason we expanded our operations in SRICITY, Andhra Pradesh for its proximity to Chennai and also extremely good infrastructure in the Industrial area.”

However, Asim Behera, Chief Operating Officer-Daifuku India is of the view that it is the distribution network that many companies have begun to deliberate post GST. “Manufacturing set-up is very segment specific — different segments have different criteria for how they set up their network. Also, many companies have set up manufacturing based on certain tax incentives they would get; thus you see that regions such as Baddi, Rishikesh, etc. have become industrial hubs. GST has not rolled out statutory tax benefits so it really wouldn’t have an impact on manufacturing network, where it will impact is the Distribution network planning. And we are starting to see various Supply Chain Heads discuss more on the distribution network planning.”

Mr Nath of VDMA says that, in the long run, we could see a definite impact of GST on India’s economic map. “GST has eliminated taxes on inter-state movement and harmonised the VAT structure across states – except for exempted goods. Border inspections are significantly reduced. That said, GST is expected to result in a significant increase in internal trade — by as much as 30 to 40 per cent, according to some estimates.”

He says that there are other economic factors also at play that can significantly alter the economic map of the country by diluting the ‘home market’ effect. “The work of economist Paul Krugman has shown that when the costs of producing a good are lowered with scale in production, there is an incentive to geographically concentrate such production. Particularly so when additionally, there are large benefits in transport costs and production costs by locating the production base near the largest market to minimise transportation costs – which brings in the well-known “home-market” effect. In this setting, a reduction in transport barriers, as is the case with GST, can change the location of production within a country quite dramatically — away from the largest market to low production-cost locations, thus diluting the home-market effect.”

Impact on Production Costs

The earlier multi-layered and multi-regional tax regime marred the efficiencies of the manufacturing sector – GST is expected to unlock the sector with reduction in procurement and logistics costs.  Mr Nath says: “One of the advantages of GST is reduced cost of production that is expected to be spurred by tax reduction. The subsuming of the entry tax for inter-state transfers is a key reason for reducing cost of goods and services. For example, a supplier of cement from Maharashtra to Karnataka was earlier required to pay entry tax when the supply crossed the interstate border. For Karnataka, the entry tax rate was 5% of the value of the goods. The supplier would pass on this additional cost to the customer, resulting in increase in selling price. With entry tax being subsumed, the supplier need not pay the entry tax rate amount and consequently, not charge the customer this amount either.” He adds that manufacturers need to re-work the prices to be quoted to the customers for each product range and work out the reduction of pricing to comply with the anti-profiteering clause.

Mr Sarda concurs that  GST has resulted in lower cost of production, “but at the same time a few companies have increased their margins to keep the prices same. We feel that over the next few quarters things will stabilize even more.” Others also advise a wait-and-watch approach. Mr Ravishankar says that presently it is too early for any manufacturer to comprehend and realise the entire cost benefits. Perhaps in the next six  months to one year the entire cost impact will be visible.

Mr Behera says that some sectors are going to have a lower cost of production whilst other will have a higher cost of production. “I am interested to see how much of this gets passed onto to the consumer,” he says.  Ms Kelkar says that for her company, GST will not see reduction in costs because most of the purchases and job work for the company is within one state.  “Yes there would be saving due to CST for which credit was not available.”

Impact On Vendor Relationships

Many Operations Chiefs that we interacted with recently said that the toughest part of GST transition was getting their vendors on to the GST network. Factors such as increased compliance cost and pre-GST inventory destocking adversely impacted vendor relationships for many companies. We asked the sector leaders their experience in this area.

Ms Kelkar concurs that GST has impacted vendor relationships, however her company has seen this as an opportunity to strengthen relationships: “In many organisations it would be happening that vendors in the last tier would have been shed off or the companies would have reorganised purchases by consolidating with other major vendors.” But she emphasises that her company has decided not to remove even the smallest vendor. “In the machine tools business, manufactured parts as per design make a lot of difference. Hence, there are many vendors who are in micro and small sector. Out company has strengthened the relationship with these vendors by offering various services like getting them registered under GST, shifting them from manual accounting process to computerised accounting and all possible assistance to be GST Compliant.”

Mr Sarda says that “The introduction of GST would have certain impact on vendor management that can’t be ignored. Creating unified credit mechanism across the supply chain till goods or services are consumed entirely is the basic structure of GST. This is only possible when the goods and services are procured from the registered vendor. In order to tackle this, the companies need to engage with their vendors in this sector early so as to understand their readiness for this tax system. Also, any further delay or blunder in depositing GST by the vendors would result into several settlement issues.”

Mr Behera agrees that procurement definitely has been impacted but more so in terms of delays due to compliance rather than a paradigm strategy shift. “We continue to use the vendors we have had long term relationships with. For any new vendors, we are looking for them to be GST compliant as a pre-requisite.”

Mr Ravishankar said that “Initially there were certain delays which resulted from ensuring that all vendors and customers in the chain are ready with the registration and process. Subsequently more or less all are registered and business process have been proceeding unhindered. Issues may crop up when the returns are filed and if there are differences in the input credit. As said earlier the real issues might get highlighted after few months when the full business cycle gets completed, the refunds are accounted and more so after one full year when the audits are finalised.”

Spurt in Contact Manufacturing

Mr Ravishankar makes a prescient point when he says, “With the state levies removed and the check posts abolished, the logistics to a large extent has got simplified. Hence contract manufacturing will get a boost as the decision will be purely based on cost and convenience. In the developed economies like Germany and US, the large corporates focus on design, development, final critical-part manufacturing and assembly; the rest is outsourced.”

He adds that the earlier trend in India was to have all manufacturing processes including the raw material procurement and even the manufacturing of machines and tools done in house to ensure that the required knowhow and technology is not available outside. Most of the companies had their own tool rooms. Now the trend is to outsource as many processes as possible to ensure that cost of manufacturing is minimised. Mr Sarda agrees: “Yes, it [boost in contract manufacturing] seems to be a natural progression.

Enabler of Mission Make in India

The present dispensation had put up GST as one of the landmark reforms that will help India realize the goals of Mission Make in India. The experts are hopeful but advise rational exuberance.

Ms Kelkar says, “It seems that the present Central Govt has really taken up the agenda of “Ease of doing business” in its stride and is working towards achieving the same sincerely.  I see it clearly that “Make in India” is not the only campaign rather one of the host of programs taken by the government that would definitely enable Mission of Make In India.  GST will prove to be an enabler of Make in India owing to the following reasons:

1)   A Simplified Tax Regime i.e. GST would definitely attract foreign investment to India which in turn will be boost ‘Make in India’.

2)   With GST, the cascading effects of taxation are removed which will benefit the customer in terms of lowered prices and will eventually present a level playing field to Indian manufacturers

3)   The uniformity of tax regime would enable Indian manufacturers to leverage the benefit of markets present in any part of the country which was actually a tough feat in the earlier tax regime.

Mr Sarda is also rationally exuberant. He say, “GST itself as an enabler for ‘Make in India’ would not be possible, but yes it would give it a push forward. The top reasons we believe for the same are:

o    A simplified tax structure hence reporting is easier.

o    Smaller vendors are now getting registered hence their costs come down creating an forward ripple effect for cost reduction.

o    With increase in contract manufacturing and jobwork outsourcing, GST will help with the simplification of the process and movement of goods.

Mr Behera says, “As of now I don’t see a direct link. The real manufacturing enablers are: good utilization of current capacity, easy availability of credit, stable government policies and an optimistic outlook for demand. All of these appear to be going the right way as our internal demands go up; so, Make in India looks more favourable than it has been for a while.

Mr Ravishankar says, “When it comes to World bank ranking on ease of doing business India still at 130 out of 190 which is far below. The introduction of GST and successful implementation will be a further step to improve the India’s ranking. Unless this ranking is improved significantly, Mission Make In India will remain a distant dream. Therefore, GST will be and an enabler for Make in India Mission. Both GST and demonetisation efforts from the Government have weighed heavily on the last quarter’s GDP Performance [the GDP growth rate has dropped to 5.7%], but these bold surgical measures by the government are expected to bring up the growth rate to 8% by last quarter.”

Mr Nath shares the optimism: “The manufacturing sector in India contributes a mere 16% to the overall GDP. However, the potential to make this a high-growth and high-GDP sector is huge. The “Make in India” campaign makes this possibility real by giving impetus to the sector. Furthermore, it is estimated that India will become the fifth largest manufacturing country in the world by the end of 2020. The introduction of the Goods and Services Tax or GST is expected to be an enabler.

One reason is that GST will usher in an era of transaction-based valuation, making calculation of tax much simpler for the manufacturer. The other being that under the new tax laws, manufacturers can claim input tax credit on input goods, which seems to be a positive sign for cash flow. SMEs are keenly observing the time difference between input tax credit and the credit being available,” he concludes.

This Article was featured in Dynamic Manufacturing India Sep -Oct 2017 issue .