GST – a step in the right direction: After a long wait, the GST constitutionamendment bill finally got approved in the upper house of parliament (RajyaSabha). But the process is still not complete and the proposed tax reform willneed to go through several rounds (state legislative approval, setting up theGST council, deciding the GST rate, list of exemptions, IT infrastructure andfinalising the operational aspect of the tax regime etc) before it can getimplemented. In the short-term, we expect some temporary disruptionsincluding rise in services inflation and adjustment pain as both the privatesector and the government come to grips with the complexity and lag in GSTimplementation. That said, we believe GST is a key structural reform thatwould help create a uniform national market, reduce the cost of doingbusiness, increase efficiency, boost investments and lower inflation.
According to our estimates, implementation of a comprehensive GST acrossgoods and services would add, ceteris paribus, 0.7-1.2% to India’s GDPgrowth in the medium term. We believe the first (and the biggest) hurdle toGST has been cleared and now the discussions related to its roll-outlikely from Apr-17) will be ongoing over the next several weeks. We shiftour focus on the upcoming monetary policy review on August 9th, inflationtargeting and the constitution of monetary policy committee.
Rates likely to be kept on hold on August 9th: We believe the goodprogress of monsoons, a deferred hike in allowances under the 7th paycommission, sluggish global commodity prices (except for gold) and agradual domestic demand recovery will likely keep inflationary pressurescontained, barring the seasonal variation in FY17. Indeed, we expect CPIinflation to average ~5.3%YoY in FY17. Considering RBI will be in a transitionmode (Dr Rajan’s term ends during first week of Sept-16), we expect rates tobe on hold in the upcoming policy review on August 9th. However, we maintainour view that the RBI will cut rates by a further 25–50bp in FY17. We believethe pace of transmission of cut in policy rates in terms of lower lendingrates will remain the key focus of policymakers.
Adopting 4% (+/- 2%) inflation targeting highlights policy continuity:Today, the government indicated that RBI will aim to keep CPI at 4% through2021, while allowing rate to fluctuate in a 2% to 6% band. It mentioned thatthe wide range allows the monetary policy committee to recognize "short runtrade-offs between inflation and growth but enables it to pursue the inflationtarget in the long run’. We believe formally adopting inflation targeting addscredibility and transparency to policy making and ensures that the new RBIgovernor stays on the path laid out by Dr Rajan (whose terms ends in the firstweek of Sept-16).
Constitution of monetary policy committee: The policymakers have beentrying to constitute a Monetary Policy Committee (MPC) so that the policy raterequired to achieve the inflation target is determined by a majority vote, unlikethe current practice, whereby the RBI governor decides the monetary policy.
The MPC will have 6 members – 3 from RBI and other 3 appointed by theCentral Government, on the recommendations of a search-cum-selectioncommittee (link). The finance ministry has indicated that MPC will beframed post the next policy review on August 9th.
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