GST Rate Cuts Amid US Tariffs: Can India’s Domestic Demand Shield the Economy?
Image by Abhyuday Majhi via pexel
New Delhi, Sep 5 (TTP): As US tariffs begin to impact India’s exports—particularly in textiles, engineering goods, and pharmaceuticals—the Goods and Services Tax (GST) Council has moved swiftly to recalibrate India’s domestic consumption story. In its latest meeting, the Council approved lower GST rates for a wide range of items, a move seen as a targeted effort to boost domestic demand and offset falling external demand.
For India, where the US remains its largest export destination, the impact of tariffs could create ripple effects across sectors. But policymakers are banking on a consumption-led growth revival, with reduced GST rates providing consumers with more purchasing power. The critical question now: Will this rate rationalisation deliver timely relief and sustain India’s growth momentum in FY 2025-26?
Why GST Rate Cuts Matter Now
- Global Headwinds: With weakening exports due to rising US tariffs, India needs to shield its economy from external volatility.
- Domestic Focus: Lowering GST rates is expected to translate into lower market prices, provided businesses pass on the benefits to consumers.
- Festive Season Leverage: If businesses adjust swiftly, the festive quarter could see a surge in consumer spending.
Policymakers believe that stimulating domestic demand at this juncture is crucial. India’s growth has been consistently driven by private consumption, and tax policy remains one of the most powerful levers available.
How Soon Will Consumers See Lower Prices?
The speed of price adjustments will vary:
- Commodities with short production cycles (such as processed food or FMCG goods) are likely to reflect lower GST rates more quickly.
- Industries with longer gestation periods and higher inventories (like automobiles, consumer durables, and construction materials) may take months before consumers benefit.
A crucial factor will be government notifications under the Central GST (CGST) and State GST (SGST) Acts. Only once these are issued and businesses account for transitional credits will reduced rates begin influencing final prices.
For consumers, expectations are high. Any delay in price correction risks disappointment—especially ahead of the Diwali shopping season.
The Transitional Credit Question
One major operational challenge is whether businesses will be allowed to adjust through transitional credit provisions.
- If permitted, businesses can offset mismatches between input tax credit (ITC) and output tax liability caused by new rates.
- Without such a cushion, companies may resist passing on rate benefits immediately, citing losses on existing inventories.
Swift clarity from the government will be essential to avoid pricing distortions in the market.
Revenue Implications for Centre and States
GST rationalisation is not just a demand-boosting measure—it also has complex implications for government revenue.
- For the Centre: Lower rates on mass-consumption goods may temporarily reduce collections, but rising demand could compensate.
- For States: The restructuring includes subsuming the GST Compensation Cess into the GST rate structure. Importantly, the highest GST rate has been raised to 40% from 28% for luxury cars, tobacco, and other “sin goods.”
This means:
- States with high luxury consumption (Maharashtra, Delhi, Karnataka) may benefit disproportionately.
- Consumption-heavy but lower-income states may find their fiscal situation strained, especially in the third and fourth quarters of FY 2025-26, when the revenue impact becomes clear.
Fiscal vulnerabilities remain a risk. If state GST revenues fall short of budget projections, revenue deficits may balloon into fiscal deficits, unless states cut expenditure—a politically difficult choice in a pre-election year.
Impact on Growth: Can Lower GST Rates Deliver?
Economic theory suggests that lower indirect taxes encourage consumption, which in turn fuels production, investment, and job creation.
An early Computable General Equilibrium (CGE) model assessment could estimate growth outcomes, but initial expectations are positive:
- Boost to private consumption – Lower consumer prices should expand demand for discretionary items.
- Higher compliance and formalisation – By making GST registration attractive, especially for small businesses, the move could integrate more enterprises into the tax net.
- Inverted duty structure risks – Where output GST is lower than input GST, refunds may rise. This is particularly relevant in textiles, footwear, and select manufacturing sectors.
Overall, while growth may receive a push, the extent will depend heavily on compliance, efficiency, and speed of implementation.
The Formalisation Angle
The GST Council has always highlighted formalisation of the economy as a key objective. Lower rates could incentivise:
- Small businesses with higher input credits to register under GST for refunds.
- Enterprises with low value addition to voluntarily enter the GST ecosystem for ITC benefits.
However, with services facing largely unchanged or higher rates, distortions between goods and services taxation may persist. This duality could complicate compliance for mixed businesses.
Risks and Challenges
While the GST rate cuts are well-timed, several risks loom:
- Delayed price pass-through may dilute the intended boost to consumer demand.
- State revenue volatility could trigger fiscal stress if demand growth is slower than expected.
- Inverted duty structures may increase refund claims, straining administrative capacity.
- Exemption list expansion could reduce overall revenue buoyancy and complicate the GST system.
Unless these challenges are addressed, the structural efficiency of GST may be undermined, even if short-term consumption rises.
The Bigger Picture: Shielding India’s Economy
India’s reliance on exports—particularly to the US—makes it vulnerable to protectionist shocks. At the same time, domestic demand remains its strongest growth engine.
By lowering GST rates, the government is betting that higher consumption can offset trade shocks, sustaining overall GDP growth. Yet, execution speed and fiscal prudence will determine whether this gamble pays off.
Final Thoughts
The GST Council’s decision to cut rates comes at a critical juncture. With external demand under pressure due to US tariffs, boosting domestic consumption is the most practical policy lever.
However, the move will be judged not by the intent, but by the speed of execution—whether businesses pass on benefits promptly, whether states manage revenue volatility, and whether consumers actually feel the relief in their wallets.
For now, this appears to be a calculated risk worth taking. If implemented efficiently, GST rate cuts could provide India with the domestic cushion it needs against global headwinds, while nudging the economy toward higher growth and deeper formalisation.