Interview: ‘Demonetisation and GST accelerated the slowdown India was already experiencing’

Anil Bhardwaj is the secretary general of the Federation of Indian Micro and Small and Medium Enterprises. This group of enterprises is popularly referred to by the abbreviation MSMEs. Mostly in the informal or unorganised sector until the Goods and Services Tax was unrolled on July 1, Bhardwaj explains their adjustment problems with the new tax regime that has created much uncertainty. He believes that GST and demonetisation have accelerated India’s economic slowdown. Excerpts from an interview:

Most accounts say the Goods and Services Tax has led to an economic slowdown. Why do you think this has happened?
I do not agree totally with this view. Even before demonetisation, the economy had been contracting because of various factors. This process was exacerbated by demonetisation. The pain of it was felt in the unorganised sector, particularly in those segments that were cash-dependent.

What is the link between demonetisation and GST?
So far as the micro, small and medium enterprises are concerned, the obvious link is the unorganised sector.

Former Prime Minister Manmohan Singh recently said that the shoddy implementation of GST has hit the informal (unorganised) sector. He said it is worrying because this sector contributes 40% of India’s gross domestic product and accounts for 90% of jobs.
He is right. You see, it is called the informal sector because policy-makers find it difficult to reach out to it. This is because they are not connected formally [to the government]. Most of them are also not members of trade bodies.

Would the micro, small and medium enterprises sector be counted in the informal sector?
I’d say 90% is in the informal sector and 10% in the formal sector. What does formal mean? It means you are registered somewhere [with the government]. You are in the informal sector if you are unregistered.

When you say registered, do you mean they are registered with a tax authority?
As far as MSMEs [micro, small and medium enterprises] go, they are registered with the District Industrial Centre. It is estimated that only 10% of MSMEs are registered with the Ministry of MSMEs and the state department of industry. But that does not mean they were not registered with the local tax authority pre-GST – 99% of them were with the sales tax authority.

But 99% of them were also not registered with the excise authority. That was largely because the excise department gave them an option – if a unit had an annual turnover of Rs 1.5 crore, it could avail exemption from excise but was not allowed [to benefit from] input tax credit [tax already paid on, say, the raw material used for producing finished goods]. The majority of MSMEs did not register with the excise department to avoid the hassles of dealing with it.

Fine, so how has GST affected them, given Manmohan Singh’s statement?
First of all, GST has brought some sectors for the first time under a tax regime. That is why the Surat sari manufacturers are up in arms. They say they work on small margins, as the saris they produce cost Rs 100 and Rs 120, and their competitiveness will be hit because of GST. Some segments of handicrafts, for instance, have also come under the GST regime for the first time. Some of them asked to be included in the GST because they wanted to avail the credit of the tax they pay on the raw material [also called input credit].

Does the problem arise from the fact that those who were earlier not registered with the excise department have to with the GST regime?
The excise threshold is gone because the excise tax is gone. GST does not distinguish between a trader, a service provider, and a manufacturer. They are all the same to the GST authority. There is just one threshold – in case you have an annual turnover less than Rs 20 lakh, you don’t have to get a GST number.

But even if you are below the Rs 20-lakh threshold and you are doing business out of the state you reside in, you have to get a GST number. [GST is mandatory for those in inter-state trade]. This means anyone who is in manufacturing has to be registered with the GST authority – they cannot but buy raw material from other states. This means that everyone in manufacturing would be gradually moving to the GST regime.

For those who were part of the state tax department, GST was not particularly new to them. They knew what Value Added Tax [its origin is pre-GST] is, what input credit is, etc. However, GST is a far advanced form of tax. Those who were earlier not part of the excise regime but migrated to GST faced a few typical problems.

Like?
Theoretically, most MSMEs [micro, small and medium enterprises] are in favour of becoming part of the GST regime. This is because it makes sense for them to be part of the formal chain. If you are not, then you lose the credit of tax you have already paid on your raw material and will not be able to compete with those who have registered with the GST authority. Your product will be costlier than your competitor’s. It is therefore a huge disadvantage.

Where did the problems arise?
These came from the system. I was moving from the Value Added Tax regime to GST and I had a credit to claim. I could claim the credit if I could get it accounted for. So with the same PAN number and with the help of the state tax department, I migrated to the GST regime.

There were glitches because of the way our departments work – the names were not spelt correctly or the PAN numbers were not recorded correctly. The system was therefore rejecting many. It gave sleepless nights to them.

But such operational glitches were resolved?
Yes, these were. But the issue of preparing invoices for submission then surfaced.

Sale and purchase invoices, right?
Actually, sale invoices. The purchase invoice is taken care of by your supplier. The supplier has already submitted his invoice and the system enables your purchase invoice to automatically match his sale invoice. The document that is most important is your sale invoice.

You have to list the item you have supplied, what is its HSN code [Harmonised System of Nomenclature, which is a multipurpose international product nomenclature with each product having a number], and based on that you have to figure out how much tax you have to charge. If you have charged it wrongly, you’d be in trouble. A lot many were worried on account of this.

Isn’t it very simple to match products with the tax levied on it.
There was a mismatch between the HSN code and products and services people produce or provide.

I don’t get it.
The HSN code is an international system. There are X number of products under this system. In India we deal with many generic products. Take the charpoy. But the charpoy isn’t listed in the HSN code, though the cot is. How would I know that the charpoy is the same as a cot? Then again, a cot in a hospital becomes a bed and has a different function.

One member of our organisation manufactures the micro-nutrient – Zinc Sulphate. But the same Zinc Sulphate has several industrial applications. In that case it attracts a duty higher than when it is used as a fertiliser.

The government kept coming out with clarifications, particularly on food items. In the HSN code there is no description of rasgulla. Then there are different types of burfis. Initially, burfis with chocolate had a different tax rate from burfis without chocolate. There was chaos for a while. After a series of clarifications, things settled down. To be fair, the government used different types of media to disseminate information.

Were there problems in uploading the invoices?
It took hours to upload invoices on the system. Of course, one issue was internet speed, which varies from place to place. Most of the industries are not in cities. For instance, most industrial units in Meerut [in West Uttar Pradesh] are 10 km to 12 km before the city proper. The [internet] speed there is different from what it is in the city. The system also collapsed several times. But they made changes to upgrade the system.

Weren’t there problems arising from the conception of GST itself?
One of the problems MSMEs [micro, small and medium enterprises] encountered pertained to those dealing with engineering items. In the B2B [business-to-business] sector, I get an advance, meaning that if you want me to customise a machinery costing, say, Rs 10 lakh, I will take an advance of Rs 2 lakh to Rs 3 lakh at the time you place the order for me. You will pay me another Rs 3 lakh at the next inspection and the remaining amount at the time of delivery.

The funny thing about GST is that you have to pay tax on an advance also. Most machines come under the 28% tax slab. So out of Rs 3 lakh paid as installment, 28% of it would go to the government. But I am not earning anything, I have to buy raw material to customise the machine you want. A little less than one-third of my working capital is gone.

What about the issue of reverse charges?
According to the reverse charge mechanism, if I am buying from a non-GST compliant entity, I have to prepare his invoice and pay the tax and then file yet another document to claim it back.

Though the charges are reversed next month, your capital is locked nevertheless.
You have hit the nail on the head. GST has put pressure on working capital. Typically, the payment schedule in the MSME [micro, small and medium enterprises] sector is two to three months. But I have to pay tax monthly. Big companies, unlike MSMEs, are in the B2C [business-to-consumer] sector. As soon as they supply to the distributor, they take a draft.

But those manufacturing machinery parts get their payments in two to three months. In GST, the moment I supply I have to create an invoice and pay tax. But I haven’t yet received my payment. I will receive it three months later. I am therefore paying the tax out of my working capital. And to think, the biggest problem of MSMEs is working capital.

Broadly, we have five slabs in GST – 0%, 5%, 12%, 18% and 28% – right? Wouldn’t it have been better to have one or two slabs?
Of course, we should have had two slabs – 12% and 18%. There were innumerable tax slabs under the earlier system. It used to lead to lobbying by sectors that wanted to be shifted to a lower tax slab. The government had the power to do that. The GST could have had two tax slabs – one on raw material and another on finished goods. In that case there would have been no lobbying.

Has the lobbying started?
It has. Isn’t the textile sector lobbying? There may be genuine problems, but multiple slabs incentivise lobbying. Besides textiles, other sectors – leather, jewelry, food, especially sweets, rice etc – have also lobbied and got the anomalies in taxes resolved, either by changing the tax slabs or their classification.

To what extent have these problems arising from GST contributed to the economic slowdown?
The economic slowdown has its own dynamics. But with a simpler GST, the slowdown might not have been of this magnitude. Or we could have recovered earlier. What the GST has done is to create a lot of uncertainty.

How?
It is only after two to three cycles I will know the precise incidence of tax on my production line. Till then, I will be in wait-and-watch mode. I will wait to see how my payment schedule works out, whether people are more complaint with the new regime than before. [After all, if compliance is not high, those who are GST-compliant will become uncompetitive.] It is only by February or March that I will come to know whether GST has made me more or less competitive, that is to say, what is the cost of compliance for my business?

What do you mean by cost of compliance?
For instance, there is no reimbursement of the credit in the textile sector. It is only by February-March that people in the textile sector will know what have been their gains and losses from GST. Then again, assume the input credit on my raw material is higher than my output credit. So I could be paying more tax on my raw material and paying less on the finished goods I produce. My credit, therefore, would keep accumulating. That becomes the cost of my business. Therefore, only by February-March I will come to know where my business stands vis-à-vis GST.

But you don’t have any option?
I don’t have any option, yes. It is not happening to me alone, it is happening industry-wide. In that sense, it is fair. If the cost of business is rising by 10% for you, then it is rising for your competitors as well. But there are sectors where it might be difficult to pass this cost to the consumer. This is because of the discipline of imports.

Meaning?
Imports could become more competitive, for instance. In that case it would be detrimental to manufacturers. It is only after two-three cycles we can get a handle on the system.

Is there any way to calculate the slowdown in the Micro and Small and Medium Enterprises sector?
It is hard to compute. There have been just too many changes too fast – we had demonetisation and then the GST, which in its very conception is complex. The world over it has taken 12 months for GST to stabilise. The GST system in Malaysia took 12 months to stabilise, though its system is not as complex as India’s. We are far more heterogeneous than Malaysia and have a far more number of tax slabs than that country has. It is reasonable to predict that GST in India will take 12 months to stabilise.

So if the GST system in India will take 12 months to stabilise, then the economic slowdown could well last for that period.
It could, but the scenario could also change. The government could reduce the five tax slabs to two. It is already upgrading the system. It has also indicated that it will not be severe in scrutinising tax returns. These statements could bolster the confidence of people to face uncertainties more boldly.

More important than the GST issue is how do we create jobs or raise the country’s GDP? How do we handle the agriculture sector? What is alarming is the sharp reduction in private investments. This is largely because of non-performing assets. As the code for insolvency and bankruptcy unravels, it is possible a lot of capital could get freed for investments.

Currently, except for a few, most business houses are not cash surplus. So the kick-start [to the economy] will have to be Keynesian style – infrastructure development and big-ticket projects. But for that you need to spend from revenue, not by borrowing. Otherwise it will stoke inflation and create a vicious cycle.

In other words, what you are saying is that from economic slowdown to demonetisation to GST, we have reached a make-or-break position or moment.
Correct, we are at a very crucial stage. It is not alarming, but it is serious.

Has GST generated a fear, which is also slowing the economy?
One aspect of the fear is the uncertainty I have talked about. GST is good for the economy, but I have to evaluate it from the perspective of the product I am manufacturing. We are in the midst of the implementation of GST – and uncertainty is always high at this stage. Currently, we are at the peak of uncertainty.

Actually no, the peak will come when the e-way bill system is introduced. [The GST network will generate an electronic waybill or e-way bill. Before goods are transported from one point to another, the supplier must secure the e-way bill spelling out his GST number, to whom they are supplying, the destination, the total worth of the merchandise and the tax paid on it.]

As per the schedule, the e-way bill will kick in from October.
I have my doubts that it will come in October. It will take another two to three months. They would like the system to stabilise before introducing it.

But e-way bills will also create problems, right?
It will throw up a new set of challenges. For one, the government will have to track the movement of goods across a wide geographical spread. For the other, goods will move through states. As of now, the checkpoints are gone. But once the e-way bill comes into play, mobile teams will inspect. It is hard to tell how they will behave. [Will they demand money and clear goods without e-way bills?]

I have spoken to many wholesalers and retailers and they all say trade is sluggish. Why?
That is because of uncertainty.

Could it be because people are not spending?
When we say people are not spending, we mean people are not spending as they used to before demonetisation. Our GDP was down to 5.7% in the April-June quarter. For the same quarter last year, it was 7.9%. That decrease is huge and it is bound to have an impact on the pattern of expenditure. I’d say that demonetisation and GST accelerated the slowdown India was already witnessing. Demonetisation is already behind us, the GST issues will get sorted out, but there are other related issues that are having an impact on the economic slowdown.

For instance, we have the curbs on spending in cash. You may have cash at home but you can’t buy high-value goods – cars and jewellery for instance – with that money because the retailer will ask you for your PAN [Permanent Account Number]. People have become acutely conscious of spending big. They feel they could be tracked somehow.

You see, the GST number has built into it your PAN number. For the first time, the Central Board of Excise Tax and the Central Board of Direct Tax are sharing data. All your transactions can be easily tracked. From your turnover and expenditure, your income can be estimated.

Under the earlier regime, a good many people were not paying income tax. However, the tax authorities can now ask that you have a turnover of, say, Rs 5 crore, but how come you haven’t paid tax for, say, 20 years? Now that is a good thing for the country, but not so for the businessman. This is the reason why businessmen are not spending.