GST Overhaul Seen Adding 0.7-0.8% to GDP this Year

India’s sweeping overhaul of the goods and services tax is expected to lift GDP by about 0.7-0.8% in the current financial year, according to ICICI Securities Primary Dealership. The GST Council this week announced major changes to the tax structure, moving from a four-slab system to a simplified two-rate regime, with a 5% ‘merit’ rate and an 18% ‘standard’ rate. The new structure will also have a 40% rate on select sin and ultra-luxury goods.

The government has estimated a fiscal implication of ₹480 billion from this rationalisation, based on consumption patterns for 2023-24. Adjusted for the current year, the impact rises to about ₹580 billion. Assuming the government’s projection does not account for the winding down of the compensation cess, the direct boost to growth will be closer to 0.65% of GDP – 0.16% from the ₹580 billion revenue loss and 0.47% from the cessation of the ₹1.5 trillion compensation cess. 

The withdrawal of the cess will not affect fiscal math, as these revenues are earmarked solely for repaying GST compensation bonds issued during the COVID pandemic and for servicing interest on those bonds.

Overall, the aggregate boost to GDP, along with short-term tax multiplier effects, is expected to be about 0.7-0.8% of GDP. Tax multipliers are typically higher when there is slack in the economy, aided by compliance gains and the release of working capital previously locked due to inverted duty structures.

Reflecting this, ICICI Securities Primary Dealership has raised its GDP growth forecast for 2025-26 to 6.7% from 6.5% earlier.

Fiscal Implications
Given the sizeable positive impact on growth, the fiscal cost of the GST reforms appears modest, even if one assumes an annualised revenue loss at ₹580 billion. For 2025-26, the effective loss will be roughly half that, since the changes are being implemented only in the second half. Of this, the Centre will bear about one-third, with the remainder falling on the states.

An additional offset is also expected, as the GST compensation fund is projected to have a surplus of around ₹335 billion, which will likely be shared equally between the Centre and the states. Thus, it is unlikely that be any fiscal drag from GST rationalisation this year. Over the medium term, the impact on government finance should remain negligible given the growth boost.

That said, the GST rejig could alter how the Centre manages its deficit financing. The compensation fund, parked with the Centre, bolstered its cash balance – the Budget had assumed an opening balance of ₹612 billion and closing balance of ₹1.24 trillion. This may explain why the government had projected net zero T-bill borrowing in the Budget.

The government has also conducted ₹870 billion worth of bond buybacks this year, which were not budgeted. Combined with lower cash balances in the second half, this could necessitate additional T-bill borrowings of about ₹500 billion in 2025-26, ICICI Securities Primary Dealership said.

Inflation Impact
The reduction in GST rates could significantly reduce retail inflation, with nearly 18% of CPI items exposed to rationalisation. If tax cuts are fully passed in, CPI inflation could fall by about 1%. In reality, the pass-through is likely to be more modest, as retailers may absorb part of the gains as higher margins. Core inflation could decline by about 1.5% if the rate cuts are fully transmitted.

Consequently, headline CPI inflation in January-March could average around 4%, compared with earlier projections of 4.5%. For 2025-26 as a whole, average inflation is now seen closer to 2.5%, down from just under 3% projected earlier. The impact on inflation in 2026-2027, however, is expected to be limited – lower inflation in the first half may be offset by higher readings in the second half as base effects turn adverse and growth momentum improves.