Tax reform

Indian Prime Minister Narendra Modi has much to celebrate after pushing through India’s biggest tax reform since the 1990s. His politically sensitive move could decide how much faster the world’s fastest-growing economy can grow. As India continues to lead South Asian growth, neighbouring countries such as Sri Lanka have to move that much faster to remain competitive and leverage on the gains being made in India. 

Modi’s counterpart Ranil Wickremesinghe will have to bring the full force of the coalition government together this week to pass the VAT Bill on 11 August and catch up crucial revenue to put deficit targets back on course. 

The VAT is crucial for several reasons. Firstly it is at the core of increasing public revenue and secondly it is essential to establishing a fundamentally sound macroeconomic environment maintained by policy consistency. Unless the Government achieves macroeconomic consolidation it is unlikely to attract foreign investment no matter how many trade deals are signed. If policy consistency is not established then it is unlikely that the private sector will “recalibrate” their risk appetite as advocated by Central Bank Governor Dr. Indrajit Coomaraswamy. Without growth in investment and exports, Sri Lanka will remain caught in a debt trap. In short the economy will continue its current decline. 

The VAT, like the Indian GST, would be the start of much needed tax reform. It would be the first step to widening the tax net and simplifying the tax system. Both these goals are critical to increasing revenue and creating a fair system where everyone pays equitable dues. India is a great example of how deeply tax reform can change the face of an economy and make it more attractive.

After a decade of wrangling, the upper house of India’s parliament on Wednesday night unanimously approved legislation to establish a nationwide goods and services tax known as GST, Bloomberg reported. The move clears the biggest hurdle to unifying India’s 1.3 billion people into a single market for the first time by next year.

Removing a jumble of taxes on interstate trade caps Modi’s push to make India more business-friendly since his landslide victory in 2014. The reform agenda now shifts to deregulating labour and land, tasks that can be tough to reconcile with political interests among India’s rural masses - especially given key state elections in the run-up to a 2019 national vote.

GST proved hard enough to pass even though most major parties broadly agreed on the concept soon after the Congress party-led government proposed it in 2006. Modi himself opposed it back when he led Gujarat state, then made a U-turn when he took national power. A frustrated and weakened Congress Party then returned the favour by obstructing the bill. It finally passed after recent state elections increased the power of pro-GST parties.

For investors, a breakthrough was long overdue. Though Modi has made a number of significant changes since taking office - allowing more foreign investment, implementing an inflation target, reducing fuel subsidies - the GST has the most potential to transform what is already the world’s fastest-growing major economy. The nation’s stocks last week climbed near the highest level since August 2015.

While the tax’s ultimate economic impact depends on details that will be negotiated over the next six months or so, executives are brimming with optimism. Some say the GST may reduce shipping costs in India by as much as 50%. It would likely help India climb several rungs in the ease of doing business rankings and if implementation happens without too many hiccups, could provide the way forward for the rest of the world to rethink their business proposition with the subcontinent.