Breakingviews. Modi’s India can ride out giant tax reform

India is heading down a bumpy road. The country is under-prepared for the July 1 nationwide rollout of a complex new goods and services tax (GST) which will create a single customs union, replacing a myriad of charges levied across 29 states. But for all the shortcomings, the reform smooths the way toward a more efficient, less corrupt economy.

The overhaul is far from the ideal of single flat rate. India’s GST will instead have bands of 5, 12, 18, and 28 per cent, plus an additional levy for certain items like chewing tobacco, fizzy drinks, and luxury cars. Petroleum products, alcohol, and electricity are among the exempt items.

The hope is that a tiered system will avoid a rise in consumer price inflation that typically results from the rollout of simpler structures, as most recently seen in Malaysia. That’s an important feature as Prime Minister Narendra Modi is due for re-election in 2019.

The downside of the complexity is a lower boost to growth. Economists at HSBC now expect a medium-term GDP uplift of 40 basis points after the change, half their original forecast before the details were agreed. Meanwhile, ambiguity over how all sorts of things are categorised will inevitably lead to rent-seeking from some tax officials.

The long-term benefits could be profound, however. The process requires companies to electronically upload reams of invoices and reconcile them with vendors. That will allow taxpayers to use their invoicing history to secure better borrowing terms, and make it harder for company owners to understate their personal income. Enterprises, like logistics firms, will be able to pick the most geographically logical location for new warehouses, instead of hunting for the state with the lowest taxes.

The big unknown is how much disruption the transition will unleash. Tax experts and company executives expect longer working capital cycles, and general uncertainty for up to one year. Indeed, most small and medium-sized companies are still coming to grips with basic concepts like input credits. New Delhi may well have to grant them a period of clemency.

Yet Modi’s masterful political spin last year on his radical demonetisation experiment, in which he cancelled most of the country's bank notes by value, suggests he can manage any teething pains. Unlike that unorthodox reform, this one enjoys near-unanimous political support.

The author is a Reuters Breakingviews columnist. The opinions expressed are her own; @ugalani