Click here to read the full report

Domestic reforms gain traction

Following up with our earlier note India: Domestic anchor amidst external crosswinds, the Indian authorities have pursued a clear strategy to boost domestic growth in midst of difficult global developments, especially inward polices by the US. We also highlighted the shift in Macro Insights Weekly: India’s revised playbook. Measures earlier in the year included income tax relief, monetary policy rate reductions, surplus liquidity and relaxation in risk weights to spur lending. This was followed by a rationalisation in the Goods and Services Tax structure (read here and here) boost demand, marking a subtle shift from the predominant supply side reforms in the past few years.

GST rationalisation to be demand-accretive

The Goods and Services Tax Council, with state representatives, approved a two-slab structure earlier in the month, after PM Modi had signalled an overhaul of the mechanism in August. This involved rationalizing the current 4-5 tiers to two-tiers – 5% and 18% (plus a higher 40% rate on a smaller pool of sin and luxury items), with the aim of lowering the tax incidence on essentials.

With this change, most items in the 28% and 12% were merged with lower tiers (18% and 5% respectively), taking effect on September 22. The GST rate on over 450 items was changed, with nearly half which were essentials enjoying 5% or nil rates after the revamp, boding well for demand. Effective indirect tax on several FMCG goods was lowered, cement (to 18%), autos, household durable goods, farm inputs, besides education supplies. GST on life insurance and health insurance premiums have also been cut to zero. Sin tax of 40% will be applicable to high sugar drinks, luxury cars, tobacco etc. Nominal GST collections (~6.7% of GDP in FY25) have risen since it was introduced, though the year-on-year growth has moderated. – see chart.

Impact

The net fiscal implication is expected to be relatively modest at INR 480bn (0.13% of GDP), after accounting for INR 930bn revenue loss but INR 450bn expected to be collected on sin/ luxury items. Under the earlier slabs, about three-fourth of the revenue collection was under the 18% bracket, with over four-fifth of the 12% bracket moving to the 18% bracket now. If these changes materially boost demand, the extent of fiscal impact can be lower than envisaged at this juncture. With the recent sovereign rating upgrade, we don’t expect any compromise on the fiscal deficit target. 

Under the four segments under which GST is collected (Centre, states, integrated and compensation cess), intra state transactions are routed to states and the centre, while interstate as well as GST on imports is collected by the centre and then subsequently shared with the states (depending on where the final consumption occurs). The compensation cess (~7% of total GST collections) which was routed to the states earlier, will be phased out this year.

Lower GST rates will be positive for growth in the second half of the year and FY27, besides improving operational efficiency and expanding the size of the formal economy. Higher elasticity of demand for low-cost FMCG products and durables is likely to make the tax cuts consumption-accretive, with these concessions to provide a one-time boost to growth.

Factoring in the likelihood of a strong 7% plus growth likely in first half of FY26, our growth forecast for FY26 stands at 6.7%. A durable improvement in demand thereafter will require a return to addressing longstanding employment and income requirements.

GST cuts would be disinflationary (50-60bp) with the government preemptively asking suppliers to pass the full impact of the change to the end-consumer. While watching the disinflationary impact, we maintain the inflation forecast for FY26, with pass-through likely to be evident in the tail end of the year and positive for FY27, where our inflation forecast is already on the weaker end of consensus expectations (DBSf 4.3%). 

Widening the net

While the overhang of the 50% tariff remains (India: Effects of 50% tariff), India has been actively seeking to counter/ address risks.

There have been signs of thawing in relations after conciliatory remarks by the US and Indian administrations in recent weeks, although a concrete step towards resumption in trade negotiations is still to be seen. India’s Commerce and Industry Minister is due to meet his USTR counterpart this week, on the sidelines of the United Nations General Assembly in New York, with resumption in the trade agreement and broader negotiations likely on the agenda.

Secondly, the government continues to reinforce its messaging on ‘buy more local’ to support domestic businesses and lower reliance on foreign goods. Thirdly, FTA negotiations with other trading partners are ongoing, after the successful conclusion with the UK and European Free Trade Area. Europe, and New Zealand, amongst others are in the pipeline.

Tightening work visa regulation

The US government has signed a proclamation that $100k fees will be applicable on every H1B visa petition, though subsequently clarified the nuances. Imposition of the fee on H1-B non-immigrant work visa, now, will apply a) only on new applications and not on current visa holders and renewals; b) it will not be annual basis but as a one-time fee (applied at the end of the 6 year cycle) and will only apply from next year’s lottery. Given the extended payment timeline, the financial impact on companies is likely to be limited in the near-term.

While these clarifications lowered the extent of uncertainty, yet it highlights the underlying shift in global policies, especially inward focus key issues including trade and immigration. To recollect, there have been other changes to the H1B visa in the past few months, including an annual cap on number of applications.

About 400k H-1B visa were approved for high skilled foreign workers by the US in 2024, 65% of which were renewals (link). On basis of nationality, Indians roughly make about 70% of the total number of H1B visas approved in fiscal 2023. Of the total H1B visas issued, information technology/ computer related sectors, account for 65% of the employees, followed by ~9% in architecture, engineering and surveying. In terms of education levels, the share of high skilled and post-graduates has continued to increase.

The top five companies that account for majority of these visas comprise four US companies and one Indian IT major. Given the dominance of American firms amongst the users of these visas, any tightening in restrictions will impact the respective companies’ performance. As it stands, Indian IT companies had already lowered their dependence on H1B visas, steering towards increased offshoring, revisiting business delivery models and encouraging offsite services in the past few years. In the near-term, the announcements are negative for sentiments and are likely to weigh on stocks of IT majors in India. Any further changes in regulations will push US/ Indian corporates to consider fresh mitigation measures.

From an economic perspective, India was the largest recipient of overseas remittances in the world, with the US’ share at about a third of the total. Remittances have been a strong contributor to current account math, consistently holding around 3% of GDP (private transfers), and about 45% of the invisibles current account balance (see chart). We don’t expect any kneejerk impact on this component, though steady tightening in work related visas in the US might impact slow inflows.

Part of this impact might also be offset by lower outflows on account of education and bigger outsourcing projects into India. While there are no broad restrictions on service trade at this juncture, we note that more than half of the software service exports are destined for the US, besides US’ firms dominant present in India’s Global Capability centers. 

Conclusion

Other examples of restrictions include the US’ decision to end the special waiver for India on operations in the Iranian port of Chabahar (intended to raise pressure on Iran) which might hurt India’s regional connectivity. US also called on Europe to impose tariffs for purchases of Russian oil, points to heightened geopolitical tensions. In face of these developments, we expect the Indian government to heighten efforts to strengthen the domestic economy, including supply as well as demand side measures.

Click here to read the full report