Transition To GST To Trigger Working Capital Challenges For Weak Entities

India Ratings and Research believes that the transition to the Goods and Services Tax regime would significantly affect companies with weak credit profiles because of a short-term liquidity mismatch due to delays in the availability of input tax credit.

This is due to the difficulties in mapping the inventory held on the transition date with respective invoices, various GST Network-related technical issues and admissibility of input tax credit claims. The admissibility could depend on companies' ability to match corresponding tax invoices with vendors' filings.

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MSME To Be Impacted More Than Large Corporates

India Ratings expects the transition to the GST regime to affect the micro, small and medium enterprises space more than other industries, as industry participants lack compliance infrastructure to map the entire outstanding inventory with tax invoices.

Furthermore, the weak credit profile of the MSME sector and risk weights attached to the loans extended to this sector in banks' books could force the sector to resort to borrowings from non-bank finance companies.

This is more costly than borrowing from banks and could aggravate the credit impact of the GST transition on the MSME space.

Meanwhile, large corporates and firms with streamlined infrastructure may find it easy to map the entire outstanding inventory with tax invoices. They would also benefit from better financial flexibility to tide over this disruption. However, their working capital requirements have increased during the transition due to their dependence on MSME vendors, since input credit availability under the GST depends on matching the input invoices for input tax credit claim with those uploaded by vendors for output tax payment.

The construction, consumer durables and metal industries across corporates are facing higher challenges than others during the transition due to the nature of their business and their respective margins and credit profiles.

Also Read: Over 20 Lakh Businesses Due To File Final GST Returns In 6 Days

Working Capital Needs Of Manufacturers To Increase

GST would result in higher working capital requirements for the majority of the participants in the manufacturing sector (steel, textile, auto and auto ancillary) owing to the requirement to pay the entire tax at the point of the dispatch of goods from factory gates, and also for the movement to warehouses.

Also, GST has been imposed on some goods for the first time (e.g. cotton value chain). Furthermore, the reduction in the cost of production for most manufacturers due to the uninterrupted flow of input tax credit would lead to some savings in working capital, which would partially offset the impact of higher working capital due to the above reasons.

India Ratings estimates the increase in working capital requirement at 200-450 basis points of revenue for the steel industry and at about 500 basis points of net value addition across the value chain for the textile industry.

Also Read: Government Considering Ways To Help Exporters, Says CBEC Chairman

The increase in working capital requirement, as a proportion of revenue, would aid bank credit growth for large corporates.

Within the construction sector, India Ratings believes that the GST would have a negative impact on the cost of setting up power plants as capex cost would increase. For power producers, input tax is a cost, as electricity (key output) is outside the GST's purview.

The absence of the ‘change in law' clause in power purchase agreements might impair power producers' ability to pass on this capex cost to power purchasers.

For engineering, procurement, and construction contracts, GST rates at 6 percent-11 percent are higher than the earlier regime. This could increase project cost, if contractors' compliance infrastructure is not robust enough to enable them to use input tax credits. Companies opting for the composite scheme under the previous regime might not have a well-developed compliance infrastructure. Furthermore, contracts signed on a gross tax basis (including tax basis) could lead to losses, if not renegotiated.

India Ratings believes that industry participants' ability to tide over working capital mismatches during the implementation phase and beyond would be relative to their balance sheet strengths and capital market access. The ability of banks to fund these mismatches depends on the risk weights attached to such lending. Although it would be beneficial for the banking system, given the low incremental credit deposit ratio, banks may refrain from providing additional financial supports to entities with a weak credit profile.

This article has been published in arrangement with India Ratings.

India Ratings and Research, a wholly owned subsidiary of Fitch Group, is a SEBI and RBI accredited credit rating agency operating in the Indian credit market.