GST anti-profiteering clause will reveal how competitive FMCG is
The government is unhappy with the trickle-down effect of lower tax outgo under the Goods and Services Tax (GST) Act. Its utterances and actions suggest a crackdown is around the corner. Elimination of multiple cascading taxes, input tax credit and lower tax rates on mass consumption items were supposed to lead to lower prices and happy consumers. The government appears unconvinced.
That’s why after GST rates were reduced in November, the government told companies to ensure prices were cut.
Another warning was notification of the anti-profiteering authority—empowered to investigate and penalize companies who are not passing on tax benefits. Responding, companies have made it a point to issue advertisements and even issued press releases saying they have or will cut prices.
What is a price cut? If a 100g soap bar priced at Rs20 is lowered to Rs15, that’s a Rs5 reduction. But the company could also increase the soap’s weight to 133g or give a free shampoo sachet worth Rs5. One could argue the cost of the soap is Rs15 in all three situations. But savings in kind is not the same as cash.
Whether the anti-profiteering authority accepts this as a price cut or not, we will know. But one thing appears to have caught the government’s attention. The Economic Times reported on Monday that the government wants product-specific tax reductions. This means that companies who were calculating tax changes across product categories and then passing on the net benefit may not be able to do so. If taxes on soap are lowered, that has to reflect in the price of soap, and if higher tax has been levied on shower gel, one cannot offset the other. This could prove a challenge for fast-moving consumer goods (FMCG) companies.
They anyway have a challenge of rolling out the new stocks. They can get modern trade retailers to change prices but once the stock is out from the distributors to the retailers or wholesalers, they don’t have control on prices apparently. They can request for stickers with prices but don’t have control over it. Even if they do, if the price cut is adjusted in the weight how can this be implemented?
A recent report by the Nielsen Co., based on market activity in July and August, says there was no clear indication of a price drop in these two months. It attributes this to the average age of stock being three-four months and the directive to use new price stickers for old stock not being followed by traditional retailers. A lag effect may also be to blame for the government or consumers not “feeling” that prices have been cut. This may happen again for products where taxes were cut in November.
While companies may not be held accountable for the trade channels not passing on lower prices, did companies pass on all the tax benefits? Only they know the answer. The government suspects they held back, explaining its ire, but will need proof. The anti-profiteering authority can delve into that. Apart from product-level input tax benefits, companies also get company-wide input tax credit. Whether this is being passed on in full is also not clear.
Quarterly results are one indicator and margins did improve in the September quarter. But stripping out the effect of other factors, such as material costs, cost-cutting and higher scale benefits due to recovering volume growth is difficult.
This issue was flagged by analysts of Kotak Institutional Equities research, who say that if individual markets, say a specific category, were competitive enough then “(1) any category-level benefit would be competed away and (2) there would be no scope of ‘portfolio-level’ benefit-pass-through decisions”.
The note says the fall in overheads and jump in the September quarter margins (and even the increase in profitability seen earlier on the back of lower raw material costs) suggest competition is benign. But it adds the caveat that not enough data exists to attribute higher margins in the September quarter to retention of input tax credit. The note adds that GST being an exceptional circumstance and indirect taxes being a pass-through (collected on behalf of the government), lower taxes (net) should be passed through to consumers and even portfolio-level flexibility (using savings in one to absorb higher taxes in another) has no place here.
If the market is behaving in a similar fashion on prices, does it indicate the presence of me-too behaviour on pricing? In some worlds, that’s called cartelization. Even if there is no cartel at work here, lack of stiff price-led competition could be a cause for concern.
The next move in this direction will come from the anti-profiteering authority, especially once it decides the methodology and procedure to determine profiteering. Investors have been sanguine about the FMCG sector’s prospects after the GST roll-out and gradual recovery seen in demand. The anti-profiteering issue poses a credible threat to that happy state.