(Bloomberg) -- Six months after Prime Minister Narendra Modi introduced a nationwide consumption tax to make India less corrupt, evasion is creeping in.
And it’s happening in Modi’s backyard. In pockets of the textile hub of Surat in the prime minister’s home state of Gujarat, some traders are colluding with transporters and suppliers to not pay the goods and services tax, or GST, preferring to conduct a cash-only business that leaves no paper trail.
Anger toward the levy -- decried as technologically tedious and expensive -- is palpable in Surat and emboldened the political opposition in state elections that ended Thursday. Most exit polls indicate the Congress party, which was written off before it tapped into discontent against the tax, will win more seats in Gujarat than it has in more than two decades. Modi’s Bharatiya Janata Party is still projected to comfortably retain power, with official results due Monday.
To help preserve its majority, Modi’s government eased the filing process and reduced rates on a slew of items weeks before the election at a cost of about 200 billion rupees ($3.1 billion) to the exchequer.
“Small traders are fed up with the anti-business moves by Modi, who is only keen on helping the big companies,” Mukesh Rathod, who owns Krishna Fashion, a ready-to-wear garment business on Vaishno Devi Road in Surat, said before the vote. “This will have ramifications in the Gujarat elections."
The BJP’s vulnerabilities have been tested in Gujarat by a farming crisis and the popularity of local caste leaders, such as Hardik Patel, demanding affirmative action. Surat has become the hotbed of an agitation seeking guaranteed government jobs and university enrollment for the Patel community, with the chaotic rollout of GST from July playing into anti-government sentiment.
The BJP will probably win 99-146 of 182 seats, according to five surveys published after voting closed. The final tally will be compared with the party’s 2012 haul of 115 seats as forecasters gauge Modi’s draw going into as many as eight states polls over the next 12 months and federal elections in 2019.
Gujarat is perceived to be the state most impacted by GST and last year’s ban on high-value currency notes, CLSA analysts led by Mumbai-based Mahesh Nandurkar wrote in a report after the exit polls. A convincing victory for Modi’s party would boost market sentiment, they wrote, cautioning that seat projections could vary “significantly” from the actual results.
Traders in Surat have backed the BJP for years. It was Modi’s nearly 13-year stint as chief minister of Gujarat that brought him to national prominence and built his reputation as a pro-business reformer. During those years, he opposed the GST, changing tack after becoming premier in 2014.
To gain support for its passage, the government ended up with four tax rates and numerous exceptions, instead of the single slab adopted in countries including the U.K., Singapore and Malaysia. GST replaced at least 17 levies and harmonized indirect taxes. It was also supposed to formalize India’s black economy -- estimated by some at nearly half of gross domestic product.
That’s unlikely to happen in a hurry and cash transactions are back given the “plethora” of rates and the costly process of becoming compliant, Krishna Fashion’s Rathod said. The need for computerized accounting in businesses often run by those who are barely literate is another hurdle.
“So now some people are avoiding the tax altogether,” said Prakash Gandhi, an independent accountant for micro units such as tailoring and embroidery shops, usually owned by women. “The government has created the very problem they want to weed out. People would rather lie and cheat than waste time and effort because the system is so tedious and complex.”
Textile production has fallen to about 2.5 million meters a day from about 35 million meters and at least 350 looms are being scrapped every day, said Sanjay Sarawagi, the managing director of Laxmipati Sarees, a manufacturer with about 5 billion rupees in sales.
“Gujaratis who had weaving in their blood are shutting businesses and turning to stock market trading. Demand has fallen substantially,” he said. His solution? A single tax rate for the entire cloth supply chain, with no refunds.
Textiles constitute 10 percent of all manufacturing in India, 2 percent of gross domestic product and 13 percent of exports. Overseas shipments dipped for the first time in 14 months this October, falling 1.1 percent to $23.1 billion.
Teresa John, an economist with Nirmal Bang Equities Pvt. said growth in indirect taxes has been hurt by the uncertainty around GST and the fiscal deficit could rise to 3.5 percent of GDP in the year to March 2018, worse than the 3.2 percent target.
For its part, the government has said it will stick to a path of fiscal consolidation even after it reduced the tax applicable on more than 150 items last month. Finance Minister Arun Jaitley has signaled a further lowering, though he said Thursday that rationalization was challenging in a non-tax-compliant society.
The filing process has been eased for traders with a turnover of less than 15 million rupees and the government will identify and act against evaders, said D.S. Malik, a spokesman for the finance ministry. “We’ve addressed their difficulties and concerns and continue to do so.”
The concessions haven’t helped Mohammad Zubair, who is based in Modi’s parliamentary constituency of Varanasi and sources yarn from Surat, nearly 1,400 kilometres away. For traders like him, there is no option but to absorb the costs of complying with GST since the small weavers he supplies can’t manage any price increases.
“A small rise in yarn prices upsets their family budgets,” he said. “This means I can’t increase prices and I bear the costs. So some traders around me are simply entering agreements with suppliers in Surat to partly hide transactions.”
©2017 Bloomberg L.P.