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Indian factory activity tanks as the GST gets underway

Some say it's a 'blip,' but confusion from new tax pushes PMI to an 8-year low

NEW DELHI Indian manufacturing activity slowed sharply in July, as the introduction of a much-heralded goods and services tax caused confusion for companies and consumers alike.

The Nikkei India Manufacturing Purchasing Managers' Index dropped to 47.9, the lowest level since February 2009, during the financial crisis. The reading for June was 50.9.

A figure above 50 indicates economic expansion, while anything below 50 points to a contraction. This is the first time in seven months that Indian industry has slipped under the midline.

The tumble coincided with the July 1 launch of the GST, which replaced over a dozen different levies with one unified one. Almost all goods and services are now subject to one of four GST rates: 5%, 12%, 18% or 28%. Though the goal was to simplify things, the new multitier system has thrown many traders and consumers for a loop.

July saw incoming work for factories drop for the first time this year, and at the steepest pace since early 2009, according to IHS Markit, which compiles the PMI survey. It said there is "anecdotal evidence" that the GST "hampered demand."

"Upcoming PMI releases will show whether underlying conditions remain on the downside, or if July's contraction was a temporary blip," Pollyanna De Lima, principal economist at IHS Markit, said.

MODI'S MOVES The GST follows the previous move in Prime Minister Narendra Modi's reform push, last November's demonetization of 500- and 1,000-rupee notes. The sudden move -- aimed at curbing untaxed wealth, corruption and counterfeit currency -- took some 15.4 trillion rupees worth of bank notes ($242 billion) out of circulation in the cash-heavy economy.

Economists see this as one reason economic growth slowed to 7.1% in the fiscal year through March, from 8% the previous year.

The GST has brought a dose of deja vu.

"New orders and output decreased for the first time since the demonetization-related downturn recorded in December last year," the PMI report said.

N.R. Bhanumurthy, a professor at the National Institute of Public Finance and Policy in New Delhi, is among those who believe the contraction is a "temporary blip."

"We may have to wait for one more quarter to find out what is the impact of GST," he said. "Even to comment on demonetization -- I think it's too early to attribute the slowdown to demonetization."

Bhanumurthy said it will take "some more time" for the industrial sector to adjust, and that there is a need to look beyond the PMI data and see "what is happening on the fronts of GST registration, GST filing or filing of income tax returns."

The government has given a two-month grace period -- July and August -- for businesses to file their first GST returns. Once that period is over, the picture should begin to crystallize.

"Over a longer time horizon, the GST should actually help to boost local manufacturing by simplifying the tax system and facilitating domestic trade," macroeconomic research agency Capital Economics said.

SOUTHEASTERN SLUMP Manufacturing conditions in Southeast Asia also turned south for the first time this year, with five of the seven countries surveyed by The Nikkei reporting contractionary PMIs in July.

Indonesia, the biggest economy in the region, saw its headline PMI fall for the second consecutive month, to 48.6, as declines in output and new orders accelerated. Around 23% of the producers surveyed were facing less new work, while one-tenth cited weaker demand from overseas.

This tougher environment forced manufacturers to reduce spending, reflected in a downturn in purchase quantities and in staff retrenchment, which has persisted for 10 consecutive months.

Nikkei staff writers Shotaro Tani in Tokyo and Joyce Ho in Hong Kong contributed to this article.

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