GST Rate Reduction Impact: Working Capital Math and Industry Analysis

GST rates have been reduced, and we are ready to enjoy the GST 2.0 bonanza started by the GOI from 22nd September 2025. On the flip side, small businesses face hurdles as they struggle to sustain resilience in an increasingly competitive marketplace.

The ET newspaper published a piece of news with the following subject line:

Ecomm, qcomm ramp up capacity & supply chains

I thought I should write something on this topic because with the CA qualification, I can understand well what small players in the market are striving to exist in the market across India.

The concern is that Diwali, along with the surrounding festivals, is fast approaching this year. The recent GST rate reductions have created an unexpected working capital crunch for sellers and brands, particularly those who stocked inventory ahead of the festive season. The mathematics behind this issue reveals a significant cash flow challenge that coincides with the industry’s peak spending period.

The Mathematical Problem

The core issue stems from how the Input Tax Credit (ITC) works under the GST law. When businesses purchase inventory, they pay GST and can claim this as an input tax credit against their future sales. However, when GST rates are reduced after inventory purchase but before sales, a mismatch occurs.

Simple Example:

• A seller stocks ₹10 lakh worth of apparel inventory at 12% GST
• ITC paid: ₹1.2 lakh
• GST rate drops to 5% before festive sales
• When selling for ₹12 lakh, the output GST becomes only ₹0.6 lakh
• Result: ₹0.6 lakh excess ITC gets blocked as working capital

This represents a 6% working capital blockage on the inventory investment, which cannot be immediately recovered.

Industry Impact Analysis

The timing makes this particularly challenging for the e-commerce sector. With the festive season, GMV is projected at ₹1 lakh crore and above.

Categories Most Affected:

• Apparel priced below ₹2,500: GST reduced from 12% to 5%
• Handicrafts and footwear: GST reduced from 12% to 5%
• Home essentials and metal items: GST reduced from 18% to 12%

The estimated total blocked working capital across the industry approaches thousands of crores, creating liquidity stress precisely when sellers need maximum cash flow for advertising, logistics, and inventory scaling.

The sellers typically invest heavily in inventory 2-3 months before the festive season, expecting to recover costs during peak sales. The GST rate reduction creates a scenario where:

• Input costs remain at the higher GST rates paid months ago
• Output realization drops due to lower GST rates during sales
• Working capital gets locked in excess ITC that cannot be immediately utilized

Operational Impact

This cash flow constraint affects multiple business operations simultaneously:

• Reduced marketing budgets during peak advertising season
• Limited inventory replenishment capabilities
• Strained supplier payments are affecting future procurement terms
• Higher borrowing costs to meet operational cash needs

Industry Response and Adaptations

Large Players vs. Small Sellers

Major e-commerce platforms like Amazon and Flipkart have shown better resilience due to their advance planning capabilities and stronger financial backing. They can:

• Absorb cost differences temporarily to maintain market share
• Negotiate better payment terms with suppliers
• Access institutional financing more easily

However, smaller sellers and D2C brands face disproportionate impact, as they typically operate with tighter working capital margins and limited access to quick financing.

Supply Chain Financing Solutions

The crisis has accelerated the adoption of supply chain financing mechanisms. Platforms are increasingly offering:

• Invoice discounting to unlock receivables faster
• Purchase order financing for inventory procurement
• Vendor financing programs to support the entire ecosystem
• TReDS (Trade Receivables Discounting System) participation for MSME suppliers

Strategic Implications

Inventory Management Rethink

This situation is forcing small players to reconsider their inventory strategies:

• Just-in-time procurement to reduce rate change risks
• Vendor-managed inventory arrangements to transfer carrying costs
• Flexible supplier contracts with GST rate adjustment clauses
• Enhanced demand forecasting to minimize excess stock exposure

To help you understand the terms Vendor-managed inventory and Flexible supplier contract, let us try to illustrate different scenarios.

Imagine a seller, “PrashantRetail,” that sells apparel. Instead of PrashantRetail ordering inventory manually, the supplier “ApparelCo” monitors sales data at PrashantRetail’s warehouses.

PrashantRetail sold 1,000 jackets last week.

ApparelCo, accessing this sales data, decides to replenish 1,200 jackets to maintain safety stock.

ApparelCo ships the jackets directly to PrashantRetail’s warehouse.

Since ApparelCo manages inventory levels, PrashantRetail does not have excess inventory sitting idle.

This reduces PrashantRetail’s cash tied up in unsold stock and GST input tax credit on excess inventory.

Here, ApparelCo assumes the risk of overstocking and manages GST costs on stock, relieving PrashantRetail of carrying costs and cash flow issues, especially during GST rate changes.

Suppose PrashantRetail signs a 6-month supply contract with ApparelCo for jackets at ₹1,000 per unit, inclusive of GST at 12%. Contract terms include a clause:

If the GST rate on jackets falls to 5% during the contract, the price will be revised to pass on the GST benefit.

Scenario:

Month 1: GST is 12%, so PrashantRetail pays ₹1,000/unit (including ₹107 GST).

Month 3: GST rate changes to 5%.

As per the clause, price adjusts so that GST component reduces, and PrashantMart pays ₹950/unit (including ₹45 GST).

This ensures PrashantRetail benefits from the tax rate reduction without excess input tax credit blockage, and ApparelCo adjusts accordingly.

This clause protects both parties financially by sharing the GST rate impact, maintaining working capital balance amid tax fluctuations.

Financial Planning Adjustments

Businesses are adapting their financial planning to account for GST volatility:

• Increased working capital buffers for rate change impacts
• Diversified financing sources beyond traditional banking
• Real-time cash flow monitoring systems
• Scenario-based financial modeling for different tax rate environments

The GST 2.0 reforms, while beneficial for consumers through lower prices, have created a complex working capital challenge for the ecosystem. The mathematical reality of excess ITC blockage, combined with festive season timing pressures, demonstrates how tax policy changes can have immediate operational consequences that ripple through entire supply chains. Success in navigating this environment will increasingly depend on financial agility and adaptive inventory management strategies.