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GST 2.0: Navigating GST transition and macro headwinds

Risk-reward evenly poised in the backdrop of a potential GST rate cut

* Vehicle finance demand has remained muted and asset quality trends have been weak in YTD-FY26 (including in Aug’25). In this muted environment, the government’s proposal to rationalize GST rates could be a critical trigger for the revival of the auto and vehicle finance sector. Reducing the GST rate for most of the segments of the auto sector from 28% to 18% could lower vehicle prices by 7-8% (assuming discounts, if any, remain unchanged) and likely revive demand for both PVs and CVs.

* While we have remained cautiously optimistic on the vehicle finance sector (Refer Report) given the weakness in demand and asset quality over the last one year, this potential GST rate cut (already accepted by the GoM and will now be taken up by the GST council) can revive consumption and has made the riskreward even for vehicle financiers.

* We delve deeper into the nuances around the timing of the implementation of the GST rate cut, the problem of existing inventory and customer behavior in the last one week since this announcement. In addition to weak consumption, we will also explore other reasons behind the weak macroeconomic activity and consequent softness in collections for vehicle financiers.

* We have not made any changes to our estimates since there are still a lot of moving variables in terms of the effective date of the GST rate cut and progress of monsoon (which started early this year, has been slightly above normal but can become troublesome if it gets extended). Depending on how some of these variables pan out over the next one-two months, we might have to revisit our estimates. We maintain our BUY rating on SHFL (TP: INR780), CIFC (TP: INR1,670) and MMFS (INR310).

Timely implementation of GST rate cut is critical for vehicle financiers

* If the GST reduction is implemented quickly, ideally before festivals like Ganesh Chaturthi (late Aug’25), it could lead to an "extraordinary" boost for the current quarter (2QFY26), significantly improving growth and sales. If the implementation is delayed to Sep’25, 2Q could take an initial hit, but the next quarter (3QFY26) might witness a “double boost,” driven by accumulated demand and festive season sales.

* A September implementation could still be partially affected by "Pitru Paksha" (7-21 Aug’25), a period when many people avoid buying vehicles, although some transactional activity still occurs. The subsequent festive period, starting with Navratri around 22nd or 23rd Sep’25, could then provide a strong uplift.

* A major challenge is the large existing stock of vehicles with dealers that have already been billed by manufacturers at higher GST rates. Auto OEMs might have to absorb losses by providing discounts on these older, higher-priced vehicles to make them competitive with new stock sold at a reduced GST rate. A retrospective implementation or a refund/adjustment mechanism for the GST already paid on dealer inventory would alleviate this, though it is a cumbersome process and clarity on this is lacking. This could involve a cut-off date, after which any vehicles sold that were previously taxed at the higher rate would be eligible for a refund or adjustment. Without such a mechanism, dealers are facing a dilemma: selling old, expensive stock or waiting for new, cheaper stock, leading to execution problems.

Waiting for clarity: How GST changes could temporarily freeze the auto value chain

* The announcement of potential GST revisions has prompted customers to postpone purchases, adopting a "wait-and-watch" stance until pricing becomes clearer. This cautious behavior would impact sales across segments, including premium vehicles where tax adjustments are less probable.

* Although a GST cut would reduce vehicle prices, OEMs are expected to scale back existing discounts, as the price drop alone would drive demand. As a result, consumers may not enjoy the combined benefit of lower taxes and ongoing discounts but will still gain from the overall reduction in net prices.

* Dealers have paused intake of new stock from manufacturers amid the prevailing uncertainty, which could eventually force production slowdowns or temporary halts at factories if inventory remains undispatched.

* The ripple effect of this uncertainty extends across the ecosystem — impacting logistics, transportation, and financing — with potential EMI payment delays for transporters and an overall slowdown in activity.

From global drags to domestic challenges: Mapping the slowdown

* We heard the commentary of vehicle financiers on the macro environment when they reported their 1QFY26 results. The overall macro environment has not improved in Aug’25. Our checks with vehicles financiers have suggested that sectors like mining, construction, and cement are still struggling and there is a widespread slowdown across all segments.

* Central government spending has been weak. Many state governments (particularly ones which held elections in the last one year) have increased their expenditures to fulfill post-election commitments, which has led to deterioration in their financial situation. New infrastructure and construction projects are not coming, and in the ongoing ones, the payments to contractors have been delayed.

* Global slowdown trends are now affecting India. Notwithstanding the trade tariff problems, the ongoing geopolitical conflicts (both domestic and global) diverted government attention and spending. The textile industry is facing problems due to global and domestic issues and this is more pronounced in hubs like Coimbatore, Erode, Tiruppur, and Gujarat due to reduced demand and difficulties in selling goods internationally, such as in the US.

* Heavy monsoon rains in Aug’25 have disrupted construction, mining, and vehicle operations and contributed to the slowdown.

The silver lining in the slowdown: Agricultural growth has been strong

* Like last year, the agricultural growth has been strong this year thanks to good monsoons, which can significantly improve the rural economy and rural consumption.

* This will benefit small commercial vehicles (SCV) and used vehicles and will help in timely loan repayments in these segments.

View on potential GST rate cut and its impact on vehicle finance sector

* While the GST reduction would make vehicles cheaper, manufacturers (OEMs) and dealers might reduce or eliminate existing discounts they typically offer. When demand increases due to a lower tax rate, there is less need for OEMs and dealers to provide discounts, which reduce their profit margins. Even if the existing discounts are reduced, the net saving for customers from the GST reduction would still be substantial (particularly in PVs where discounts are much lower than CVs).

* While the GST rate changes could offer a demand boost, their effectiveness hinges on quick, clear implementation, particularly addressing the challenge of existing inventory. The broader economy, however, faces headwinds from multiple macroeconomic factors and government spending challenges, making any sustained recovery dependent on these larger issues.

* The GST cut in itself could spur consumption and provide a short-term spurt for 6-9 months. However, sustained improvement in demand and asset quality trends would require fundamental on-ground macroeconomic improvements rather than just a price reduction.

* While the good monsoon promises healthy agricultural growth and rural economic benefits, its immediate heavy rainfall and associated disruptions are currently contributing to the challenging macroeconomic environment and hindering market activity in 2Q. A timely withdrawal of the monsoon, alongside quick GST implementation, is crucial to see a significant recovery in 2Q.

Risk-reward now evenly poised for VFs under our coverage

Cholamandalam Finance (CIFC)

* The company reported some softness in asset quality in 1QFY26, with the weakness more evident in its vehicle finance and CSEL segments. While credit costs in the CSEL portfolio are expected to remain elevated in FY26, a gradual improvement in the vehicle finance book is anticipated in 2HFY26. Chola’s strong presence across both new and used vehicle segments — spanning CVs, PVs, two-wheelers, three-wheelers, and tractors — positions it well to strategically adjust its portfolio, going overweight or underweight in specific product categories to capture market share opportunities.

* While margin tailwinds should support earnings through the remainder of FY26, a close monitoring of asset quality, particularly in the CSEL and VF portfolio, will be key to sustaining profitability. Additionally, the potential of this GST rate cut provides a favorable backdrop for volume improvement (from a boost to consumption) and reduces the risk of earnings downgrades for the rest of this year. Maintain BUY on CIFC with a TP of INR1,670 (based on 3.8x FY27E P/BV).

Shriram Finance (SHFL)

* SHFL, like its peers in vehicle finance, has been showing some weakness in asset quality, particularly with Stage 2 loans rising over the last three quarters, leading to heightened investor anxiety. An important factor to note is that a GST rate cut, which would reduce prices of new PVs and CVs, also leads to a decline in prices of used vehicles. However, SHFL has built strong provision coverage across its Stage 1, Stage 2, and Stage 3 assets over the past two years, providing a buffer even if used vehicle prices drop by 4-5%. Additionally, its focus on financing vehicles aged 5-10 years mitigates risk, as most depreciation for vehicles occurs within the first five years.

* What has irked investors recently is the company’s elevated liquidity levels, which have created negative carry and put pressure on margins. With liquidity expected to normalize over the next 2-3 quarters, margins should start to improve. Overall, SHFL remains our preferred pick in the vehicle finance sector. Maintain BUY on SHFL with a TP of INR780 (based on 2x FY27E P/BV).

Mahindra Finance (MMFS)

* MMFS has a strong presence in the new vehicle financing segment, with preowned vehicles accounting for <15% of its business assets. The anticipated GST rate cut is unlikely to cover SUVs. Around 44% of MMFS’ loan book is linked to assets of parent Mahindra & Mahindra (M&M), whose portfolio is largely SUVfocused, limiting benefits from a broader demand recovery in the entry-level and mid-segment cars from a cut in GST rates. While tractors are expected to see a GST rate cut, this segment already suffers from an inverted duty structure as the majority of its components are taxed at 18%. Hence, the entire input tax credit cannot be claimed and we are not quite sure if tractors will see a commensurate benefit from GST rate cuts.

* The company’s performance last quarter was impacted by elevated credit costs, and we expect asset quality pressures to persist this year. While the anticipated GST rate cut will provide some support, the upside may be limited.

* The only key positive for MMFS is the strong agricultural growth, which could boost rural income and consumption -which has historically been a significant driver for MMFS’ portfolio. Given the undemanding valuations, we maintain our BUY rating on the stock with a TP of INR310 (based 1.6x FY27E P/BV).

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