Most fast-moving consumer goods (FMCG) companies flagged weakness in the wholesale channel as a problem that affected sales growth in the March quarter. The rural market has been affected more than urban markets. Wholesalers operate in urban markets too but to a smaller extent and companies have direct reach through their own distributors. Since the rural sector can contribute to as much as 30-40% of sales for some mass-market products, the health of this channel is vital. If demonetisation was the first blow, then the goods and services tax (GST) is the second blow that is lying in wait.

What is ailing this channel? Wholesalers deal almost entirely in cash. Rural retail consumers buy with cash, the retailer pays the wholesaler in cash, who in turn buys the product in cash. Demonetization broke this chain. Now that cash is back in circulation, the problem should ease up. It has, but not entirely. The income- tax authorities have been pushing to widen the tax net, frowning upon large cash transactions, leading to fears that wholesalers may come under scrutiny. This has happened in urban markets.

One company chief executive implied that the more trying problem—compared to demonetisation—was that these wholesalers may be operating below the tax radar. If they had to now pay tax, then the business may become unviable. Companies may have known this fact but were paying relatively lower commissions, so may have looked the other way.

GST adds another dimension to this problem. Chances are these wholesalers may not have been paying local sales tax either, or at least not on the entire sales value. Earlier, the central government authority extended to output tax on goods and the state authorities levied value-added tax (VAT). Now, there is a common chain. It ends when the retailer sells the product.

If the wholesaler breaks the chain, the tax revenue will be lower. The authorities can enquire why they haven’t got the full tax revenue. Since all GST transactions can be accessed centrally, sharing data with the income-tax authorities will be simpler. Remember that goods being sold through the wholesale channel are at the same retail price as elsewhere. That may mean that the local sales tax component and the income tax on profits from the business were being pocketed. If the government gets its GST framework right, this won’t be possible any more.

Very small traders will not get affected. Under GST, those with revenue below Rs20 lakh don’t have to pay GST, and those below Rs50 lakh will come under a composition scheme, paying a flat tax rate. But no input tax credit will be available. That’s for GST but the chain of transactions means that if the GST people share data with the income-tax guys, knowing who’s not paying their tax dues is child’s play on a worksheet.

What next? Companies are worried. They are saying we are prepared and our distributors are prepared for GST but we don’t know about the others. Others are wholesalers and small retailers or the kirana shops. These kirana shops form the bulk of all FMCG sales, even in urban markets.

What happens next? If the wholesalers have to remain in business, companies have conceded they may have to increase commissions. That means higher costs. In some places, they may extend their direct reach, if that is more cost-effective. This transition has already started, will take time to complete, so some trade-related disruption seems inevitable in the initial phase of GST.

The last chain is where the customer buys from the shop. Since the kirana shops are not ready for GST, what happens after 1 July remains to be seen. The smaller shops may be below the threshold. Others may qualify for the composition scheme, where they pay a flat rate.

If they are tax compliant, on both VAT and income-tax fronts, then this is just teething trouble. If they are not, GST puts them at a disadvantage. The kirana shops are vital for FMCG companies. They may have to step in, to help them become compliant with GST. They even have to pay higher commissions, if that helps to keep them in business.

Modern trade including e-commerce, physical retailers, and cash and carry outlets are best placed to transition to a GST framework. If the unorganized part of the FMCG supply chain cracks under the pressure of compliance, and the transparency that it brings, the organized market will be happy to step in and fill that gap, at least in the urban markets.