GST Reforms and Sustainability of MSME in the Tannery and Leather Industry: A Study of Ambur and Vaniyambadi Clusters in Tamil Nadu

Abstract The tannery and leather industry clusters in Ambur and Vaniyambadi, Tamil Nadu, represent a vital MSME-dominated ecosystem contributing significantly to India’s leather exports and regional employment. This study examines the impact of the Goods and Services Tax (GST), implemented in July 2017, on the financial sustainability of these clusters, with specific focus on interest costs arising from short-term borrowings. GST’s input tax credit (ITC) mechanism and monthly compliance requirements, while enhancing transparency and supply chain formalization, have created severe working capital mismatches for tanneries. Firms must remit GST on outward supplies (5–18% on leather products) before receiving payments from buyers, whose credit cycles typically range from 30 to 90 days. This liquidity gap forces reliance on high-interest short-term loans (12–18% per annum from banks and NBFCs), eroding already thin profit margins. Literature on Tamil Nadu’s leather clusters confirms pre-GST cascading tax burdens and post-GST liquidity strain, particularly for export-oriented MSMEs. Empirical observations indicate that smaller tanneries incur interest expenses amounting to 5–10% of annual turnover, severely constraining reinvestment in technology, workforce skill development, and environmental compliance. Supply chain vulnerability persists due to fragmented supplier networks, delayed ITC refunds (often 60–90 days), and compliance complexities for informal players. The study recommends targeted financial support mechanisms including interest subvention schemes, GST-linked working capital loans with preferential rates leveraging GST return data for credit assessment, faster refund processing for exporters, and cluster-level common service centres. Best practices for resilience include e-invoicing, blockchain-based traceability, supply chain finance models (factoring/TReDS), and backward-forward integration. Conclusively, while GST has fostered market integration, addressing liquidity gaps through policy interventions is essential for the financial sustainability of Ambur-Vaniyambadi MSMEs, protecting livelihoods and enabling inclusive, resilient growth. Keywords: GST, working capital, interest cost, MSME, leather cluster, Ambur, Vaniyambadi, supply chain finance 1. Introduction 1.1 Background of the Cluster The Ambur-Vaniyambadi leather cluster, spanning the Vellore and Tirupathur districts of Tamil Nadu, constitutes one of India’s oldest and most concentrated industrial agglomerations for leather processing. The cluster comprises over 500 MSMEs, including tanneries, footwear component manufacturers, and finished leather goods producers. Collectively, these enterprises account for approximately 35% of India’s total finished leather exports, with major markets in Germany, Italy, the United Kingdom, and South Korea (Council for Leather Exports, 2022). The region’s competitive advantage historically derived from access to raw hides from local slaughterhouses, abundant semi-skilled labour, and inter-firm trust networks that enabled trade credit and just-in-time supply chains. Prior to GST, the cluster operated under a fragmented indirect tax regime comprising central excise, state VAT, entry tax, and local cesses. This multiplicity of taxes led to cascading (tax-on-tax) effects, high compliance costs, and frequent checkpost delays. However, the system also allowed many MSMEs to remain below registration thresholds, effectively operating informally with minimal tax liability. Small tanneries often paid composite taxes or remained outside the formal net, relying on cash transactions with local agents. 1.2 GST Reforms and the Leather Sector The Goods and Services Tax (GST), effective July 1, 2017, subsumed over a dozen central and state taxes into a single, destination-based levy. For the leather sector, GST rates were fixed as follows: Product Category GST Rate Raw hides and skins (untanned) 5% Finished leather 5% Leather footwear (price > ₹1000) 18% Leather footwear (price ≤ ₹1000) 5% Leather goods (bags, belts, wallets) 18% Leather chemicals 18% *Source: GST Council Notifications 2017-2021* While the 5% rate on finished leather represented a reduction from pre-GST effective taxes (which ranged 8–12% due to cascading), the 18% rate on higher-value footwear and accessories increased tax burdens for certain downstream producers. More significantly, the shift from origin-based to destination-based taxation, mandatory monthly filing (three returns per month initially, later simplified to GSTR-3B and GSTR-1), and the input tax credit (ITC) matching mechanism fundamentally altered working capital dynamics for MSME tanneries. Under GST, a tannery that purchases wet-blue leather (input) pays 5% GST, which it can claim as ITC when paying GST on finished leather sales. However, the credit is only available after the supplier files its return and the system matches invoices. Typically, this ITC realization takes 30–90 days. Meanwhile, the tannery must pay output GST on its sales within 20 days of the month-end, regardless of whether it has received payment from its buyer. This “pay-first-claim-later” cycle creates a persistent liquidity gap. 1.3 Problem Statement and Objectives MSMEs in Ambur-Vaniyambadi operate on thin equity bases (average 15–20% of total capital) and have limited access to formal bank credit. Historically, they relied on trade credit from buyers or advances from commission agents. Post-GST, the requirement to pay output tax in cash before receiving ITC or customer payments has forced many tanneries into expensive short-term borrowing. This study therefore aims to: (1) quantify the incremental interest burden on cluster MSMEs attributable to GST-induced working capital gaps; (2) analyze supply chain disruptions arising from changed credit terms; (3) recommend financial and operational interventions to restore sustainability. 2. Literature Review 2.1 Cluster-Specific Studies on Ambur-Vaniyambadi Tanneries Edwin and Dhas (2019), in a survey of 50 tanneries in the Ambur-Vaniyambadi belt, found that average working capital days increased from 45 days pre-GST to 78 days by 2019. The study noted that smaller firms (investment < ₹1 crore) experienced the most severe liquidity compression, with 68% reporting delayed customer payments exacerbated by GST filing requirements. Similarly, the SELCO Foundation (2021) documented that tanneries in the cluster typically operate with current ratios below 1.2, indicating potential insolvency, and rely on informal financiers charging 18–24% annual interest. Kumar and Rajan (2020) conducted a qualitative study of supply chain relationships in Vaniyambadi, finding that pre-GST trust-based credit between tanneries and footwear manufacturers eroded after 2017. Large buyers began insisting on tax invoice matching before releasing payments, extending their own credit periods while demanding immediate GST payments from suppliers. This power asymmetry disproportionately harmed MSME suppliers. 2.2 GST Working Capital Impacts Multiple studies have established that GST increases working capital requirements for MSMEs across sectors. Garg and Narayanan (2018), using a cash conversion cycle model, estimated that the average MSME requires 25–40% additional working capital post-GST due to ITC lock-up and monthly filing cycles. Rao (2020), analyzing RBI data, found that the average ITC realization period for manufacturing MSMEs increased from 22 days under VAT/Cenvat to 67 days under GST in the initial two years, improving only marginally to 52 days by 2020. For export-oriented units, the problem is compounded. Bhatia and Singh (2021) noted that while exports are zero-rated under GST (allowing refund of accumulated ITC), the refund process itself takes 45–90 days, forcing exporters to finance the tax component from their own working capital. The authors recommended a deemed-export scheme for clusters like Ambur-Vaniyambadi where over 60% of production is exported. 2.3 Interest Costs and MSME Finance The cost of short-term credit for MSMEs in India remains prohibitively high. The Reserve Bank of India (2022) reported that banks lend to MSMEs at 11–14% for working capital, while NBFCs charge 16–22%, and informal lenders 24–36%. Pandey (2021), studying tanneries in Kanpur and Chennai, found that post-GST interest costs as a percentage of turnover doubled from 3.5% to 7.2% within 18 months of reform implementation. The study attributed this to “bridge loans” taken to pay GST on receivables. Specifically for the Ambur-Vaniyambadi cluster, a report by the Centre for Financial Accountability (2022) noted that the average interest coverage ratio (operating profit / interest expense) fell from 2.8x in 2015-16 to 1.5x in 2020-21, indicating that many firms barely generate enough profit to cover interest payments. Firms with interest coverage below 1.0 (i.e., losses before interest) increased from 12% to 34% of the cluster over the same period. 2.4 Supply Chain and Formalization Challenges The shift to formalization under GST has created both opportunities and costs. Mehta and Desai (2019) argued that while GST reduces checkpost delays and enables seamless transport, the e-way bill system (mandatory for consignments above ₹50,000) imposes compliance costs of ₹5,000–15,000 per month per firm. For a cluster with many small players, this is a significant burden. Furthermore, mismatches between e-way bills and invoices lead to detention, demurrage, and penalties, further straining cash flows. Recent literature emphasises the need for cluster-level interventions. Sharma and Venkatesh (2022) proposed “GST Suvidha Kendras” (common service centres) in industrial clusters to handle filing, reconciliation, and refund applications. They estimated that such centres could reduce compliance costs for MSMEs by 40–60%. 3. Methodolo