Over the past couple of years, two major economic reforms have taken off (though both may be considered as works in progress): the transition to a nationally integrated Goods and Services Tax and the activation of the Insolvency and Bankruptcy Code. On the other side of the ledger, the same period has seen continued appreciation of the real effective exchange rate of the rupee (REER) and the ominous resurrection of higher customs tariffs.
In my last column (Business Standard, July 12, 2018), I had noted that the 20 per cent appreciation of the REER (according to the RBI’s 36 country index) between January 2014 and January 2018 had very probably hurt our export performance badly, with non-oil goods exports having fallen to only 10.2 per cent of GDP in 2017-18 (the lowest level in at least 15 years) and trade and current account deficits rising uncomfortably high. This large real appreciation of the rupee probably also fuelled higher imports of goods and services and helped stoke protectionist tendencies inherent in substantial parts of our “neta-babu” class and our domestic industry (“Why should we import? Why can’t we make these things in India?”). These outcomes are not surprising, since a 20 per cent appreciation of the rupee is tantamount to an uniform 20 per cent tax on all exports and a 20 per cent uniform subsidy (or a 20 per cent point cut in extant tariff rates) on all imports. Why the government and the Reserve Bank of India (RBI) allowed this to happen is a mystery.
Certainly, the revival of higher protective tariffs over the past year has been a damaging reversal of the cross-party reform commitment to reducing tariff levels to “East Asian levels” that had prevailed since 1991. The move towards higher protective duties began in 2016 and reached a crescendo in Mr Jaitley’s budget this February. What I wrote then remains true (Business Standard, February 8, 2018): “Far more significant…is the Budget’s retrograde proposal to increase import tariffs on a wide range of commodities, including: automobiles and components, mobile phones and parts, some processed foods and oils, a range of cosmetic products, footwear, furniture, watches and clocks, various toys and sporting equipment. As Mr Jaitley himself noted, this will constitute a reversal of more than 20 years of import tariff reductions, which he justified to promote ‘Make in India’. In fact, many decades of global experience and our own economic history has amply demonstrated the ill effects of tariff protection. As in the past, these steps are likely to increase inefficiency, raise domestic prices, hurt exports, encourage more tariff hikes in other areas, invite retaliation from trading partners and generally weaken the development of an efficient and competitive manufacturing sector. They are not consistent with the Prime Minister’s strong criticism of protectionism at Davos and could well undermine our recently reaffirmed commitment to stronger trade and economic integration with ASEAN nations and others in the Regional Comprehensive Economic Partnership.”
As predicted, further tariff hikes have followed on a range of products. In July, tariffs were raised on over 70 items of textiles and garments; and on August 6 tariff increases on a further 328 textile/garment products were notified. Early last month, the government established a “high-level task force” under the Cabinet Secretary to identify products and policy interventions to reduce dependence on imports. Recent reports in the financial press in the past five days indicate that further import tariff increases are imminent on a range of consumer durables such as televisions, washing machines and refrigerators (Economic Times, August 4, 2018).
Professor Arvind Panagariya, former vice-chairman of Niti Aayog and a globally recognised expert on foreign trade policy, has eloquently argued that our “Current turn to import substitution will take the economy down from the turnpike to the dirt road” (Times of India, July 25, 2018). Tariff hikes may reduce our imports; but they will also reduce our exports. More than 80 years ago, economist Abba Lerner had pointed out that a tax on imports was akin to a tax on exports. The argument is straightforward. Import tariffs (like export taxes) change relative prices and profitability: tariff increases (or higher export taxes) make import substituting domestic production relatively more profitable relative to exports. To the extent tariffs are on intermediate goods such as steel, components of consumer durables or textile fabrics, they raise input costs for exports as well as import-competing production, thus fostering a high cost (less competitive) industry. In essence, import tariffs and export taxes both discourage trade, imports and exports; they do not necessarily reduce the trade deficit and certainly do not foster a competitive manufacturing sector.
Furthermore, high growth of trade (especially exports) usually correlates well with high growth of national output and employment. When India’s trade growth was low (1950-1980), our economic growth averaged less than 4 per cent a year. Post 1991, the periods of high trade growth (1992-97 and 2003-2011) have also been periods of high economic growth.
If tariff hikes are obviously bad policies for pursuing the twin objectives of lower trade deficits and a more dynamic and competitive manufacturing sector (Make in India), what alternative policies can government and RBI pursue? They should work to reverse the large real appreciation of the rupee that was wrongly allowed to occur between January 2014 and January 2018. To some extent, that is already happening in the last few months as our external payments situation has come under pressure because of stagnant exports and rising imports. This depreciation trend should be allowed to play out. Certainly it makes little sense to heavily deploy forex reserves to prevent rupee depreciation, which would help secure both objectives.
Greater reliance on better exchange rate policy (rather than import tariff hikes) will also help India’s participation in major regional trading arrangements, notably the Regional Comprehensive Economic Partnership (RCEP). Protectionist domestic lobbies have little love for RCEP. They do not seem to appreciate that in today’s world, with the WTO-based international trading order under threat, participation in RCEP provides significant insurance for long-term preservation of India’s international trade and prosperity. Staying out would be against our long-term national interest.
The writer is honorary professor at ICRIER and former Chief Economic Adviser to the Government of India. Views are personal