Protection raises inefficiency, increases input costs for user industries, hurts manufacturing exports and prompts retaliation by trading partners.
Corporate India has lobbied Finance Minister Nirmala Sitharaman for competitive tariffs when she announces the Union budget on February 1. That marks a welcome change from India Inc’s usual clamour to shield domestic producers. It seems to have realised that the best way to become part of trade networks is to move away from a protectionist mindset. GoI must grab this opening to align custom tariffs with global manufacturing hubs, instead of muddling along the status quo.
Globalisation will continue as the world recovers from the Covid-19 pandemic. And, hopefully, the trade war between the US and China — which harms India — will end with Joe Biden in the White House. So, India must now focus on openness in policy, reducing both tariff and nontariff barriers in a time-bound way. This would nudge local producers to compete with the world in the local market and also make their products globally competitive.
Unlike, say, the changes to the farm laws, this reform is eminently doable as the goods and services tax (GST) offers much greater protection to the domestic industry. Imports are treated as inter-states sales within the country and attract integrated GST (IGST), which qualifies for input tax credit, making production more efficient.
Lowering customs duty has been the mantra for policy reforms since 1991 — peak duty being lowered to 10% from 150%. It halted in 2007-08 and there have been some signs of reversals over the last couple of years. This should change. Protectionism is not a way to an atmanirbhar India. Competition must drive industry.
Our customs tariff regime — that comprises basic tariffs, cesses, assorted exemptions and end-use restrictions on imports — is quite complex. The transition to a simple system calls for transparency in rates to prevent mis-classification, easing customs procedures and doing away with exemptions.
The Confederation of Indian Industry (CII) suggests a graded roadmap towards competitive tariffs over three years, with the lowest slab between zero and 2.5% for raw materials, highest of 5-7.5% for finished goods, and 2.5-5% for intermediates. A better way is to have a uniform import duty of 5% on raw materials, intermediate and final goods, giving all lines of value addition the same effective rate of protection.
Bound by Bound Rates
Most imports now attract ad valorem rates. This includes 52 most-favoured nation (MFN)-applied rates that range from zero to 150%. The simple (unweighted) average MFN rate is about 17.1%, twice that of other neighbouring countries that include China and Bangladesh. India’s bound rates, ranging from zero to 300%, are also among the highest. The difference between the bound rates and MFN rates allows the country to change tariffs while adhering to World Trade Organisation (WTO) commitments.
But the average effective tariff rate — revenues from customs duty as a proportion of the total value of imports — has been declining, and stood at a mere 2.6% in 2018-19, pointing to a significant erosion of the tax base. Trade experts say the widening gap between MFN rate (17.1%) and average effective tariff rate (2.6%) shows the extent to which special treatments lower the revenue potential from import duties.
Regional and bilateral agreements account for nearly a third of imports. Petroleum products, which account for nearly 27% of imports, enjoy preferential treatment. It is hardly surprising that customs duty revenues accounted for just 0.6% of GDP in 2018-19, compared to Brics (Brazil, Russia, India, China, South Africa) and Asean (Association of Southeast Asian Nations) economies, which raised an average of 1.2% from customs duty.
Converging multiple rates into a single MFN rate of 5% (with the exception of farm products), and removing exemptions over a three-year period, will help shore up revenues. It will also offer protection to the entire economy without disturbing the relative prices of goods and services.
Can New Delhi afford to stay out of trading blocs, when most of the world is part of them? No. Joining the Regional Comprehensive Economic Partnership (RCEP), the world’s largest trading bloc, will help the country reap gains from global value chains. India can negotiate the rules to protect its interests and to stand up to China, besides seeking access to services. A review of its position to stay out of RCEP is in order
Non-tariff reforms are equally important. The Trade Facilitation Agreement (TFA) has highlighted the key role of these reforms. Rightly, GoI has also drawn up the National Trade Facilitation Action Plan (NTFAP), a sort of TFA-plus. These reforms must be implemented swiftly, prioritising expeditious clearance and certainty of obligations.
The World’s a Stage
Various time-release studies have shown that major customs formations have cut cargo-release time significantly. Also, a revamped and more comprehensive Customs Authority for Advance Rulings (CAAR) will help in faster dispute resolution.
The larger point is that the wall of import tariffs has, in the long run, the effect of keeping industry homebound as small players incapable of dominating the world stage. This is because protection raises inefficiency, increases input costs for user industries, hurts manufacturing exports and prompts retaliation by trading partners.
So, India must open up global trade and investment to join global supply chains, raise its ability to make goods that it had not produced before, and realise its potential to be an economic powerhouse. The budget and beyond provide a golden opportunity.