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By Karthy Nair
Introduction
The Indian Economy has taken an astronomical leap forward in many aspects. Although India's trade as percentage of its GDP has risen steadily up to 34.9%, the contribution of export to India's GDP is still quite meagre at 9%1. The stagnation in trade of exports can in parts be blamed on the historical deliberate crippling of export of manufactured goods by the British. However, the mismanagement of export policies following independence was perhaps even worse for the newly-independent country. Obsessed with the idea of self reliance, a quasi-closed economy – a Mahalanobis Utopia -- was sought to be established, where import substitution by domestic producers would cater to the domestic needs and exports would be reached by and by when there was eventually a surplus. However, what occurred was a misalignment. While imports despite all restrictions grew, exports were curtailed and stifled. This (along with a host of other factors) led to the worst balance of payment crisis situation in 1991 that India ever faced. India was forced to reform its financial situation or lose international face. The debate of whether liberalization has jumpstarted Indian trade is highly contestable given the fact that it was only in 2006 that India's share in world exports increased to 1% from its previous high of 0.7% in 2001. However, there cannot be a mistake as to the fact that India has finally woken up to the need for better trade policies that will have long-term goals as witnessed by the Export-Import Policy of 2002-2007 and the Indian Foreign Trade Policy 2004-2009
Exchange Rate Instability & its Effect on Exports
Exchange rate instability has a history of wreaking havoc on the economy of the country as has been witnessed recently in the East Asian Crisis of 1998, the Argentinean crisis of 2001 etc. Its adverse impact is high in the export sector. While the import sector has for long enjoyed protectionist measures, the export sector has been left vulnerable to exchange rate instability. When the rupee depreciates, the export sector, it is hoped, will gain as the goods are cheaper abroad. But this does not happen. This is explained by the J-curve which shows how on depreciation, the cost of previously ordered imports rises while exports which have already been valued at a currency price remain unchanged. This situation however is temporary as trade balance situation is likely to improve as foreign demand for the cheaper goods is set to rise, while the domestic demand for expensive imports will reduce. When the rupee appreciates as it has been doing steadily against the dollar since September 2006, its adverse effect is quite large especially on goods which have low import content (and thus have little or no benefit from the cheaper import prices) and high rates of employment such as textile, handicraft, marine products etc.
The RBI does try to control the situation with short term manipulations in the forex market, but there is need for newer or reformed versions of existing trade policy measures to strengthen the export sector. There are many areas where the exporter faces problems in which the government could try and alleviate even if its some of general measures like the, ‘high cost of finance', ‘below par infrastructure' and ‘high and complex taxation structure'.
Some of the important measures like the duty exemption or remissions schemes which are provided are compatible in the development framework and consistent with international rules. These rules are covered in the S&D provision and therefore enjoy the exemptions, many of which, however, invite countervailing duties, are being phased out.
Duty Exemption Schemes
• Advanced Licence Scheme
The Advanced Licence scheme exempts payment of Basic Customs Duty, Additional Customs Duty, Special Additional Duty (SAD) etc on imported goods which are needed for export purposes. It has its genesis in subsection 1 of section 25 of customs act of 1962 which allows the government to exempt materials imported from certain taxes on grounds of public interest. The scheme is present in two forms -- Advance Licence for Annual Requirement under FTP 2004-2009 and Advance Licence under ftp 2004-2009. These duty exemptions are however subject to fulfilling export obligations and requirements such as holding a star export house certificate.
Duty Remission Schemes
• Duty Entitlement Pass Book Scheme (DEPB)
The scheme provides for duty credit by which the custom duty on import content of exports can be neutralised. The credit given can either be used for payment of custom duty or can be sold to another importer. It is a duty remission scheme as envisaged under section 4.1 of the FTP 2004-2009.
• Duty Free Import Authorization
This licence allows duty free import of goods which are needed for export. The custom duty is replenished for goods which are of the same technical characteristics, quality and specifications as used in the resultant product.
Other export promotion measures include the Export Promotion Capital Goods Scheme (EPCG), Export Oriented Units (EOU), Export Processing Zones (EPZ), and Special Economic Zones (SEZ).
Problems associated with these schemes are:
• The schemes are all licence-based schemes and come with the inherent problems associated with them. Licence schemes encourage rent seeking and bureaucratic inefficiency. For example, the successful operation of these schemes requires the smooth and complementary working of the DGFT and the customs office, and this is sorely lacking.
• The Advanced Licence scheme, the DFRC etc, involve highly cumbersome procedure which is not only complicated but also time-consuming. It also tends to be inflexible, which could prove damning for exporters. For example, there is a high interest on the unutilised quantity of raw materials even in case where the default is genuine under the Advanced Licence scheme.
• The policies in place are export promotional in nature. The Advanced Licence scheme, for example, is only available for those exporters who fulfil certain export obligations and/or have obtained Star House Certificates. Also, it does not include small-time exporters in its ambit. The policy could be broadened to help all exporters, especially perhaps those small-time exporters who are hit by exchange instability to a larger extent and are unable to tide over it.
• A larger issue looming over these schemes is that of WTO compatibility. The subsidiary and countervailing mechanism agreement (ASCM) differentiates between prohibited subsidies -- section 3.1(a) and actionable subsidies section 3.1(b). Though India still does not invite disciplinary actions associated with prohibitive sanctions, actionable sanctions are applicable on it2. Many Indian export incentive schemes have been questioned as being incompatible. This situation is of grave concern for Indian industries which have been used to export incentive schemes for over four decades. The department of economics and statistics of Tata sons has calculated that nearly 70% of the prevalent schemes such as EOU,EPZ,EPCG, DEPB etc are countervailable, i.e. a tax can be levied on such exports to neutralize the perceived subsidy given by the exporting country. This is one of the major reasons why policies such as DEPB have been sought to be phased out over time.
Other policies like the exemptions on services and duty drawbacks and dovetailing of state and central policies need to synergise if there is a need for protection of export sectors from the vulnerability in exchange rates.
1. Tax exemption on services
There has been a push since 2007 to provide for tax benefits on services rendered as part of the export process both in India as well as abroad. Though this is available in part for some services, service tax is still charged for important transactions such as commission to foreign agents and bank charges.
2. Duty Drawback Schemes
The duty drawback schemes are meant to help refund custom duties or taxes on goods that are used in manufacturing or processing of goods that are made in India and exported. Two types of drawback schemes that are available are -- All Industry Rate (AIR) drawback and Brand rate.
However, these measures will not prove beneficial unless timely refunds are made. There needs to be a smooth functioning mechanism of tax refund that is missing in the existing format of the scheme. The FIEO for example has pointed out how hundreds of crore of rupees as tax refunds is still awaiting procedural processes and is yet to reach the exporters.
3. Aligning state and central policies
Increasingly with the efforts taken by the Central Government to cut down on taxes and duties that exporters have to pay, the State levied duties and tariffs also need to be cut down. There is need for basic formulae of tax rebate/refund that states can apply to exported goods which falls on the Centre to develop. There is also need for aligning policies in various states. For example, in Tamil Nadu, Andhra Pradesh etc VAT refunds are done within 90 days of claim submission while in West Bengal the process has not even begun.
Trade policies like the exchange rate instability and export instability cannot be worked from the subsidy perspective and sudden knee-jerk reaction may not be trade compatible. Any subsidy dispersed having a distortionary impact on trade might implicit automatic countervailing duties and even risk general classification of these measures to all products and further delays in imports at the importing countries ports. Even India being a leader in development issue should strive for more equitable trade policy that takes care of the interest of other lesser developing countries and enable more structural initiative like better trade facilitation, infrastructure etc rather than bank on knee-jerk reaction of relief for exporters in light of the exchange rate instability.
Conclusion
Most of the measures already in place or likely to be suggested are based on notions of tax refunds and duty exemptions. But it must be remembered that these measures are supposed to be an exception rather than the rule. There also needs to be a calculation of the opportunity cost that these tax exemptions etc constitute which stands at massive amounts. Though we may be able to avoid the WTO compatibility issue for a while in the long-term shielding, our weak exporters will not help our growth. Though these measures may prove beneficial in the short run, there needs to be policies in place which would help to give a long term boost to the export sector. These however call for reforms in various other sectors. There needs to be development in infrastructure, better technology and trained workforce in manufacturing and processing and a better financial structure. The approval of setting up of a National Export Insurance Account in 2006 to cover risk that exporters face for example is a step in the right direction. As a dynamically developing nation, the rupee appreciation is only natural – protecting the exporters from its ill effects can only be a short-term measure but it cannot form the main essence of the foreign trade policy which should plan for more effective measures and not bank on knee jerk reactions which may not be sustainable in the long run and which may weaken the development mandate India has always stood by.
1 Statistics as per 2005 . Pitiable in comparison to the East Asian giants such as Hong Kong were exports stand at 117% of its GDP or even to its immediate neighbour China were export stands at 23% of its GDP.
2least developed nations and developing nations with a GNP per capita of less than 1000$ are exempted from the disciplinary action that is associated with prohibitive subsidies but can still be held liable for actionable sanctions. Developing nations can also be held liable when they have already achieved economic competitiveness in a particular product.
April 4, 2008
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