Budget 2005-06: new trade policy paradigms clearly emerging for SMEs

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: For a change, the Budget presented for 2005-06 did not have any attractive announcement for small and medium enterprises (SMEs) — the mention of SME Growth Fund and increase of overall investment limit from Rs 3 crore to Rs 4 crore are, at best, inconsequential. Instead, withdrawal of the excise exemption option with Cenvat would upset a large segment of SSIs. However, the Budget underlines the new paradigms emerging in India’s trade policy having implications for the SME sector.

These paradigms broadly have two dimensions. One, the reforms being taken up by India unilaterally and, two, navigating trade policy in light of present international commitments, or ones that are on the horizon. The Budget proposes to reduce the peak rate of customs duties from 20% to 15%. It also proposes reduction of the input cost of a large number of SMEs, by reducing customs on primary and secondary metals from 15% to 10%. Thus, the commitment of successive governments to achieve alignment of duty levels with Asean seems to be staying on course, though the convergence between the two at 0-5% levels are only likely to happen around 2008-09.

The reduction prepares the industry for the challenge emanating from free trade agreements, especially Indo-Thai and Indo-Asean. However, even now India’s duty levels are still among the highest in the world. The good thing is that the difference of average customs duties between China and India has got compressed considerably, around an average industrial tariff at 10%, and would narrow the competitive advantage of China over India. Further, the Budget proposes removal of duty on specified capital goods and all inputs required for the manufacture of Information Technology Agreement (ITA)-bound items, while a countervailing duty (CVD)) of only 4% is to be levied on the imports of ITA-bound items and their inputs that attract nil duty.

The duty reduction also needs to be seen in the perspective of ongoing WTO negotiations on non-agricultural products. According to a study by Rajesh Mehta and Pooja Agarwal (RIS & FISME study), based on the proposed NGMA-CD formula, if the value of coefficient is taken as 1, the average bound rate of customs duties on 2,016 SSI tariff lines (at an 8-digit level) would be around 22%. If the coefficient value is taken as 0.5, the average bound rate will be 14.7% for SSI tariff lines. Therefore, even if a very ambitious stance is taken by WTO members to reduce the bound rates of customs duties multilaterally, there should not be shocks for Indian SMEs at the 15% peak duty level proposed in the budget currently. There may be a few tariff lines, though, which may require special treatment.

Second, the budget puts a stamp on harmonisation of classification of excise and customs at ITC HS 8-digit level. This is a development of far-reaching consequences, as it seamlessly connects the domestic and international trade so far as classification is concerned. The classification issues are going to be important, as India enters into a spate of bilateral and regional FTAs. This will obviate the need to lobby for favourable classifications and their resultant distortions in the value chains in domestic trade. Third, the budget specifically focused on two of India’s most promising sectors from the exports point of view, textiles and leather. Both the products figure in the WTO-Nama negotiations, under the zero-for-zero proposal. Though it is not yet certain whether countries would agree for a zero-duty regime on the two sectors, yet the Budget prepares a ground for the two sectors to take on higher responsibilities.

Accordingly, the customs duties have been brought down on important machinery for leather, from 20% to 5% and on ethyl vinyl acetate, an important input, from 20% to 10%. Similarly, in textiles, the budget announced dereservation of 30 textiles (knit products) of a total of 108 to be dereserved this year. Further, duty reductions have been announced on polyester, manmade yarn and textile machinery. Fourth, the Budget makes the historic move for implementation of Vat. Though it didn’t announce details and passed the responsibility of implementation on states, yet the move is extremely significant. What is reassuring are the post-Budget comments on the chairman of the empowered committee on Vat, Asim Dasgupta, that states will not change the APril 1 implementation date. The promise of Vat is alluring, as it promises to reduce the cascading affects of taxes, remove distortions and increases ancillarisation, smoothen the flow of goods across different states and reduce transaction time and cost. Making the possibility of India as one market a reality. It would remove artificial incentives affecting the choice of location of business and also bring about a shift from the archaic physical verification system to an audit-based system. More significantly from the trade point of view, Vat frees exports from the tax burden with WTO compatibility. However, it would take quite some time to put the process of Vat in place in all states and realise its stated objectives. The transition period is going to be tough and trying for industry, as well as trade. Therefore, while the Budget decisively takes the industry towards a regime characterised by further opening of external trade, at both regional and multilateral fronts, it also seems to be conscious of the need to push complementary internal reforms. Therein lies the balancing act of this Budget.