It is budget time. It is also time for review of the foreign trade policy. There are two trade policy issues that demand serious attention during these exercises.
Inverted duty structure
The jury is out on whether the FTA agreements have benefited India. However, there are worries that in one respect they may have harmed the country?s economic interest. India, like its partners, has excluded a number of non-agricultural products from the elimination of duty in these agreements. The exclusions have resulted in an inverted tariff structure, whereby the import duty has been eliminated on the finished products while being retained on parts and components. As a result, the original equipment manufacturers prefer to do business by importing finished goods rather than manufacturing the product in India from imported or domestically-produced parts and components. There has been a large influx of imports of such goods as refrigerators, air-conditioners, washing machines, microwave ovens and television sets (below 19 inches). The tariff structure is stimulating imports and inhibiting local manufacturing.
The Information Technology Agreement (ITA), under which tariffs have been eliminated on 200 tariff lines including computers, has benefited India on the whole, and the infusion of technology through duty-free import of IT equipment transformed many segments of the Indian economy. However, one of its unintended consequences was an inverted tariff structure, which affected the hardware industry adversely. Although the parts and components required for the manufacture of IT products are also included in the ITA and benefit from zero tariffs, the materials, such as plastics, copper, aluminum, glass etc (dual-use items), are not. These inputs are also widely used by industries other than the IT and attract duties at significant levels. For these items, the government has issued an exemption notification allowing imports at zero duty by IT product manufacturers. The procedures are, however, cumbersome and it is much simpler for the original equipment manufacturers to import the finished products rather than manufacture it locally.
Export incentives schemes
India has a plethora of export incentive schemes on non-agricultural products. Some of them are aimed at exemption of an exported product from duties or taxes borne by the product or the remission of such duties and taxes. These schemes, such as the drawback scheme, are not deemed to constitute export subsidies. However, a number of schemes clearly constitute an export subsidy, and are covered by the disciplines of the WTO agreement. Examples of such schemes are focus product, focus market, market-linked focus product and preferential pre-shipment and post-shipment export credit. Since the WTO rules do not allow rebate of taxes on capital goods used in the production of the exported products, the Export Promotion Capital Goods (EPCG) Scheme also involves the grant of an export subsidy. Concessions on income tax envisaged in the SEZ programme are also an explicit export subsidy.
As a rule, the WTO Agreement on Subsidies and Countervailing Measures (ASCM) prohibits the use of export subsidies, i.e., subsidies contingent upon export performance, on non-agricultural products. However, India was one of the low-income countries listed in Annex VII of the ASCM, which were exempted from the obligation, until such time as the per capita income reached $1,000. Even a country in Annex VII is mandated to phase out export subsidies over eight years once it has reached export competitiveness in a product group. Export competitiveness in a product is deemed to exist if the developing country concerned has reached a share of 3.25% in world trade of that product group for two consecutive calendar years.
India?s competitiveness in textiles and clothing has been under scrutiny in the WTO. In April, 2010, a secretariat report showed that India?s share of world trade in this sector grew from 2.9% in 2004 to 3.4% in 2005 and has remained at 3.4% or higher since then. Thus, in 2007, India?s share of world trade in textiles and clothing had been above the benchmark of 3.25% for two years. Under the rules, therefore, it is required to eliminate export subsidies on textiles and clothing by the beginning of the calendar year 2015. The withdrawal of incentives at one stroke now is bound to cause shock waves in the industry.
The lesson from the experience on textiles is that government should start planning early for the time when it is eventually excluded from Annex VII of the ASCM. The countries listed therein, other than those which are designated as LDCs by the UN, will become subject to the prohibition on export subsidies once their GNP per capita has reached $1,000 per annum. At the Doha Ministerial meeting, it was decided that the members listed in Annex VII would exit from it only after their per capita GNP reached 1,000 in constant 1990 dollars for three consecutive years.
The WTO secretariat updates the calculation of per capita GNP in constant 1990 dollars from year to year. According to the last calculation released by the Secretariat on July 13, 2013, India?s per capita GNP in constant 1990 dollars rose from 871 in 2009 to 926 in 2010 and further to 966 in 2011. Even though the GDP growth rate in the country has slowed down since then, it is likely that the per capita GDP would have either crossed the $1,000 mark or would do so soon. The day is not far when India would become ineligible for the benefits accorded to an Annex VII country.
Clearly, India?s status as a developing country, eligible for flexibility in using export subsidies, has reached a critical stage. Its entire export incentives programme, except the measures that envisage exemption from or remission of indirect taxes, is on the line. The time has come for India to prepare for phasing out all export subsidies on non-agricultural products.
The author, a former deputy director general of the WTO, is Chair Professor of Trade Policy, ICRIER