Stress has to be on reducing overall transaction costs

Updated: Mar 22 2006, 05:30am hrs
Even when India is being hailed as an economic success story with a sustainable gross domestic product (GDP) growth rate of above 8%, its export performance in the current financial year has been even better. With just a bit of luck, India may be able to cross the $ 100 billion mark this year exceeding the already ambitious export target.

Given the fact that the export growth is more than three times the average GDP growth rate, and exports account for about 12% of GDP, the incremental contribution of exports to GDP growth is almost one-third. However, despite such impressive spurt in exports, the balance of trade (BoT) is anything but healthy, the reason being a still higher growth in imports.

Aggregate imports during April 05-February 2006 stood at $ 126 bn, which is 33% higher than the preceding corresponding period. Since aggregate exports rose by only 26%, cumulative trade deficits during the period rose to $ 37.6 bn which is $ 13 bn higher than last year.

One reason behind the import surge is obviously the spurt in oil prices. Oil imports rose by almost 50% while non-oil imports increased by 26.6%. While deficits in the BoT for a growing economy like India is not necessarily bad, escalating deficits on account of higher crude oil prices contribute to inflationary pressures and introduce a strong element of uncertainty for the future. The role of Foreign Trade Policy (FTP) of India has to be seen in this context.

With the on-going endogenous liberalisation as well as the WTO mandated legal regime, the FTP has lost its former significance. Current policy regime is a modest combination of a few schemes designed to give customs duty drawback or duty-free imports related to exports. The principal scheme is the DEPB scheme which the EU considers to be WTO-non compatible. Therefore, the government is trying to develop an alternative scheme.

Since complete neutralisation of domestic duties is allowed under WTO, it is critical that a proper WTO compatible offsetting mechanism is presented in this years policy. Indian exporters are burdened with a number of domestic taxes and the 4% countervailing duty proposed in this years budget and the incidence of service tax can be an additional dampener for exports.

As the short and medium term behaviour of the external value of Indian Rupee is expected to be within a small band, exporters cannot expect a reprieve there, the need for an exporter-friendly neutralisation scheme is even greater.

FTPs in the recent years have focused on area-specific and product specific programmes. This began in 1995, with the enunciation of 15x15 matrix. Experience since then has shown that the market is more dynamic than what can be captured by such programmes.

For example, without any specific governmental incentive, trade with China has flourished and is estimated to be growing at more than 30% annually. China could shortly surpass USA to be the largest trade partner of India.

Media reports have said that the government has identified textiles, toys, leather, gems and jewellery, sport goods and processed foods as priority in this years FTP. Most of these are highly labour intensive and can, therefore, be considered to be internationally competitive, a priori.

Any FTP-based incentive would have substantive impact on their export performance. What is more important is that overall transaction costs are reduced.

Making FTP policy more IT-enabled will be a step in the right direction. Networking with other service providers will complete the loop and make a substantive dent on transaction costs. A lot has already been done. What remains is to go the last mile.

It is necessary to accept that in a consistently low tariff regime, it is not possible to provide substantive financial benefits to exporters through FTP, even if one assumes away all concerns relating to distortions. Further, most relevant interventions for trade development are outside the commerce ministry mandate, such as infrastructure development or labour market reforms.

The forthcoming policy will be the last annual policy within the 5 year policy framework. It is the most appropriate time to think whether there is really any continuing need for this annual ritual.

The author is director, IILM