India’s tariff reforms: Issues and policy suggestions

Relooking India’s Tariff Framework, a comprehensive study by the EXIM Bank of India in collaboration with Dr HAC Prasad, Former Senior Economic Advisor, Ministry of Finance, Government of India, examines India’s tariffs in general and also in the context of the Preferential Trade Agreements; and suggests policies and strategies for rationalisation of India’s tariffs both general and preferential. We bring you edited extracts of the 236-page report, highlighting issues relating to engineering goods

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RECENT GLOBAL AND INDIAN TRADE PERFORMANCE AND TARIFFS

India’s trade openness and tariffs since the 1991 reforms

Until the early 1990s, India was a relatively closed economy. In 1991, the country embarked on a series of major trade reforms, progressively cutting tariff- and non-tariff barriers, phasing out quantitative restrictions, and easing limitations on the entry of foreign investment. Even though India is still considered a highly protected economy, progressive liberalisation has produced remarkable results. The country’s openness indicator has more than trebled since the late 1980s, and the economy has been expanding at a high rate, second only to China except for the recent slowdown. Exports contributed greatly in the growth in China as the share of China’s exports to world exports increased almost 14 times in the last three decades, whereas India’s export share in world exports remained flat after a slight improvement in the 1990s and 2000s period, i.e. after the economic reforms including trade reforms.

The increasing openness was also due to tariff liberalisation with trade openness and tariff reductions moving in opposite directions. However, following the recent global trend of protectionist measures, both simple and weighted tariffs have risen in 2018 (Figure1).

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Source: Computed from WITS-TRAINS data and IMF: WEO

Recent global trade situation

The pace of global economic activity remains weak after slowing sharply in the last three quarters of 2018. Rising trade and geopolitical tensions have increased uncertainty about the future of the global trading system. As per the January 2020 update of IMF’s World Economic Outlook (WEO), global growth is projected to rise from an estimated 2.9 percent in 2019 to 3.3 percent in 2020 and 3.4 percent for 2021 – a downward revision of 0.1 percentage points for 2019 and 2020 and 0.2 percentage points for 2021 compared to those in the October 2019 WEO. The downward revision primarily reflects negative surprises to economic activity in a few emerging market economies, notably India. The recent break out of Covid19 could further lower global growth prospects.

As per WEO, world trade volume (goods and services) growth estimated at 3.7 percent in 2018 is projected to grow at a lower rate of 1 percent in 2019 and expected to improve to 2.9 percent in 2020. Escalating trade tensions and a slowing global economy have led WTO to sharply downgrade its forecasts for trade volume growth in 2019 and 2020 to only 1.2 percent in 2019, substantially lower than the 2.6 percent growth forecast in April 2019 and the projected increase in 2020 is now 2.7 percent, down from 3 percent previously projected. Downside risks remain high and the 2020 projection depends on a return to more normal trade relations. Further rounds of tariffs and retaliation could produce a destructive cycle of recrimination.

Global tariff levels

Out of a set of 118 countries in 2018, India had the fifth highest simple average MFN tariff (17.1 percent). Only four countries Bahamas (32.5 percent), Egypt (19.1 percent), Algeria (18.9 percent), and Ethiopia (17.4 percent) have higher average tariffs than India. However, if we compare the trade weighted average tariff for 108 countries in 2018, India ranks 21st highest (11.7 percent). Even if we compare both simple and trade weighted average tariffs of India, with comparable economies, India’s average tariff is still very high (Table1).

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Note: *means the values of the nearest years
Source: Compiled from WTO data

Rising protectionist tendencies

Protectionism has been on the rise in recent years. During the last three years (2016 to 2018), among the G-20 nations, the maximum number of trade restrictiveness interventions was made by the USA followed by India, Germany, UK, Italy, and China. While in the same period, the maximum number of liberalising interventions was made by Brazil, followed by Indonesia, the USA, and India. The restrictive interventions are mainly in the form of Antidumping. The liberalising interventions are mainly in the form of import tariff reforms and FDI relaxation (Figure2).

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Source: Based on Global Trade Alerts (extracted from www.livemint.com)

In the case of restrictive interventions faced by economies during 2016 to 2018, India faced the second highest number of restrictive interventions from advanced G-20 economies.

Global Value Chain (GVCs) can amplify the impact of tariffs on trade and activity. Growing protectionism, which can end up in trade conflicts or even trade wars can slow the expansion of GVCs. As in many countries, in the Indian case also the foreign value added content of exports, after rising in the early 2000s remained almost flat for some years and then declined.

Recent developments in trade negotiations including tariffs

Negotiations in WTO including on tariffs are almost stalled. The twelfth Ministerial Conference of the WTO (MC12) was scheduled to be held in June 2020 in Nur-Sultan, Kazakhstan. Discussions for an outcome at MC12 are underway at various informal Ministerial meetings and regular meetings at the WTO. As per WTO TPR 2015 for India, India’s tariff structure remains complex and the simple average MFN tariff rate increased during the review period. Since India’s average tariff has suddenly increased in 2018 as per WTO data, the issue may come up for discussion in MC12.

India has bilateral trade arrangements with many major regional groupings/ countries. India has 10 Free Trade Agreements (FTAs) and six Preferential Trade Agreements (PTAs), which are already in force. There are as many as 22 on-going trade negotiations also. Of these some are new and some are expansions of the ones already in force. While tariff negotiations have been the major plank of FTA/RTA Agreements, of late other areas like Investment, Services, etc. have been included in the FTA/RTA/CECA negotiations.

Tariff related changes in budget 2020-21

Budget 2020-21 has also come out with some changes related to India’s tariffs. While some measures are liberalising in nature, some others have been taken to counter the rising protectionism of other countries and also with the aim of Make in India.

Some important changes related to tariffs in Budget 2020-21 include the incorporation of a new Chapter VAA (a new section 28DA) in the Customs Act to provide enabling provision for administering the preferential tariff treatment regime under trade agreements; creation of new tariff items; review of customs duty exemptions for certain imported goods; changes in customs duty for MSMEs and promoting Make in India, particularly by increasing customs duty under phased manufacturing programme (PMP) for electric vehicles and cellular mobile phones; promoting Make in India in electronics sector; and reducing customs duty on raw materials and inputs imported by domestic manufacturers in many areas.

The relatively high average MFN tariffs of India suggests the need for tariff reforms. The stalled WTO negotiations and the growing bilateral and regional agreements also call for a detailed look at the tariff policy in the context of bilateral/ regional agreements. These are examined in this report.

INDIA’S GENERAL AND PREFERENTIAL TARIFFS: SOME SECTOR-SPECIFIC ISSUES AND SUGGESTIONS

Rationalising MFN and preferential tariffs in different sectors

In this report an attempt has also been made to list out issues and cases for rationalisation for different sectors including lowering or raising tariffs both general and for FTAs and listing some remaining cases of inverted duty structure in the industrial sector. This is not an exhaustive list, but only an indicative list.

Engineering goods

The engineering goods sector is an important sector of India’s exports and also in the Make in India plan. This sector has been adversely affected by FTAs mainly with Japan, Korea, and ASEAN, which are also India’s competitors. Some examples of the adverse effects of FTAs on engineering sector are the following. In the case of steel, 74 percent of the steel imports in India are from Japan and Korea at a much lower tariff under the FTAs affecting the domestic sector. In the case of air conditioner, the AC machines are covered under the India-ASEAN FTA (5 percent preferential tariff) whereas the AC compressors are not covered (10 percent MFN). Hence, AC manufacturers from other East Asian countries set up their shops in ASEAN and import fully assembled AC machines under the preferential route to India rather than the compressors. This adversely impacts the industry in India. It is also a growing trend that many Chinese engineering goods manufacturers are setting up shops in India’s FTA partner countries and exporting products directly to India under the preferential route.

While some FTAs are already being reviewed, other FTAs also need to be reviewed. The government has also indicated now that all FTAs will be reviewed. Under the FTAs, most of the engineering goods are imported duty free while a few goods which belong to the negative/sensitive list such as automotive, electrical machinery, products of iron and steel, etc. have high duty. Lowering the duty of those products may have an adverse impact on domestic industries as imports will be cheaper.

Shipping

Though shipping is a service, there is one main tariff-related issue of import of shipping vessels. Certain types of shipping vessels are subject to imposition of customs duty, as well as a surcharge. This includes anchor handling tug-cum-supply vessels, multipurpose platform supply and support vessels, fire fighting-cum-safety vessels, well stimulation vessels, jack-up rigs, production platforms, and floating production, storage and offloading unit drillships. A foreign maritime services provider has no commensurate liabilities, and can hence provide similar services at much more competitive rates.

Various duties, taxes and surcharges are levied on an Indian shipping provider for use of any input goods and input services. The input services for the maritime service sector are zero-rated in most countries worldwide. This makes foreign shipping vessels more competitive, because of the lower costs for their operations.

Besides the tariff levied on ships imported, tax is also levied on Input goods like IFO, lubes, paints, spares and also on input services. Even a 5-10 percent tariff will have a large impact on this capital-intensive sector. Meanwhile, foreign shipping services are not taxed on any comparable parameter, thereby giving them a comparative advantage.

In fact a type of inverted duty structure has emerged in the shipping sector as shipping services have no tariffs but the import of all other inputs of goods and services like ships, fuel oil, ship spare, insurance etc all attract import duties, effectively incentivising imports of shipping services rather than facilitating/setting up and expanding the use of Indian shipping services. This anomaly needs to be addressed if India desires to have strong domestic shipping.

Thus, the sector-specific analysis indicates that there are cases where tariffs can be increased and cases where it can be decreased. There are also many FTA related issues, while inverted duty structure issues have become less, though some remain or have cropped up. Any tariff rationalisation policy should carefully examine these sector-specific issues also before arriving at general policy measures.

India entering into new FTAs: Sectoral impact

The second issue to be examined here is the need to enter into new FTAs from the point of view of different sectors. While ongoing negotiations are taking place to conclude new FTAs or expand existing ones, the two recent and important RTAs/FTAs being discussed are the RCEP and Indo-US FTA. Besides, some other FTAs have been suggested by stakeholders.

RCEP

While India joining the RCEP has been put on hold for the present, one cannot rule out pressure building up again to join the RCEP. India needs to weigh the options carefully, lest it gets into a catch-22 situation.

Engineering goods

During the inception of the RCEP negotiations, engineering industry had cautioned about the threat of having China in the agreement. A differential tariff structure under RCEP for China is needed with minimal tariff liberalisation for China, in case of any future negotiations on RCEP by India.

India-US FTA

Currently there is a lot of interest and talk on a possible India-US FTA. USA has in a way already cleared the decks by withdrawing GSP benefits to India making India to negotiate on what was earlier granted. While India can negotiate separately on GSP, US may likely make it a part of the proposed India-US FTA.

Engineering goods

Unlike other FTAs where agricultural items are sensitive items, in the case of Indo-US FTA, engineering goods could be sensitive items. In fact, the Indo-US trade conflict in 2018 started due to engineering goods with US levying/increasing tariffs on steel and aluminium products. India’s retaliatory tariffs on US also include many iron and steel items. Given the sensitivity of US-India relations, negotiating an FTA without proper caution may lead to unwarranted fall in tariffs in some items resulting in the higher import of the items presently manufactured in India. So, a careful examination of the items is needed before going ahead with any negotiations from the point of view of the engineering sector.

Thus, in terms of tariffs, except the engineering goods sector which is a heavyweight sector, some segments of electronics sector and some sensitive agricultural items like dairy and related products, most of the sectors are positive about India-US FTA. However, broader consultation with stakeholders in India is needed before finalising the FTA with USA. Some of the sticky issues are the restoration of GSP benefits to India and the issue of reinstating India to the developing country list on the US side. On the Indian side, the sticky issues are lowering import duties on high-end motorbikes like Harley Davidson motorbike, dismantling retaliatory tariffs on US items like almonds, walnuts, and pulses and giving market access to dairy and related products. Tariff on iron and steel and related engineering goods appear on both siwdes of the negotiating table. Besides issues other than tariffs will also come up like Intellectual Property (IP), Rules of Origin, Dispute Settlement Mechanism, Social and Environmental Compliances, etc.

Forming other FTAs or renegotiating old FTAs

Some other FTAs suggested by different stakeholders are given below.

Engineering goods

India can have FTAs with African countries, Eurasia, GCC countries, and Latin American countries other than MERCOSUR and Chile (with which India already has FTAs/RTAs) as there are significant untapped opportunities. FTAs with these countries can help India’s engineering exports.

Thus, in the agricultural sector, higher concessions are given by India’s FTA partners like Japan, South Korea, China, and the Philippines to other countries compared to India with respect to coffee. Other markets like the EU, Russia and Turkey also give higher concessions to other competitors of India. There is scope to negotiate with these countries, though political factors will also be important as in the case of Turkey. In the case of other plantation and agricultural items, it is not desirable to go for new FTAs as India has many restrictions on land usage which other countries do not have. Unless there is parity with respect to rules and regulations, it is not advisable to go in for new FTAs. Plantation commodities should not be included in future FTAs and wherever included in present FTAs, there is a need for renegotiations in many areas.

In the non-agricultural sector, the views are varied. While FTA with EU, Canada, and Australia seem beneficial for textiles and clothing sector, an early conclusion of FTA with EU would be beneficial for the leather and footwear sector. While FTAs with African countries, GCC countries, Eurasia, and Latin American countries could help the engineering sector, FTAs are unlikely to benefit the electronics sector.

The sector-specific analysis of tariffs shows the varied nature of interests and issues in different sectors. Some sectors/ items need higher tariffs and some lower. In some sectors, inverted duties continue. The experiences of FTAs, sector-wise is also varied. While most of the stakeholders have reservations regarding RCEP, many are positive about Indo-US FTA. The different stakeholders have also suggested many new FTAs. Since the interests are varied, the options should be weighed carefully before arriving at any holistic view.

INDIA’S TARIFF REFORMS: ISSUES AND POLICY SUGGESTIONS

The analysis of India’s tariffs, both general and preferential and also by sectors throws open many policy areas and issues on the tariff front.

Issues and policies related to India’s tariff structure and rationalisation

Tariff rationalisation, while aiming at greater liberalisation and exports, needs to rectify any anomalies in the tariff structure keeping in mind domestic concerns as well. Some major issues/ areas in this regard are the level of tariffs, both BCD and total; inverted duty structure; prevalence of non-ad valorem (NAV) tariffs; and multiple tariff rates.

Level of tariffs

India’s tariff liberalisation policy started particularly since the 1991 economic reforms. As a result, India’s peak rate of tariffs started falling and at present is at 10 percent. Simple average MFN applied tariffs have also been falling except recently in 2018 when there was a rise which may be due to some protectionist measures in line with other countries and to some extent, a data issue as TRAINS based WITS data does not indicate any increase. India’s simple average applied MFN tariffs (as per WTO and WTO based WITS data) at 17.1 percent in 2018 is the fifth highest in the world and higher than that of comparable trading partners of India. Thus, in the first instance India’s tariffs seem to be relatively higher than many other countries including the ASEAN countries, though Korea has relatively high simple average tariffs (total) due to its high tariffs on the agricultural sector.

This, however, is not the real picture as around 68 percent of the tariff lines covering around 86 percent imports in the non-agricultural sector have less than 10 percent MFN applied tariffs. In the nonagricultural sector, import values and tariff lines are more concentrated in the lower end of the tariff range, while in the case of agricultural items they are more concentrated in the higher end of the tariff range.

Moreover, India’s weighted average MFN applied tariffs are lower for total items and for non-agricultural items, though ASEAN countries have still lower tariffs. The lower average weighted MFN tariffs compared to simple average MFN tariffs, particularly for non-agricultural sector indicates that India’s imports of high tariff items are lower which could also imply that high tariffs could have led to lower imports of such items.

Effective tariffs taking into account India’s preferential tariffs to different countries, is much lower with simple average effective tariffs at 8.7 percent and weighted average effective tariffs at 4.9 percent in 2018 (as per TRAINS data). This shows that India’s import tariffs are not as high as it is believed to be. If this be the case, there is also a need for India to dispel the belief that India is a high tariff country by highlighting the facts and wherever possible rationalising MFN tariffs closer to effective tariff levels.

Realised tariffs go one step further. Though not strictly comparable to other tariff terminologies, realised tariffs (basic) which is based on customs revenue collection was very low at 3.2 percent in 2018, further reinforcing the fact that India’s tariffs are not as high as they appear to be. The different tariff concessions by the government including preferential tariff concessions are all captured in the realised tariffs. A similar indicator giving realised tariffs for the US was 1.6 percent in 2018. Thus, India’s realised tariffs are not that high compared to that of the US. However, the US realised tariff is only slightly lower than its average MFN tariff unlike India’s, which is much higher.

Some studies state that India’s tariff policy is focusing more on revenue collection. This is wrong if we see the realised duties where a lot of revenue is forgone in the form of exemptions. The revenue forgone due to various exemptions gets reflected in the realised tariffs (Table2). The revenue impact of unconditional exemptions was Rs1,29,622 crore in 2018-19 and estimated at Rs1,22,737 crore in 2019-20. Of this, FTAs/CECAs, etc account for Rs48,793 crore in 2018- 19 which was estimated to increase to Rs65,734 crore in 2019-20.

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Source: Computed from Receipt Budget 2020-2021, GoI

The net revenue forgone due to conditional exemptions and export linked incentive schemes in 2018-19 was Rs75,753 crore and was estimated to increase to Rs81,970 crore in 2019-20. Among the conditional BCD exemptions, the major items in terms of share in total conditional BCD exemptions, are other items (73 percent) in 2018-19 followed by specific goods used in the manufacture of mobile phones (21.4 percent).

Thus, while there is a need to bridge the gap between perception and reality, a careful rationalisation of tariffs is also needed to bridge this gap between realised tariffs and MFN applied tariffs. But tariff rationalisation has to be done cautiously as there are many sensitive items and items having livelihood concerns. To begin with tariff lines with BCD above 10 percent should be examined for rationalisation. Even items at the borderline of 10 percent covering 38.3 percent of tariff lines and 23.7 percent of imports in the non-agricultural sector can be considered for rationalisation.

It is to be noted that for many items, already duties have been lowered under FTAs. In fact, effective tariffs for many items with MFN tariffs above 10 percent are low and even below 10 percent due to preferential tariffs, etc. Thus, for many items already preferential tariffs apply for FTAs and if MFN tariffs can be lowered slightly to effective tariffs (AHS) levels or near to it, India’s MFN tariffs for majority of non-agricultural items will be below 10 percent. The final list of items for rationalisation should, however, be arrived at after wide-ranging consultations with stakeholders. Thus, there is scope for rationalising tariffs at least up to or near the effective tariff level if not up to or near the realised tariff level.

One more issue in the case of tariff rationalisation is the level of total duties. India’s total import duties including BCD, IGST, and SWS is double or more than double the BCD in most of the nonagricultural items. While there is no refund or input credit for SWS, in the case of IGST, though input tax credit (ITC) is available, there is the drill of paying IGST first and then claiming input credit later. Besides for some final consumption goods, there is the problem of claiming ITC. So, there is a need to make IGST less protective and remove SWS on imports to reduce the level of total duties.

Inverted duty structure

The government has been addressing inverted duty structure from time to time. Yet some inverted duties continue and new ones are appearing. One new type of inverted duty has cropped up due to FTAs wherein preferential tariffed finished goods imports have zero/low tariffs while non-preferential tariffed imports of earlier stages of production like raw materials and intermediate goods have higher duties. These and other specific cases of inverted duty need to be addressed.

Non-ad valorem (NAV) tariffs

While India’s non-ad valorem tariffs have fallen over the years in the non-agricultural sector, still 5.5 percent of the MFN applied tariff lines had non-ad valorem tariffs in 2018, though in terms of import share, they formed only 0.3 percent of total imports of India in 2017. In the agricultural sector, NAV tariffs are lesser than non-agricultural sector in terms of tariff lines (0.3 percent in 2018), though in terms of import share, they were higher at 2.9 percent in 2017. There are many NAV tariffs in the textiles sector. Though some advanced countries also have many tariff lines with non-ad valorem tariffs, for simplifying the tariff structure it would be better if India reduces the tariff lines with NAV tariffs to the maximum possible extent and convert them to ad valorem tariffs.

Multiple tariff rates

One important issue in the context of rationalisation of tariffs is the many rates of tariffs (basic customs duty). While tariff reforms till now have helped in bringing India’s peak duty to 10 percent and also supposedly reduced the number of tariff rates, in reality, in 2019 there were still 24 ad valorem tariff rates including the zero-duty rate covering 11839 tariff lines. While agricultural sector has 19 tariff rates covering 1432 tariff lines, non-agricultural sector has 18 tariff rates covering 10,407 tariff lines. While it is believed that the number of tariff rates has been reduced over the years, India still has many tariff rates even if only ad valorem tariff rates are considered. This calls for reducing the number of tariff rates to the barest minimum. While converting non-ad valorem to ad valorem will increase the number of rates further and also give it in decimals as done in WITS database which gives ad valorem equivalents (AVEs), this is more of an academic exercise. If NAVs (as given in WTO data) are also considered, then India had 252 distinct MFN duty rates in 2018.

The tariff rates of the agricultural sector are top-heavy (15-150 range), while tariff rates of non-agricultural sector are bottom-heavy (0-30 range). Maximum tariff lines are in the tariff rate of 30 percent for agricultural sector, and in the 10, 7.5, 20, and 5 percent rates in the non-agricultural sector. Thus, the modal tariff rate in agricultural sector is 30 percent and the most appearing tariff rates in non-agricultural sector are 10 and 7.5 percent followed by 20 percent.

There are four tariff rates in the agricultural sector and six tariff rates in the non-agricultural sector below 10 percent tariff rate (i.e. single-digit tariffs). These are cases to be examined for rationalisation in terms of the number of tariff rates. Merging some tariff rates at the tail ends (upper and lower range) can easily reduce the number of tariff rates (agri and non-agri) at one shot without affecting many tariff lines.

There are 1379 tariff lines in agricultural sector and 6384 in non-agricultural sector with tariff rates at and above 10 percent. In terms of tariff lines, 96.3 percent in agricultural, 61.3 percent in non-agricultural and 65.6 percent in total; and in terms of import share 87.7 percent of tariff lines in agricultural, 46.4 percent in non-agricultural and 48 percent in total have tariff rates of 10 percent or above. These are the tariff rates that have given India the tag of a high tariff economy. Thus, it is the tariff lines in these tariff rates that need to be examined for rationalisation in terms of both level of tariffs and tariff rates. Merging some tariff rates can reduce the number of tariff rates.

Thus, in short, policies related to India’s tariff structure and rationalisation should include reducing the tariffs at least up to or near the effective tariffs and wherever possible near the realised tariffs coupled with a reduction of IGST rates in sectors where it is highly protective and removing the social welfare surcharge (SWS) from imports. Rationalisation should also include reducing the number of tariff rates by merging some of them; pruning the non-ad valorem tariffs to the barest minimum; and addressing the remaining cases of inverted duty structure wherever possible. Sensitive items particularly in the agricultural sector and having livelihood concerns should also be taken care of.

Policies related to rationalisation of preferential tariffs

India though a late entrant in the area of FTAs has entered into many PTAs/FTAs/ CECAs/CEPAs. In terms of share in total imports and exports, among the existing FTAs, APTA, ASEAN, and SAARC as country groups and Singapore, Korea, and Japan as individual FTA partners are the major trading groups/countries.

For the last three years (2016-18), the share of preferential imports from all FTAs together in total imports of India was in the range of 16-17 percent. The share of preferential imports by India in its imports from FTA/RTA partners is high in the case of Afghanistan, Bangladesh, Sri Lanka, Nepal, SAARC, Japan, and Chile. But the share of preferential imports of these FTA/RTA partners in their imports from India is much lower. In the case of Singapore, share of preferential imports in its total imports from India is negligible as Singapore’s MFN tariffs were already low. Thus, India has not gained in terms of tariffs in India-Singapore CECA and gains need to be seen only in other parameters covered in the CECA. Some sort of balance in terms of preferential trade can be seen only in the case of India’s preferential trade with South Korea and beneficial for India in APTA and MERCOSUR, though preferential trade is limited especially with MERCOSUR.

Preferential tariffs (weighted) is much lower than MFN tariffs on India’s import side except for APTA, while in India’s FTA partners’ side, preferential tariffs are closer to MFN tariffs except mainly for Korea, APTA, and MERCOSUR. This indicates that the margin of preference given by India to its FTA partners is higher than the margin of preference given by them to India except mainly in the case of Korea and APTA. Thus, there is some sort of an ‘Unequal Exchange’ in India’s FTAs in terms of tariffs.

One more thing to be noted is that, more than the utilisation rate of FTAs being lower by India on the export side, it is the low coverage of items under preferential trade in the imports of FTA partners of India and the relatively low preference margin which are important.

Thus, India’s FTAs have not benefited India much in terms of tariffs, the main parameter of any FTA negotiations, but for some exceptions. While factors other than tariffs are also important, the importance of tariffs cannot be ignored. So, India should not rush to conclude FTAs with many countries/groups. A proper evaluation even of existing FTAs is needed on the lines of a zero budgeting exercise. This is important particularly in the context of the revenue impact of FTAs (Table3).

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Source: Computed from Receipt Budget 2020-2021, GoI

The revenue impact due to India-ASEAN CECA was the highest with the share of revenue impact in total at 47 percent in 2018-19 and estimated to increase in 2019-20 to 52.9 percent. The share of PTA with LDCs and APTA together was next highest at 22.9 percent in 2018-19 and estimated at 19.9 percent in 2019-20. This was followed by India-South Korea CEPA with a 15 percent share in 2018-19 and estimated to be 11.4 percent in 2019- 20. Japan followed by Malaysia were the other two FTAs with a significant share. The revenue impact of SAFTA was very small despite a major part of imports covered under preferential trade as India’s imports itself is relatively less from SAARC countries. Since the revenue impact of FTAs is significant, proper evaluation of the gains for India needs to be made before negotiations/renegotiations on FTAs.

Since some countries are in multiple FTAs and the same commodities are included in tariff concessions in different FTAs, there should be some uniformity. The tariff concession for a tariff line by India should be the same for all FTAs. This will help in avoiding an FTA partner trying to use or misuse the best concessions in the FTA which has relatively lower preferential tariffs. This will also help in removing the confusion to domestic producers and make actions of a multiple FTA partner predictable.

Many FTAs of India to developing countries have resulted in mainly giving tariff concessions. So, a proper evaluation of the less developed and developing countries needs to be done to see whether they have graduated to a level where tariff concessions may not be needed for some items or whether the same countries are competing against India, using the tariff concessions. With the US withdrawing GSP benefits to India but not to some developing FTA partners of India, India will be more open to competition in the US market from its FTA/RTA partners. In this context, India has to see whether any of the existing concessions given to LDCs have to be re-evaluated. Along with the ‘graduation clause’ for the developing country FTA partners, there is a need for a ‘sunset clause’ for some concessions to FTA partners.

Since WTO negotiations are not making much headway, FTAs have mushroomed all over the world. However, if WTO negotiations take place or if India can come up with some major tariff-related offers, then many of the existing FTAs may become irrelevant. So, the tariff policy towards FTAs should be in sync with general tariff policy and possible offers by India on tariffs at the multilateral level. The next WTO Ministerial was scheduled in June 2020 in Nur-Sultan, Kazakhstan (but postponed due to the pandemic). Before that, India needs to firm up its policies towards FTAs.

In the case of negotiations for any new FTAs in the future, if the MFN tariffs of the partner countries are already zero, near-zero or low, India should try to get maximum gains in areas other than tariffs as the preference margins for India would be low. FTAs should be based primarily on economic gains resulting in tariff liberalisation on both sides without affecting sensitive sectors particularly agricultural sector. Political, strategic or other gains should be only secondary.

There is also a need to see that total duties do not become unduly protective both in the context of general trade and preferential trade. While IGST has to be rationalised, SWS should not be applicable for custom tariffs as it adds to the protection.

So, a multi-pronged strategy to rationalise tariffs in the context of India’s FTAs is needed.

Rationalising tariffs in the light of Make in India

The Government of India in its Budget 2020-21 has made some tariff-related changes to help Make in India. These include among others increase in customs duty, particularly under the phased manufacturing programme (PMP) for electrical vehicles and cellular mobile phones; an increase in customs duty for electronic sector and food processing industry; and lowering customs duty for inputs in many items.

The analysis of imports by India from the world by stages of processing, taking the weighted average for both MFN and effective tariffs shows that India is moving in the right direction towards Make in India with tariffs for raw materials, capital goods, and intermediate goods falling and also being low except for intermediate goods. The weighted tariffs, both MFN and effective, were still relatively high in 2018 for intermediate goods. The MFN and effective tariffs were at 8.6 and 7.1 percent for intermediate goods in 2018 (Table4). However, simple average MFN tariff is the highest for raw materials at 20.6 percent. Even simple average Effective tariff is high for raw materials at 10 percent. The difference between simple and weighted averages indicate that while tariffs for many tariff lines of raw materials are high, making simple average tariffs higher, the weightage of low tariffed raw materials in imports is high.

While India’s tariff structure for world imports has helped in imports of some low tariffed but high weighted raw materials, the tariff structure of the world on imports from India is helpful for India’s exports of intermediate goods and even capital goods (particularly if we see weighted tariffs both MFN and AHS). But consumer goods exports from India face high tariffs.

Despite a high value of raw material imports by India having low duties, there is a need to see that in terms of the number of tariff lines also, India’s raw materials imports particularly for the non-agricultural sector have low tariffs and any inverted duty structure is avoided. Tariffs for intermediate goods should also be reduced further. This can help Make in India and further help India move up the value chain.

Further dovetailing tariff liberalisation policies with pointed tariff policies in some sectors like electronics including optical fibres and cables, and items not in ITA1, shipping sector and even plantations sector can further help in Make in India or Produce in India. In this context, India could make major gains if the optical fibre/optical fibre cables sector is promoted under Make in India under the phased manufacturing programme.

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Source: Compiled from WITS Database

Rationalising tariffs in the light of export promotion schemes

A World Trade Organization (WTO) dispute panel ruled on 31 October that India’s key export promotion schemes violated WTO rules and hence should be withdrawn within six months. The verdict was based on a complaint filed by the United States of America (USA), which argued that five export subsidy schemes worth over $7 billion that India offers, are not compatible with WTO rules. The ruling covered India’s schemes such as the export oriented units (EOU) scheme and sector-specific schemes, including the electronics hardware technology parks (EHTP) scheme and the bio-technology parks (BTP) scheme, the merchandise exports from India scheme (MEIS), the export promotion capital goods (EPCG) scheme, the special economic zones (SEZ) scheme and the duty-free imports for exporters scheme (DFIS).

The low realised tariffs of India are also due to different concessions under export promotion schemes, including EPCG, MEIS, etc. As per the receipt budget 2020-21, the revenue impact on account of export promotion schemes was Rs65,720 crores in 2018-19 and estimated to increase to Rs73,060 crore in 2019-20. Of this, the revenue impact of MEIS itself is more than 50 percent (Table5).

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Source: Computed from Receipt Budget 2020-2021, GoI

There are two types of export promotion schemes – input tax neutralisation or exemption schemes and export linked incentive schemes. The revenue impact of input tax neutralisation or exemption schemes was Rs24,702 crore in 2018-19 (and estimated at Rs24,840 crore in 2019-20). Of this, advance license scheme has a major share (61 percent), followed by EOU/EHTP/STP/SEZ schemes (23.2 percent) and EPCG scheme (13 percent). The revenue impact of export linked incentive schemes was Rs41,018 crore (and estimated at Rs48,220 crore in 2019-20). Of this, merchandise exports from India scheme (MEIS) has a major share (89.3 percent) followed by service export incentive scheme (SEIS) (9.2 percent).

Many of the export promotion schemes result in a triple negative effect. Firstly a lot of revenue is forgone as indicated by the gap between applied MFN tariffs and realised tariffs. Secondly, India is questioned at the WTO as some of the schemes are considered as WTO incompatible; and thirdly, the perception of India being a high tariff economy results in trade negotiators of other countries looking at India with jaundiced eyes.

Though different rates of tariffs are levied not just with the motive of revenue generation, but for various other reasons including protecting the domestic sectors, providing differential treatment to sectors, avoiding inverted duties etc, there is scope for India to reduce its applied tariffs substantially and simultaneously phase out some of the export promotion schemes. This will not cause much revenue loss. The applied MFN tariffs can at least be near to the effective tariffs and wherever possible near realised tariffs. Even customs revenue realised can be higher if applied tariff rates are kept slightly above the current realised tariff rates along with plugging leakages by phasing out the export incentives and keeping them to the barest minimum. Trade and industry including exporters will also not be adversely affected as the import duties are lower. Instead, they can benefit due to lower transaction costs. Domestic concerns should, however, be taken care of by addressing issues related to sensitive items.

Tariff policies and strategies for multilateral and bilateral negotiations

The WTO negotiations are in limbo with the different groups of countries sticking to their standard positions. Not much headway is expected in the twelfth WTO Ministerial scheduled for June 2020 in Kazakhstan if countries stick to their old scripted stand. While India’s applied tariffs are below the bound tariffs, the bindings themselves are at a higher level, both for agricultural and non-agricultural sectors.

In this context, the question is whether in the forthcoming WTO negotiations,India can throw a surprise in the area of tariffs. This may be possible if India first does its homework properly and decides on the tariff reforms at home as outlined earlier. A carefully thought out plan of reducing tariffs coupled with the withdrawal of the WTO incompatible export promotion schemes can not only help in the growth of the economy but also have a positive effect on India’s trade negotiations and help in removing the tag of India being a high tariff economy.

For this, a comprehensive list of sectors and items where India can comfortably lower its tariffs has to be prepared. As a starting point, a list of items with a high difference between MFN applied tariffs and effective tariffs on the one hand and a second list giving the difference in MFN applied tariffs and realised tariffs, on the other hand, has to be prepared. The first list can help in preparing the first cut off for India’s tariff offers and the second, the lower limit for the tariff below which negotiated tariffs should not go. Both the lists should be prepared sector-wise and tariff line-wise. While data for the first list is available in WITS, though the latest year is for 2018, for the second list, only the government has the data. This should be backed by wide consultation with all stakeholders. A list prepared giving the difference between MFN and AHS tariffs code-wise at 2 digit level and 6-digit level for items with simple average tariffs at or above 10 percent and with the difference between MFN and AHS greater than 4 percentage points shows that the difference between the MFN and AHS tariffs is noticeable in many codes. There are 427 items at the 6-digit level with tariffs at or above 10 percent with the difference between simple average MFN and effective tariff of 4 percentage points. The major non-agricultural items are photographic or cinematographic goods; textile items; iron and steel items; electrical items; vehicles other than railways; footwear; toys, games and sports items; chemicals items like cosmetics and perfumes, etc. There are many items in the non-agricultural sector with the difference between simple MFN and AHS above 10 percentage points. Thus, there are many items in which the MFN tariff can be lowered to the effective tariff level or near it. This will help in formulating India’s negotiating stand.

Meanwhile, there is also a need to dispel the impression that India is a high tariff country by giving the facts and figures of India’s effective and realised tariffs.

In the case of ITA1 items where India lost badly, at least new products not covered in ITA1 should be given separate tariff lines where India can decide its offers. This may help in avoiding disputes like the present one, where Japan, EU and even the US have raised their objections for the tariff on some IT products and the EU has even invoked dispute settlement proceedings against India. India, however, contends that these items were not in existence at the time of ITA1 and not included in ITA1.

In the case of FTAs, there is a need to systematically review all existing FTAs. The government has already indicated its intent to do so. Renegotiating existing FTAs along with negotiating new FTAs should be based on its assessment. The graduation clause and sunset clause mentioned earlier should be included while renegotiating existing FTAs or negotiating new ones.

An App-based system should be developed where all the parameters related to tariffs should be put in one place with an alert system warning negotiators if they go beyond a particular threshold. For this, databases have to be inter-connected and trade experts should continuously monitor the data.

Tariff related policies for moving up the stages of processing and greater participation in global value chains (GVCs)

While global value chains help in greater efficiency and greater integration into the world economy, in recent years there has been a weakening of the GVCs due to protectionist policies of countries and now a disruption in GVCs due to Covid19, which hopefully is a temporary phenomenon.

In line with the global trend, in the case of India also, as per TiVA indicators after an increase from 18.8 percent in 2005 to 25.1 percent in 2011 and 2012, the foreign value added content of India’s exports indicating ‘imports for exports’ has declined by 9 percentage points to 16.1 percent in 2016. As stated by the OECD, the low level of foreign content in India’s exports, relative to OECD and G20 averages, is likely due in part to a shift towards local suppliers of intermediate inputs, particularly in the growing services sector. This is despite an increase in the foreign content of gross manufacturing exports between 2005 and 2015 as the information and communications sector carries a significant amount of weight.

The industries with the most foreign value-added content in their exports in 2015 were Coke and refined petroleum products (47 percent), basic metals (38 percent), and ICT and electronics (36.8 percent). The most foreign content of total exports came from Coke and refined petroleum products (2.8 percent).

In the case of foreign final demand in domestic production overall 16.4 percent of India’s domestic value-added in 2015 was driven by consumption abroad, up from 15.9 percent, a decade earlier. By industry, the shares of major sectors were 54.5 percent for other manufacturing nes and 52.8 percent for information and communication services.

While the TiVA indicator helps in seeing a country’s integration into the GVCs, it does not show the role of tariffs in this integration. Tariffs can play an important role in greater integration in the GVCs as indicated in the analysis of tariffs by stages of processing. India’s general tariffs for the world by stages of processing show that India’s tariffs are helpful for Make in India, while the general tariffs of the world for India show that they are helpful in the export of intermediate goods from India.

The analysis of preferential tariffs in FTAs by stages of processing shows that India’s tariffs have fallen and are low for all the FTAs in all stages of processing after FTAs were implemented. However, the preferential and effective tariffs on raw materials are relatively higher than in other stages of processing in many FTAs. This needs to be addressed to avoid a type of inverted duty structure due to FTAs. This could also be due to the composition of raw materials particularly agricultural raw materials which have relatively higher tariffs.

While India’s FTAs have resulted in lower preferential tariffs for India’s FTA partners in different stages of processing (except for raw materials in some cases) helping to integrate in the value chains of production, the preferential tariffs of India’s FTA partners for India show that the tariff structure changes have helped in India’s exports of mainly intermediate goods to these countries. Consumer goods exports have increased only for Singapore and ASEAN, but this is not due to tariff concessions.

India faces a tariff disadvantage compared to the world for its raw materials exports in many FTAs. This is possibly a pointer that India’s FTA partners are giving more concessions to other countries in their other FTAs. It could also be due to the differing composition of the raw materials import basket from India and the world by these FTAs.

Thus the tariff structure in the context of FTAs has helped mainly in the integration of India’s intermediate goods in the global value chains through the forward linkages in India’s exports rather than finished or consumer goods for which FTA partners’ preferential tariffs are relatively higher for India. In India’s tariff negotiations/renegotiations with FTAs, India should also try to get greater market access for its finished goods also to move higher up the value chain.

Policy in the context of trade wars and tariff escalations including GSP withdrawal

Trade wars and trade escalations have led to not only increasing tariffs but also fall or slowdown in trade along with trade diversion as indicated in our analysis earlier on US-China trade wars. While the US-China trade war has opened up many opportunities for India, there seems to be a truce between the warring parties and the impact of the trade war may be shortlived. However, in the case of India-US trade conflict, withdrawal of GSP benefits has already affected many sectors. To counter the effects of the withdrawal of GSP by the USA, India can have a carefully crafted FTA with USA without affecting sensitive sectors and in which India can ask for duty concessions for all items out of GSP.

Withdrawal of GSP and removing India from the developing countries list has forced India to negotiate on the concessions which were available earlier. An FTA with the USA can possibly help in regaining benefits similar to GSP. Alternatively, India can also try to get the US GSP benefits for some important items at least. The Indian government can also think of giving temporary relief to its exporters for GSP affected items, to increase exports to the USA. Since WTO compatibility of the export incentive schemes is under question, it is better to think of measures to support the marketing of Indian products.

Tariff escalation and withdrawal of GSP affect India in another way. While India is out of GSP of the USA, some developing and LDC countries continue to enjoy GSP benefits from the USA. These countries get tariff concessions in India’s FTAs, some as LDC partners. These very countries, which continue to enjoy US GSP benefits, compete against India in the very same commodities for which GSP has been withdrawn for India, particularly Bangladesh. Vietnam is also very competitive in some products like textiles. This needs to be addressed by the graduation and sunset clauses in India’s FTAs.

A mechanism for regular monitoring of tariffs

As indicated in Budget 2020-21, a new Chapter VAA (a new Section 28DA) is being incorporated in the customs Act to provide enabling provision for administering the preferential tariff treatment regime under trade Agreements.

While this is a welcome move, there should be a more systematic way of monitoring tariffs on a regular basis both general and for FTAs. While private institutions are assigned piecemeal research work on tariffs, it would be better to have a Government institution that is privy to a lot of information and data and is backed by authority, which helps in getting necessary information from stakeholders. A separate cell can be set up in the Government for this purpose. USTR and METI like organisations are needed to monitor tariffs along with trade policies.

This trade policy making and monitoring (TPMM) body should include trade experts to prepare and monitor tariffs and other trade policies on a regular basis. This will also give continuity in trade policy discussions and also ensure that institutional knowledge is not lost even when there is a change of guard of trade policy negotiators of the government who have an average tenure of two-three years.

The database with the government should be up to date and should also be available in public domain except for very confidential information. The setting up of a special institution and updating the databases should go hand in hand.

Timelines for tariff reforms

This report has focused on the varied tariff-related issues and has also suggested some practical policy measures. These measures could be implemented over a period of time. However, there is a need to prioritise the reforms as per indicative timelines. The timelines for tariff reforms can be as follows:

First, specific duties need to be converted to ad valorem duties in the short term to the extent possible. Second, the number of tariff rates needs to be reduced over time. Third, inverted duties need to be removed as and when they arise. Fourth, reducing tariffs over a time period to help exports and also for greater integration into the GVCs. For this, in the first stage, bringing MFN tariffs to the level of effective tariffs should be attempted. In the next stage bringing MFN tariffs near realised tariffs along with pruning some export incentives should be explored.

So, lowering peak duties across the board may not be an ideal solution at this juncture. What needs to be done is to bring MFN tariffs closer to effective tariffs and realised tariffs to the extent possible. Items with above 10 percent tariffs need to be examined first for tariff rationalisation. While prioritising sectors for tariff reduction over a time frame, electronics and agricultural sector should be kept in the exclusion list to the extent possible. The objectives of Make in India and the interests of sensitive items particularly in the agricultural sector should be kept in mind while rationalising tariffs.

CONCLUSION

Thus this report makes an in-depth analysis of India’s tariff-related issues, both general and preferential using the latest available detailed data from different sources and powered by the practical experiences of different stakeholders. Based on this analysis specific and focused policies to rationalise tariffs have been given. In the case of preferential trade, this report focuses mainly on tariff which is the main pillar of any preferential trade negotiations, though other parameters are also important in the formulation of holistic policies. Some novel policies and strategies related to tariffs for multilateral and bilateral negotiations backed by domestic tariff reforms have also been suggested as per indicative timelines. Implementation of these suggested general and sector-specific policies within a time framework should help in greater liberalisation of tariffs along with safeguarding the interests of the domestic sector.

This paper is an attempt by EXIM Bank to disseminate the findings of research studies carried out in the Bank. The results of research studies can interest exporters, policymakers, industrialists, export promotion agencies as well as researchers. However, views expressed do not necessarily reflect those of the Bank. While reasonable care has been taken to ensure authenticity of information and data, EXIM Bank accepts no responsibility for authenticity, accuracy or completeness of such items
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