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View: India’s duty structure must be turned upside down for global competitiveness

Usually, countries keep import duty low on Key Industrial Raw Materials (KRMs) and high on Value Added Products (VAPs). But in India, KRMs attract higher import duty than corresponding VAPs. This increases the cost of production and make exports u...

TOI Contributor|
Oct 31, 2019, 10.54 AM IST
Setting IDS anomaly right will make existing Indian value added manufacturers more competitive.
By Ajay Srivastava

Internet of Things, automation, robotics and analytics are changing the world of manufacturing. But, Indian manufacturing also needs a more fundamental game changer. It needs to correct the import duty structure on Key Industrial Raw Materials (KRMs).

Usually, countries keep import duty low on KRMs and high on Value Added Products (VAPs). This gives domestic producers the freedom to buy the cheapest KRMs from any country and focus their energy on making VAPs. But in India, many KRMs attract higher import duty than corresponding VAPs.

The technical word for this anomaly is Inverted Duty Structure (IDS). Import duties include customs, anti-dumping, or safeguard duties. IDS creates many problems for the user industry.

High import duty on KRMs closes the global sourcing option for the user industry. They have to buy KRMs from domestic suppliers whose prices are higher than international prices. Any product made using expensive KRMs becomes high cost. Exports become uncompetitive. The user industry becomes vulnerable to imports due to low import duty on VAPs.

Each KRM is used for the making of thousands of VAPs. And each protected and hence high-priced KRM makes all products made from it expensive. Let us discuss the examples of steel, the key raw material for a large number of industries.

High duty on steel and low duty on equipment made from steel puts equipment manufacturers under strain. The equipment user industry, that is most factories in India, prefers to import equipment. The story repeats for the large diameter Line Pipes industry employing close to 1.5 lakh people. Higher duty on HR coils than on the pipes has made the domestic market vulnerable to imports.

Capacity use of Indian firms has gone down to less than 40% – for no fault of domestic equipment or pipe manufacturers. Their steel to pipe conversion rate is the lowest in the world. They are captive to using high cost domestic steel.

High cost steel makes all products made from it expensive. Machinery, automobiles, roads, bridges, ports, houses, consumer items, and many more. It also increases the cost for big projects: Make in India, Pradhan Mantri Awas Yojana, Smart Cities, Automotive Mission Plan, and many more.

We list a few KRMs for important sectors: Chemicals – Caustic Soda, Soda Ash, Acetone, etc; Rubber and Plastics – SBR, Polystyrene, Polypropylene, and PVC. KRMs like ‘Purified Terephthalic Acid’ (PTA), Polyester Fibre hold the key to the growth of the Synthetic Textile sector.

IDS across sectors explains why we have so many large firms making primary products, but few large firms making VAPs. Here is how the manufacturing environment looks like in many product groups. The raw material producers are protected from global competition through high import duties. But, the user industry has to compete with global manufacturers for exports and in the domestic market. And they have to do this using high cost local raw materials.

But KRM producers are no villains in this story. The cost of producing a KRM in India is high due to the high price of factors of production. These include land, labour, capital, power, inputs, unrebated taxes, etc. This makes them vulnerable to imports. Many countries with excess production capacity want to dump subsidised KRMs. It’s a continuous battle for KRM producers.

As the economy expanded post-1991, few KRM producers sought protection from cheap imports. Soon the government imposed the first anti-dumping duty in 1992. And by the end of 2000, most KRMs secured protection from imports.

The strain further increased with the signing of Free Trade Agreements (FTAs). FTAs increase the duty gap between a KRM and corresponding VAPs by allowing customs duty to become zero on most VAPs. GST adds to the complexity in a few cases like Synthetics, where the tax on raw material is higher than on the finished product.

If we cut import duties on KRMs, cheap imports may replace many large domestic industries with billions of dollars of investments. This will erode India’s painstakingly built self-sufficiency in KRMs. The trade war is all about protecting local KRM industries. But if we don’t do this, value added sectors in India will remain strangulated. India can never become a strong manufacturing country. We are in a catch-22 situation.

A possible way out is to recognise that not all KRMs may need protection from imports. When should we protect a KRM? I suggest three criteria: One: If local production of a KRM meets 80% of domestic demand, do not protect. Limited imports will put healthy pressure on local firms to improve productivity.

Two: High protection comes at high cost to the economy. It should not expand the profits of KRM producers. For example, usually a firm exports at lower prices than it sells in the domestic market. The price difference must equal or be less than the tax rebates/ incentives provided by the government on exports. Any substantial difference merely increases personal profits. Lower protection in such cases.

Three: Create a national vision for important products. Bring import duties, GST rates, FTA openings, exports and domestic incentives in sync with this vision.

Finally, continue land, labour, power, infra and capital reforms. They will make most distortions lose justification for their existence.

Setting IDS anomaly right will make existing Indian value added manufacturers more competitive. Also, the trade war is nudging large firms to relocate manufacturing to a new China+1 place. Changes will make India a more competitive place for Indian and global firms alike.

(The writer is an Indian Trade Service officer)
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