Date: 28/01/2023

Relevance: GS-3: Indian Economy, mobilization of resources, changes in industrial policy and their effects on industrial growth.

Key Phrases: Gross Domestic Product, Production Linked Incentive, Inverted Duty Structure, Effective rate of protection (ERP), Major Industrial and Trade Policy Tool

Why in News?

• Customs duties remain a major industrial and trade policy tool for India to regulate India’s merchandise imports, which stand at around $700 billion — a fifth of Indian GDP.
• While the government may announce duty changes at any time, the Union Budget is the best time for making significant changes.

Key Highlights:

• With the rising nationalist tendencies and waning of the globalisation phase, nations have started turning inwards.
• No country is in favour of reducing trade barriers, including Customs duties. In contrast, the countries are increasing barriers to entry.
• The US is implementing Production Linked Incentive-type programmes, giving about $500 billion in subsidies and increasing tariffs.
• Obtaining minimum local value addition in the US is a precondition to getting a subsidy.
• India could not impose such conditions in its PLI schemes even though it was critical to rule out superficial manufacturing, as it was WTO incompatible.

Turning Customs Duties into Tools for strengthening Make in India:

• Freezing Import Duties:
  • India should announce a five-year duty freeze as the change may upset many PLI/PMP and other manufacturing programmes. Also, the government must reduce import duties only when a clear economic case is present.
  • The five-year duty freeze should be co-terminus with five years of the PLI scheme as the duty freeze will also convey the message of policy stability.
  • Steep and sudden reductions in import duties in the mid-1990s forced most small and medium firms in pharma, electronics, chemicals, dyes, and toy product groups to shut operations while many manufacturers became traders for goods from China.
• Retaining Import Duty on Components:
  • Import duty on components will promote deep manufacturing.
  • India will become a true manufacturer of electronics and telecom devices only when components are manufactured here but if the duty on components is zero, they will be imported, resulting in the simple assembly of final products in India.
  • Most firms that do this will disappear when incentives end. There have been several such cases in the past.
• Creating Duty Arbitrage:
  • India has thousands of good-quality manufacturers in engineering and other sectors. Such sectors must be supported through the creation of duty arbitrage between input and output.
  • Technical regulations, quality control orders, and compulsory registration orders need to be introduced as this will ensure quality production and check substandard imports.
• Removal of Inverted Duty Conditions from Important Product Groups:
  • An inverted duty structure (IDS) is a situation where the import duty on finished goods is lower than the import duty on intermediate products or raw materials. Duty inversion could also exist because of IGST, anti-dumping and CVD duties.
  • IDs cannot be determined by just looking at the duty rates on output and input and the effective rate of protection (ERP) needs to be determined.
    • ERP is defined as the percentage excess of domestic value added created because of the imposition of tariffs and non-tariff barriers. Calculations take into account the:
      • share of imported inputs used in production.
      • effect of tariff paid on the domestic value add.
• Determining the effective rate of protection (ERP):
  • An industry may not be affected if ERP remains positive despite IDS because the tariff structure still protects it but the government may consider changes if ERP for a sector is negative due to IDS.
  • It is crucial to establish a link between IDS and ERP.
  • FTAs (free trade agreements) have multiplied the number of IDS cases.
  • Therefore, a mechanism must be created to look at each case, as IDS has the potential to destroy the entire product sector.
• Reduction of duty slabs to avoid confusion and minimize litigation:
  • There are more than 26 rates for Customs duties ranging from zero to 150 percent. In addition, there are over 100 specific or mixed-duty slabs.
  • More duty slabs result in different duties for similar items, leading to classification disputes and expensive litigation and making the automated processing of documents difficult.
  • The government, therefore, must compress the duty rates to five. Doing this may not be complex.
    • Already 85 percent of tariff lines are covered under six duty categories. These are 5 percent, 7.5 percent, 10 percent, 15 percent, 20 percent, and 30 percent.
  • Reduction in the number of duty slabs will immediately enhance the system’s transparency, reduce classification disputes, and allow for machine processing of documents.

Conclusion:

• The customs duty will increase the import price of the components, having a protective effect in the form of shielding domestic suppliers from the competition from imports.
• Moreover, the objective of customs duty should be to create an incentive to get more and more value created in the host country.
• If raw material becomes very expensive to export, then domestic manufacturers will increase prices, and the value addition will not be in the host country, instead, people with import finished products directly.

Source: Hindu BL

Mains Question:

Q. Account for the failure of the manufacturing sector in achieving the goal of labor-intensive exports rather than capital-intensive exports. Suggest measures for more labor-intensive rather than capital-intensive exports. (250 words)