Safety nets have to be put in place
Financial Express, India
Safety nets have to be put in place
Improvement in infrastructure could cushion adverse effects of duty cuts
ABHIJIT DAS
8 March 2006
With global trade increasingly becoming the dominant sector of India’s economy, exporters, importers and trade policy experts were anticipating important trade-related initiatives in the Budget 2006-07. By announcing significant reduction in peak customs duty from 15% to 12.5%, complemented with significant steps for improving infrastructure, the finance minister did not disappoint. While the implications these initiatives would have require a detailed examination, some quick and far-reaching conclusions can be drawn.
The decline in customs duty does not appear to have severely affected the overall customs duty collected. Based on the current projections, while the revised estimates for customs duty for financial year 2005-06 is pegged at Rs 642.15 billion, the estimate of collection for Budget year 2006-07 is around Rs 770 billion. While high import elasticity may account for this increase in customs revenue, lower duty may also encourage greater compliance by importers.
The Indian industry has withstood the steady reduction in customs duty since 1990. This has mainly been possible due to appropriate sequencing of domestic reforms. Tariff simulations undertaken by Unctad indicate that further tariff cuts, beyond the levels existing in 2004, could entail adjustment costs in terms of fall in output and labour use. Simulations suggest that labour utilisation increases in sectors that experience a growth in economic activity, except for other agricultural products, where a decline in demand for skilled labour is accompanied by an increase in output. The demand for both unskilled and skilled labour rises in textiles and wearing apparel. Some of these effects could arise on account of reduction in peak customs duty to 12.5%.
While trade adjustment costs arising from reduction in customs tariff could be higher in sectors such as auto components, food and steel, the extent would depend on developments in areas such as infrastructure. Trade adjustment costs from declining industries could also be more significant than in the earlier decade. A comprehensive set of domestic safety nets would be required to meet these costs. An example is the recently enacted through the National Rural Employment Guarantee Act, which promises to guarantee 100 days of employment to every household. More such schemes should be put in place.
It is also apprehended that trade liberalisation may not deliver the desired gains because of inefficient transportation, notably roads, maritime services and ports, which constrain trade and add to the overall costs of doing business.
In addition, the power sector has become a major bottleneck to economic activity. India’s infrastructure requires both a massive increase in investment and greater efficiency in order to support economic growth. In this context, initiatives announced to augment capacity for power generation by 39500 MW in three years, increase in outlay on national highway to Rs 9945 crore and plan to provide 250 million phone connections by end-2007 could prove to be useful steps in improving the infrastructure.
Sustaining and reinforcing these initiatives over the next few years would create a facilitating environment for India to harness the benefits from liberalisation in global and bilateral trade regimes. On the other hand, certain estimates suggest that the effective cost of importing capital goods could increase by about 3%, on account of the 4% countervailing duty which would obviously have a detrimental effect on investment and growth.
Reduction in peak customs duty to 12.5% would also have implications for India’s growing PTA/FTA engagements with other countries. These negotiations are mainly held on the basis of countries offering a margin of preference on the generally applicable customs duty, also called the MFN customs duty. As customs duty declines in India, the extent of absolute advantage enjoyed by India’s PTA/FTA partners would get eroded. This could result in hard bargaining by India’s negotiating partners, who may seek deeper bilateral tariff cuts so as to enhance the margin of preference.
While improvement in domestic infrastructure could cushion some of the adverse effects of deeper margin of preference under PTAs/FTAs, the message would not be lost on the Indian industry-become cost competitive or make way for imports. The countervailing duty of 4% would, however, effectively take away the sting for the domestic industry of this tariff reduction.
With non-agricultural market access (NAMA) negotiations steadily gathering momentum at the WTO, the reduction in customs duty offers India’s trade negotiators the flexibility to offer deeper tariff cuts. As the tariff cuts in WTO negotiations would be made applicable on the bound rates and would be essentially irreversible, it would be in India’s interest to leverage the space offered by recent reduction in customs duty for seeking ambitious market access in products of its export interest, particularly those in textiles and clothing and leather and footwear.
The author is senior trade officer, UNCTAD India Programme.Views expressed are personal
