HOW TO LIBERALIZE TRADE

From Business World of 3 September 2004.

The ball is in FM’s court

Why is it necessary to have import-export (now renamed trade) policy? It is because India subjects certain imports to quantitative restrictions. But did it not promise in Marrakesh that it would abjure quantitative import restrictions (QRs)? It did. And did it not abolish them in 2001? No; every WTO rule has an exception, especially for the so-called developing countries, and you can push elephants through it – especially if you find a precedent in some advanced country. For instance, the French government was once irritated by Japanese consumer durables flooding its markets. So it decreed that they had all to pass customs examination in a remote inland post. Brilliant, thought Indian bureaucrats, and they subjected rubber imports to the same inconvenience.

Most of India’s QRs relate to exporters. India’s import duties are high, and handicap exports; so it purports to exempt imported inputs if they go into exports. This is in practice extremely difficult. Consider a catalyst that is used to produce stainless steel. It does not actually get embodied in the steel; is it to get duty rebate or not? Some of that stainless steel is exported; the rest is sold at home. How much of the catalyst that went to produce it is to be allowed to be imported duty-free? Suppose Larsen and Toubro buys stainless steel, makes a centrifuge and exports it; should it get rebate on the duty paid on the catalyst that went into the stainless steel? Complexity makes this a prime area for rule-making, obstruction and bribery.

Suppose that to get over the hassles customs create over such problems, L&T sets up a factory that exports its entire production, to obviate questions on how much went abroad and how much was sold at home. After making the centrifuge, it is left with some scrap. Exporting it would cost more than it is worth. Should L&T be allowed to sell the scrap within the country? If so, how much duty should it have to pay? The machines exported by L&T will have hundreds of components, some imported, some not. Should L&T get rebate for the taxes paid by its domestic suppliers? Should the imported parts be imported duty-free, or should L&T pay duty and claim rebate when it has exported the machines? How can the customs at the port know which parts were imported and which were not?

Some of these questions are unanswerable, and others would require just too much paperwork and inspection to answer. The problem of exempting exports from duty is therefore practically insoluble. What the commerce ministry does is to give the answers in four defined circumstances.

1. Itinerant exporters: It puts out a thick book showing, for a large number of products, what inputs it will assume to have been imported and in what proportions. Once the customs certify that those products have been exported, the ministry would give certificates that would entitle exporters to refund of duty on the specified inputs if they are imported – duty drawback. This arrangement caused such delays and such corruption that it has been largely given up now. Instead, the exporter may either take an export order to the ministry (actually, to its daughter, the Directorate General of Foreign Trade [DGFT]). The clerk there will refer to the thick book and issue advance licences which would permit duty-free import of the inputs. This has eliminated the delay, but not the corruption. And then there is the problem of what to do with guys who got advance licences but then did not export. To reduce red tape, the DEPB scheme was introduced ten years ago; under it an exporter gets a credit whenever he exports and can use it to pay duty on the inputs specified in the thick book whenever he imports them. The customs hate it because it has reduced bribes, and have saddled it with onerous conditions. But exporters still love it. They are upset that somehow, the government did not fight EU’s attacks on it and it was declared incompatible with WTO rules.
2. Exclusive exporters: If a firm exports over three-quarters of its output every year, it is called a 100% Export-oriented Unit (EOU). Then it is treated as a foreign island on Indian soil. It can import any inputs it likes duty-free. But if it sells anything within the country, it is taxed on these “imports” into the country.
3. Export enclaves: The government treats all firms located in a certain area as EOUs. Such zones are called Export Promotion Zones (EPZs) and, to create another fashion, Special Economic Zones (SEZs).
4. Lumpy imports: Some inputs – called capital goods – are used to produce other goods over long periods. An exporter may import them, get duty drawback, and then stop exports and use them to produce for the domestic market. For such goods the government allows imports at a concessional duty, but takes a promise that the exporter would export a multiple of the value of the goods in five years. This is the EPCG scheme.

Addressing itinerant exporters, Kamal Nath assured them that the government would not use the term DEPB after April, but bring back a very similar scheme under some other name. It is actually quite easy. Not just exporters, but all traders should be asked to open an account with a bank – let us say, the Exim Bank. They must always have a positive balance in the account. The account may be used only to pay import duty. Whenever a product is exported, the customs should give the exporter automatic credit for his drawback entitlement in his account; whenever something is imported, the importer should pay duty out of the account. In this way, rebate will always be directly related to an export; and exporters will pay duty just like everybody. That would be the rational arrangement, but let us see what obstacles the customs manage to create.

Now, if a jeweler wants to import enamel or varnish, he can do so duty-free, but not over 2% of his exports. He can take back jewellery a buyer has rejected, but not beyond 2% of his exports (why not?). He will not pay duty on a sample his customer sends him for copying, but it had better be under Rs 100,000. He will be allowed to import gold over 18 carats. The stupid theory was that because major markets such as US and Japan use only 18-carat jewellery, the goldsmith should be allowed to import only 18-carat gold. Now it has been jettisoned.

Indian handicrafts look too indigenous. To increase their appeal abroad, craftsmen and leather goods makers will be allowed duty-free imports of “trimmings and embellishments” up to 5% of their exports. That will create plenty of room for disputes with the customs over what is a trimming and what is an embellishment.

Services exports have done very well without any help from the Commerce Ministry; no software exporter would care to go near it. But the helping hand of the ministry is always there even if the exporter does not want it. For services there was a DFEC scheme like the DEPB scheme for exporters of goods. That is not a grand enough name; it will be called Served from India Scheme. Under it, a restaurant will get a rebate of import duty of 5% of its foreign exchange earnings if it is inside a hotel, but 20% if it is next door. That would be a strong incentive for hotels to hive off their restaurants.

Our banks have lent billions to industrialists who did not pay, and for ten years the government and the Reserve Bank have been giving carrots and sticks to end this legacy of black borrowers. The EPCG scheme is a similar scam; thousands of exporters have brought in capital goods and not done the necessary exports, and they continue to be pursued by DGFT. The minister has promised them “additional flexibility” – a vague and pretty safe promise to make. And if travel agent imported a bus to carry foreign tourists, the central excise till now insisted on an “installation certificate” because they wanted to be sure the travel agent kept the bus with himself. They will no longer do so. A minister can earn popularity simply by removing irrational harassment. 

Exports have always been exempt from excise on inputs. But since Chidambaram brought in service tax eight years ago, the excise authorities have refused to give service tax rebate on inputs. Now that he is back as finance minister, Kamal Nath has finally managed to get him to overrule his excise officials and exempt export inputs from service tax.

The commerce minister has done other admirable things to reduce red tape. But there is an even easier way to eliminate it, not just to reduce it. If there were no import duty, there would be no need to rebate it. The finance minister should abolish as many import duties on inputs as possible. He should start with engineering. Steel and non-ferrous metals already bear very low duties. He should abolish them, as well as duties on metal goods and machinery. That would get rid of EPCG. Then he should abolish duties on cotton, oil, petroleum products and petrochemicals. That would free the entire textile industry, and make it fit to grab the huge market that will become available to it with the abolition of the multifibre agreement next year. We have a bold finance minister; this is the time for bold action, and there is not much time.