Post-GST protection for domestic industry makes a compelling case for customs duty cut


Interim Budgets are usually staid affairs. And, yet, here’s corporate India waiting with great expectation, speculating furiously over what tax policy and rate changes the government will bring about tomorrow ahead of the Lok Sabha polls. In all this din, however, what stands out is the clamour for the protection of domestic industry.

One could swear that the tune is that of the plaintive strains once made by the ‘Bombay Club’, that venerable lobby that emerged following economic liberalisation in the 1990s. Over time, of course, the fears of the members of the Bombay Club proved to be tenuous — their companies did grow in India, and they even made forays overseas.

Some 25 years later, the same logic that disproved their concerns holds. Raising tariff walls will lead to domestic inefficiency, push up input costs for user industries, and trigger retaliation by other trading partners. This ammunition, of course, has been used more recently.

Close on the heels of the US and China imposing penal tariffs on their mutual imports, India, too, imposed anti-dumping duties on many products.

Should there be a further slide towards protectionism? Or should GoI earnestly restart the reform process that began in 1991but was halted in 2007-08? Clearly, the latter. And such a process can be conducted outside the interim Budget, as GoI has the power to change indirect tax rates.

Ideally, India should move towards reducing peak customs duty to 5% from 10%. It will raise the quality of domestic produce and make our products competitive in the international market. A single rate — be it the raw material, component or finished good — will ensure that domestic relative prices are not disturbed.

The Confederation of Indian Industry (CII), though, wants the peak customs duty of 10% to continue for this fiscal to provide protection to the domestic industry. “The impact of slowdown of economy in many countries still continues and these countries are making all efforts to export to other countries including India at a lower price. Any reduction in peak rate of customs duty will go against the campaign ‘Make in India’,” stated the CII pre-Budget memorandum on indirect taxes, which is dotted with sector-specific recommendations to tweak import duties.

Lacking custom
Having adopted the goods and services tax (GST), India should not regress in indirect tax reform. Past experience shows that import substitution through higher tariffs is not a good way to promote domestic manufacturing. So, the notion that raising import duty would help promote ‘Make in India’ is seriously flawed.

The domestic industry is getting far greater protection in the post-GST regime than before. Prior to GST, ‘protection’ included a 10% import duty, a 10% countervailing duty to offset excise duty, and a 4% special additional duty to offset state taxes. This amounted to a net duty rate of 28.13%, given all duties are compounded.

In comparison, the sale price of a domestically produced good — with 12% excise duty and 13% state value-added tax (VAT) — had a net tax rate of 26.56%. That gave an effective (customs) duty protection of 1.57% over an imported good, making the domestic producer competitive by Rs1.57 on a basic price of Rs 100.

With GST, imports are treated as inter-state supplies into the country, and attract integrated GST (IGST). So, with 10% import duty and 18% IGST on imports, the net duty would amount to 29.8%. A domestically produced good attracts only 18% GST, leading to an effective customs duty benefit of 11.80%.

It actually makes the domestic producer competitive now by Rs 11.80 on a basic price of Rs 100.

The effective protection on a value addition of 20% worked out to about 7.84% in the pre-GST regime, and is a whopping 59% in the post-GST regime.

Which is why an increase in the level of protection makes a case for reduction in customs duty acceptable. It will make India a low-cost producer, and more attractive as a base for export production.

Import tariffs and export taxes are protectionist in equal measure. (Ask economists about the Lerner symmetry theorem used in international trade theory.) So, any economic gain through import substitution will be offset by loss in exports. It will enrich only promoters through rent, without any additional economic activity.

Whereas a reduction in customs duty will reduce prices and inflation, enabling RBI to cut interest rates and improve the competitiveness of Indian industry.

Projects will become viable, increasing new investment and employment.

Budget for later
Indian companies should also not practise bogus value addition. Instead, they should focus on R&D to promote genuine manufacturing, taking advantage of the huge market and low wage costs.

‘Make in India’ can succeed only if Indian companies are on par with their global peers in research spending.

Industry also wants an unconditional reduction in the corporate tax rate from 25%, without any turnover criteria.

CII says the rate should be cut to 18% over a phased manner. A flat rate without exemptions makes sense, and will put all businesses, whatever their size, at the same level. By convention, however, past governments have not changed direct tax rates in an interim Budget. The present government should not deviate from this tomorrow.

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