India has long suffered from the anomaly of imported raw materials being taxed more than the finished product. Economists call it the inverted entitlement structure. A series of free trade agreements (FTAs) in the past have not helped. Are the new ones better? Mint dives deep:
Why is the reverse service structure a problem?
Where manufacturers cannot deduct taxes paid on raw materials from the tax on the final product, the excess tax paid on inputs is built into the price of the product. This makes a product made in India more expensive than the imported finished product, which affects the competitiveness of Indian manufacturers. The problem is acute in sectors such as textiles and clothing. In December, the GST Board postponed tax rate changes on several industry items that were due to come into effect in January, under pressure from part of the industry. Correcting tariff anomalies is key to attracting investment in the manufacturing sector.
Will the new FTAs make the problem worse?
It seems unlikely. The FTAs currently being negotiated are structurally very different from those signed ten years ago. FTAs signed in the early 2000s covered manufacturing hubs like the 10 countries of ASEAN, which includes the Philippines, Vietnam, South Korea and Japan. Most of these countries compete directly with India in a host of manufacturing sectors including apparel, electronics and engineered goods. They produced much of the same goods as India. In contrast, the new FTAs signed by India are with countries like the United Arab Emirates (UAE) which share complementarities with India in terms of trade interests.
How does India deal with tariff anomalies?
India has increased import duties since 2014-2015 to correct the inverted tariff structure for non-FTA countries and the average tariff fell from 13.5% in 2014 to 15% in 2020, according to the World Trade Organization (WTO). In fact, the last two budgets have sought to correct it by removing duty exemptions and lowering the duty on raw materials.
What impact have previous FTAs had on India?
In past FTAs, India agreed to reduce or eliminate duties on finished products. But import duties on raw materials remained high. It was therefore cheaper to import the final product than to manufacture it in India, which hurt domestic manufacturers. This is reflected in the fact that ASEAN’s share of India’s total imports fell from 8.2% in FY11 to 12% in FY21, while exports stagnated at 10 %. South Korea’s share increased from 2.83% in FY11 to 3.23% in FY21, while exports increased slightly from 1.5% to 1.6% in during the same period.
And how are the new FTAs different?
The United Arab Emirates, for example, is a service-, oil-, and gold-driven economy rather than a manufacturer. India has duty-free access for mobile phones, which the UAE does not manufacture. Australia, which signed a pact with India last week, is again not a big manufacturing economy, but a service economy with key interests in wines and minerals, pears, oranges , etc. Incidentally, this time around, the government is holding consultations with industry during the FTA talks, doing a SWOT analysis to ensure that FTAs benefit India’s exports.
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