India has long suffered the anomaly of imported raw material being taxed more than the finished product. Economists call it the inverted duty structure. A spate of free trade agreements (FTAs) in the past have not helped. Are the new ones any better?
What is the inverted duty structure?
- An inverted duty structure comes up in a situation where import duties on input goods are higher than on finished goods.
- In other words, the GST rate paid on purchases is more than the GST rate payable on sales.
Why is it a problem?
- When manufacturers cannot set off the taxes paid on raw materials against the tax on the final product, the excess tax paid on inputs gets built into the price of the product.
- This makes an Indian-made product more expensive than the imported finished product, affecting the competitiveness of Indian makers.
- The issue is acute in sectors like textiles and apparels.
- Correcting duty anomalies is key to attracting investments in manufacturing.
Will new FTAs worsen the problem?
- Looks unlikely. The FTAs under negotiations are structurally very different from those signed a decade ago.
- The FTAs signed in the early 2000s were with manufacturing hubs like the 10-nation ASEAN which includes the Philippines, Vietnam, South Korea, and Japan.
- Most of these countries directly compete with India in a host of manufacturing sectors including apparel, electronics, and engineering goods.
- They largely produced the same goods as India.
- By contrast, the new FTAs being signed by India are with countries like the United Arab Emirates (UAE) that share complementarities with India with respect to trade interests.
How is India addressing duty anomalies?
- India has been increasing import duties since 2014-15 to correct the inverted duty structure for non-FTA countries and the average tariff rose from 13.5% in 2014 to 15% in 2020.
- In fact, the last two budgets sought to correct it by removing duty exemptions and lowering the duty on raw materials.
How did the earlier FTAs impact India?
- In old FTAs, India agreed to lower or eliminate duties on finished goods. But import duty on raw materials remained high.
- That made it cheaper to import the final product than make them in India, hurting domestic manufacturers.
- This can be seen from the fact that the share of ASEAN in India’s total imports has grown from 8.2% in FY11 to 12% in FY21, while exports have stagnated at 10%.
- The share of South Korea rose from 2.83% in FY11 to 3.23% in FY21, while exports are up marginally from 1.5% to 1.6% during the same period.
And how are the new FTAs different?
- The UAE, for example, is a services, oil, and gold-led economy rather than a manufacturer. India benefits from duty-free access for mobile phones, which the UAE does not make.
- Australia, which signed a pact with India last week is again not a major manufacturing economy, but a services one with key interests in wines and minerals, pears, oranges, etc.
- Besides, this time around, the government is holding consultations with the industry during the FTA talks, doing a SWOT analysis to ensure FTAs benefit India’s exports.
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