India’s shift towards protectionism is increasingly evident with tariffs being deployed as a policy instrument to boost domestic manufacturing capabilities. However, scant attention has been given to the policy’s viability. The article examines the claim of rising protectionism in India and attempts to establish a case for Indian industry through the linkages in trade and historical evidence on FTAs. It also reasons that India will have to re-look some of its existing trade practices in order to be integrated into the global supply chain, especially at this crucial juncture when countries are looking for alternatives to China in manufacturing.
Angira Shukla and Nissy Solomon
Protectionism in India is often synonymous with the pre-liberalisation era after which the country relaxed its trade restrictions with the rest of the world. Therefore, when the 45th US President Donald Trump called India as a “Tariff king,” it sparked a media chase on India’s trade policies.
After pulling out of the Regional Comprehensive Economic Partnership (RCEP) in November, the tariff for medical equipment, footwear and furniture was increased followed by a ban on defence equipment and refrigerants later in the year. According to the latest data compiled by the World Trade Organization (WTO),India’s real tariff has increased from 13.5 per cent in 2014 to an average of 17.6 per cent in 2019. Trade-weighted average tariff too rose from 7 per cent to 10.3 per cent between 2014 and 2018, showing that protectionism is rising in real terms. There have been changes in customs sphere such as increase in customs duty on finished goods as well as on certain raw materials, stringent measures to ensure Free Trade Agreement (FTA) compliances, introduction of tariff quota as a safeguard measure and enabling provisions for imposition of non-tariff import restrictions. These have been accompanied by rising non-tariff restrictions as well.
At a time when India faces some of the highest unemployment rates in the decades after independence, the Atmanirbhar Bharat package was launched as a means to stimulate the economy by merging domestic production and consumption with global supply chains without being self-contained or being closed to the world. Atmanirbhar India aims to turn the country into a manufacturing hub, a sector which has accounted for not more than 17 percent of the GDP in the last decade despite having such a large pool of skilled and unskilled workforce.
The population of the country leads us to have a comparative advantage over other emerging Asian hubs like Bangladesh and Vietnam. Yet, India has failed to integrate itself into global value chains (GVC) with its potential. The Modi government has been publicising the sentiment of export-orientation and entrepreneurship since 2016 through the Startup India and Make in India initiatives. The Atmanirbhar package takes it forward through increased investment in domestic industries in the form of credit.
The government, in its defence on the rhetoric of protectionism, points out to the disadvantage that India has had through its past FTAs. Another argument is that it will help reduce India’s merchandise trade deficit unless the exports are ready with the capacity to compete at the global stage. The current regime rationalises this protectionist policy at a time when most of the developed world are looking to shift manufacturing base from China.
First, the data does not support the claim that FTAs are causing our skewed export track record. In the years of high growth [2004-05 to 2009-10], exports were rising faster than the GDP growth rate and as a share of GDP when India became a much more open economy by usual measures. Between 1995 and 2018, India’s overall export growth was the third largest in the world, averaging around 13.4 per cent annually (in $). This shows that, historically, a more open economy has been beneficial in terms of the growth of exports as well as its share in GDP.
Figure 2: Growth Rate in Imports
Second, the goal professed by the government was to give space to the domestic industries to make growth in exports, but the actions seem to suggest otherwise. The tariff regime is unlikely to improve the scope for Indian exports as it incorporates imported goods to the extent of 50 per cent of their value, meaning that the majority of these imported goods are used for making export products. In that sense, the goal to reduce trade deficit would be fulfilled but it would not be because of an increase in the share of export in GDP, but due to a fall in imports. This hampers the overall continuum of production.
Even though India’s trade deficit with three of its FTA partners and China has been rising and is a concern, this problem arose not merely from increasing merchandise imports, but more from the inability of India’s merchandise exports to find access in the international markets. Data does not show a fall in overall imports despite the rising tariff structures in place. The growth rates for imports fell in the years 2013 to 2016, but again grew by 24 per cent and 39 per cent in the subsequent years. The year-on-year imports of products like base metal mounting, fitting or similar items meant for furniture, etc, fell by only 3.7 per cent in the year 2019-20, when overall merchandise imports were down by as much as 7.8 per cent.
Exports, on the other hand, show a slow trend growth of 8 per cent in the current decade as opposed to 17.3 per cent in the previous decade. The growth was even lower in the second half of this decade (at 1.4 per cent between 2014-15 and 2018-19).This regime does not facilitate the industries to function optimally through free movement of goods.
Figure 3: Growth Rate in Exports
Even if the budget is subliminally trying to target the domestic market, it is important to examine how the reforms affect the efficiency of the domestic market. Countries like China, South Korea, Bangladesh and Vietnam have a high number of small to medium-sized firms to whom subsidiary work like assembling, packing, etc are outsourced. This trend is missing from the Indian industrial sector. In India, even if we ignore the lack of infrastructural constraints, the share of these kinds of firms is missing.
The IMF expects India’s per capita GDP to decline by 10.5 per cent to US$ 1,877 in 2020. An inward looking policy that solely focuses on the Indian markets may also not work in the long term due to the large share of the lower income class, who cannot afford the relatively higher-cost Indian products.
Figure 4: Herfindahl-Hirschman Market Concentration Index
If we examine the trend of Herfindahl-Hirschman Index (HHI), which measures the concentration of big companies in the Indian market, we observe that the share of the biggest companies in India has been rising since 2014. An increase in HHI is an indication of decreased competition in the market and that the concentration of market power is increasingly going into the hands of a few, which is a sign away from entrepreneurial capitalism.
An increased tariff regime will only prompt business uncertainty and further avert investments, making it more difficult for smaller firms to get access to finance. India fell by 10 positions in the World Economic Forum’s Global Competitiveness Index to 68 in the year 2019. Factors underlying this include inadequate infrastructure, restrictive land and labour policy, among others. Niti Aayog studies on trade agreements have shown that Indian exporters suffer logistics, compliance and transaction costs twice as high in other countries. According to an HSBC report, India’s domestic bottlenecks explain 50 per cent of the recent slowdown in overall exports, by world growth (33 per cent) and exchange rate (just 17 per cent). Long procedural waiting times and unpredictable policy framework have led to significant problems in the industry. An example of this, Facebook Inc. waited for two years for approval for WhatsApp to send and receive payments. Even if we consider low cost of (informal) labour, the structural problems pertaining to the industry such as transportation and communication drive up the cost of production. As per World Bank parameters, India’s logistic cost is as much as two-three times of the global benchmarks. To cement our presence in global value chains, it is important that we set right institutional policies that enable open and more competitive spirit in the market. Increased protectionism will not contribute in reducing the cost of production for the manufacturers.
In a bid to enhance domestic capabilities, the Production-Linked Incentive (PLI) Scheme was recently initiated, which gives government subsidy to firms for a limited period on incremental sales such that minimum qualifying criteria of investment and sales are met.
Although it is a much better alternative to the tariff-based policy, concerns remain regarding its implementation. There is incongruence in tariff policy with the PLI Scheme making it more difficult for market players to navigate through the system. The high customs duty placed on many products, when continued for too long, thwarts the idea of raising India’s competitiveness. For PLI to be successful, a strict sunset clause is imperative coupled with a gradual phasing out of high customs duty, to truly achieve global competence.
More openness to trade is important for sustainable growth of the economy. Foreign Direct Investments will be a major driver of the implementation as it brings global practices, technological exchanges and access to bigger markets. In the COVID-19 era when companies are looking to diversify their investments, it is important that India avoid backsliding into protectionism and instead create the right institutional support that enables an open and technologically-innovative ecosystem.
Angira Shukla is Research Intern under CPPR Articleship programe and Nissy Solomon is Senior Research Associate at Centre for Public Policy Research. Views expressed by the authors are personal and need not reflect or represent the views of Centre for Public Policy Research.
Featured Image Source: Deccan Herald
Amendment to Section 11 of the Customs Act, 1962
 NITI Aayog – A Note on Free Trade Agreements and their Costs.
Dhar, Biswajit, and Ramaa Arun Kumar. 2020. “Union Budget and the Trade Sector.” EPW, February 29, 2020.