## Jun 5, 2017

### ITC HS harmonisation method for trade data analysis - a proposal

(I have used LaTeX in this post for math symbols. If you are using a mobile browser, you may consider requesting a desktop version of the page in order to view the table and formulae properly)

The International Trade Classification - Harmonised system (ITC HS) codes are used for classification purposes in international trade. All products traded internationally are represented though these codes. The codes extend upto 8 digits in India, first 6 of which are harmonised with the international system. Most of the countries are harmonised at 6 digits which implies that the product classification upto 6 digits is common. However, the next two digits are country specific and this sub classification or further bifurcation is a function of statistical and industry needs. Some countries have further two digits, taking the number of digits to 10 to help further statistical purposes. In India, it stops at 8 digits. First two digits in the classification are known as chapter number (01 to 99), the third and fourth digits make up the 'heading', the fifth and sixth digits are called 'sub headings'. The last two digits are called 'tariff headings'. A tariff heading is usually given a number ending with 00 in order to classify all 'other' products falling under the sub-heading after important ones are allotted various numbers starting with 11 and running upto theoretically 99. At times, this 'other' which ends with '00' grows big enough to warrant it's own tariff heading. I have seen tariff headings where the data under 'other' warrants a split to get granularity in data, but it has not been done. At other times, I have seen tariff headings that take up a huge bandwidth (a disproportionate share of the trade under the heading) and yet they have not been split to show further granularity. At times, it feels that the process could be automated. However, till now as I understand, the Govt. depends on various representations from industry and requests from statistical bodies for a split in the sub-headings. The requests are not always very scientific and arise out of ad-hoc needs.

This I feel may be avoided by automating the function of splitting sub-headings of ITC HS. The proposal below suggests a method to decide if a particular tariff heading needs further bifurcation into lower levels, e.g. from 6 digits to 8 digits, or from 8 digit heading ending with 90 or 00, to further divisions and so on.

The proposal would use the same technique used in calculating Herfindahl­ Hirschman index for market concentration in antitrust/competition law cases. The proposal doesn’t apply to cases where the new heading is needed due to environment/public interest and so on. Such headings can be considered on ad­hoc basis. The proposal utilizes the relative weight and not absolute value method. The absolute values in terms of trade in ‘X’ crore rupees might become cumbersome as the relative importance is missed out. e.g. a 20 crore exports under a particular heading under handicrafts is significant enough to have a separate heading whereas even 200 crore is negligible in the case of diamond exports. Hence a technique of harmonization that looks at relative importance with respect to parent heading might prove superior to a method of looking at absolute value. The core idea behind this proposal is to develop a system that can be programmed, thus obliviating the need of human intervention in drilling down the headings. The working is illustrated with an example below, in which a case of 6 digits HS codes at sub-heading level are being considered for further harmonization up to 8 digits.

### Steps:

Step 1

List down the 6 digit codes under consideration, with the total trade value of previous year and the corresponding share in their parent heading at 4 digit. Let’s take the heading 8413, under which the eight 6 digits subheadings are:

ITC HS CodeTrade ValueFractional Share in Parent 4 digits (8413)
841311A1$S1 = \frac{A1}{\sum A}$
841319A2$S2 = \frac{A2}{\sum A}$
841330A3$S3 = \frac{A3}{\sum A}$
841350A4$S4 = \frac{A4}{\sum A}$
841360A5$S5 = \frac{A5}{\sum A}$
841370A6$S6 = \frac{A6}{\sum A}$
841381A7$S7 = \frac{A7}{\sum A}$
841391A8$S8 = \frac{A8}{\sum A}$

Step 2

$Index number = S1^2 + S2^2 + S3^2 + … + S8^2 = \sum S^2$

Step 3

If Index number is greater than 0.25, there is a case for further bifurcation of that subheading at 6 digit which has the highest share in trade into 8 digits.

Step 4

The process is repeated till all high value 6 digits are bifurcated into 8 digits. The highest possible value for the $Index Number$ is 1 (only one heading with 100% share). $Index Number$ below 0.01 indicates a highly distributed trade. $Index Number$ below 0.15 indicates an unconcentrated trade. $Index Number$ between 0.15 to 0.25 indicates moderate concentration. $Index Number$ above 0.25 indicates high concentration of trade requiring further granularity. The concentration begins somewhere at the point where the $Index Number$ reaches 0.15 and crosses the threshold once the number reaches 0.25, at which point it should be further drilled down into lower headings.

A worked example with some numbers is given below:

Let’s take a case where there are 16 sub­headings at 6 digit level. Now, we will consider two cases in which the six largest 6 digit headings (out of those 16) cover 90% of the trade value:

Case 2: One sub-heading covers 80% while five other sub-heading cover 2% each, and the rest 10 subheadings share a minor 1% each like Case 1.

By inspection (and common sense) we can say that the first case would be fine at 6 digits without further harmonisation, whereas the second case is apt for further bifurcation/harmonisation.

The Index Number for these two situations makes it strikingly clear:

Case 1:
$Index Number = (0.15^2+0.15^2+0.15^2+0.15^2+0.15^2+0.15^2) + (10 \times 0.01^2) = 0.136$

Case 2:
$Index Number = 0.80^2 + (5 \times 0.02^2) + (10 \times 0.01^2) = 0.643$

The squaring of the shares this way in the index number calculation penalises bigger shares more than the smaller ones, giving additional weight to headings with larger size. The threshold value 0.25 is based on popular usage of this threshold in antitrust/competition law cases of market monopoly. In a way, any higher share of one among many is a kind of monopoly, hence calling of use of such an index number. The above steps can be easily programmed in simple tools like excel. Any request that comes for addition of a sub­heading at 8 digit can be evaluated using this method and if deemed fit, may be taken up for harmonisation.

## Mar 29, 2017

### GST effect on Foreign Trade Policy: Effect on various exemption and incentive schemes - Part 2

I had elaborated my thoughts on the topic in the Part 1 of the series. This is a continuation and part 2 of the series. As was outlined in part 1, it appears that the duty exemption schemes, specifically the popular advance authorisation scheme may get a short shrift under GST and may be made ineffective. As proposed, GST would allow only refunds on the duties suffered, unless a course correction is done before the launch and now.

I have discussed some details in the video post here:

I have also summarised my thoughts on other schemes, namely the Export promotion capital goods scheme and the export incentive schemes in the same video. I guess I got too lazy to type at some point and decided to video log it over a coffee.

To sum it up, it appears that GST has not kept the best interests of exporting community in mind at the time of rollout. However, one must also agree that GST is being rolled out with a sense of urgency and there will be kinks and knots and pockets of dissatisfaction which would get ironed out over a period of time. Probably there would be revision or rethink about the exemption schemes too. The last word is not yet out. I would most likely come up with a final part of the series then. Till then fingers crossed.

## Jan 6, 2017

### Undervalued currency of China and learnings for India

China maintains an undervalued currency which is one of the key reasons for trade surplus of China with most trading partners. It has also led to huge forex build up over the years. While China's undervalued currency has faced criticism from trading partners, the public policy choice of this tool for development of China is not well appreciated. China has used the currency as a policy tool to empower itself; it is just incidental that this policy has done damage to trading partners. The undervalued currency of China acts as a direct subsidy for exports. A 20% undervaluation of currency is equivalent to 20% direct subsidy support in terms of export price. Given that China has usually maintained an undervaluation of a quarter to a third of its price, Chinese exports have enjoyed this subsidy. In addition, an undervalued currency acts as a tax on imports into the country, leading to further favourable change in terms of trade.

China has used currency as an evolutionary policy response against stifling conditions imposed upon it from WTO and other bilateral/multilateral arrangements. If one looks at China's growth decades, it can be seen that the late 70s and early 80s growth right up until mid 90s rode on the active state support to the manufacturing industries. Heavy structural change towards industrialisation was led by the state, leading to rapid increase in productivity in the manufacturing sector. During this period, China maintained heavy import restrictions, provided subsidies to industries, and incentivised investments into the manufacturing sector in the country. The strategy worked and led to creation of world beating manufacturing sector in China. The scale of industrialisation met and surpassed advanced industrialised nations within two decades. None of the above steps that China took to support its domestic industry were compatible with WTO, and therefore China didn't come onboard at the time of WTOs inception in 1995.

While China prepared for joining WTO during late 90s, (it ultimately joined WTO in 2001) it realised that the earlier strategy of direct subsidy and import restrictions would not work. Therefore it resorted to an undervalued currency strategy which was not countervailable under existing WTO rules. The decade from late 90s onwards till very recently, China maintained an undervalued currency, thus helping its manufacturing sector weather the gradual withdrawal of direct subsidies and state support that fell foul with WTO provisions. This strategy ensured that Chinese industries continued with the state cushion while appearing to follow all WTO rules. Even today, currency policy cannot be countervailed under WTO. It was the protest by trading partners, and problem of burgeoning forex reserves that made China do a partial rethink.

In contrast, Indian manufacturing industries were not well prepared to withstand global onslaught once the gates were opened under WTO, especially from competitors like China. Wherever Indian government provided even semi decent support, Indian manufacturing industries showed good results. For example, in auto and auto ancillaries industries Indian government had made provision for incentivising localisation, mandated joint venture requirements for direct investments in the sector, and had levied heavy import duties on fully assembled imports during the 90s. While these provisions fell foul with WTO rules later on and had to be removed, these policy steps during formative years helped our auto and engineering sector thrive. Similarly, in pharma sector, Indian patent laws allowed the industries to operate and copy generics and derivatives despite TRIPS, and today India's pharma sector has done exceedingly well. On the other hand, electronic hardware manufacturing sector in India was opened up to the world from initial days under Information Technology Agreement of WTO, and no meaningful support was provided during the early days and today we are struggling in electronics manufacturing.

Lest I be misunderstood, the argument is not about infant industry protection or supporting protectionist policies of the yore or even to recommend currency devaluation as a potent tool for India. It is about the need for policy makers to carefully analyse the options available as policy tools whenever an industry is being subject to inorganic changes such as globalisation, treaties, change in import policies, state support introduction or withdrawal etc. To cite an example from recent times, the imposing of anti dumping duties on imported steel in order to protect the steel industry in India has bled the engineering and auto sector by raising input costs on them. It appears that policymakers did not do a good cost-benefit analysis, and therefore helping one sector is harming another. If steel sector needed to be protected, one needs to build in adequate protection for engineering sector which needs imported steel.

Chinese policymakers were indeed smart to introduce currency devaluation while they withdrew from direct subsidies. It was a policy option they had in hand and they exercised it very well to their advantage. That's a lesson for policymakers worldwide.

## Nov 16, 2016

### Light at the end of the tunnel - Indian exports hit the nadir

Exports have finally started to look up. While there is certainly base effect in play due to continuously decreasing exports for last two years, I have a hunch that we have hit the nadir and things will languish at this level or they might slowly (and very very slowly) start looking up as time passes. Till then, we shall have this silly increase and decrease of exports which do not carry much significance.

### The merchandise trade situation is as below:

 Exports and Imports - Merchandise/Goods trade from India October 2016

### The services sector trade situation is as below:

 Exports and Imports of Services September 2016
The global trade scenario has not improved. While the sentiment for more trade has mellowed down across the globe, there has to be a point which can be called lowest. Probably for India, this was it. Now the question is, how to climb back from this valley we find ourselves in.

## Sep 16, 2016

### Institutionalizing Twitter governance - from chaos to order

A random guy feels cheated because Snapdeal, an online retailer, gave him an offer of 32GB iPhone memory expansion drive for Rs 51 (it usually retails for around Rs 4000); and then canceled it within a minute. Probably the deal was on the site by mistake, or maybe it was a technical glitch. Snapdeal sends a prompt message promising a refund of 51 rupees within four working days. The guy in question, who is obviously well enough to own an iPhone, takes offence at this and tweets about it. He tags the commerce minister on his tweet, which is indeed noticed by the commerce minister, who in turn directs a Joint Secretary to look into the matter, and the aggrieved guy is told to connect with the officer. All on twitter. You can google! This is not a lone case. It's bizarre to go through the twitter handles of most of the ministers and departments. People want all and sundry problems to be solved through them, instantly on twitter. Some of them are indeed picked up and solved, or directed to a hapless officer, who takes up the case on priority as it is referred by the minister. Twitter feeds are monitored and each tweet where the minister is tagged becomes a 'Paper Under Consideration' (PUC) for a babu in the department who is sacrificed to monitor the twitter feed.

While using twitter to handle complaints/grievances needs to be lauded, one must also acknowledge the grim reality that this is creating an institutional bypass where the need to create a strong institutional mechanism of addressing service delivery issues is obfuscated with knee jerk tweet replies and artificial back-slapping praises for a random case where the issue gets addressed. This has built a skewed incentive for ministers in the system to launch various so called 'sevas' on twitter to address public grievances and solve problems. It makes good headlines, and at times indeed looks like a laudable effort. However, without building up back end capacity to handle the twitter grievances when they scale up in numbers, it is a disaster in making.

Twitter cannot be a replacement for formal institutional mechanism for grievance redressal. In the current form, it fails the basic test of a good institution of being effective, accountable and inclusive for all. But then, twitter is a social network, it was not designed to serve as a state institution.

For example, the correct institutional mechanism to address the case of snap deal cheating is through a strong consumer court institution which operates without delay or harassment. Twitter is not effective enough. One random case might get attention, but when it scales up, the department cannot afford to bother to take up each case.
The mode is also not accountable. There is no track and trace mechanism that is built into twitter, unlike a properly designed ticketing system for grievances. No one knows if the problem was ultimately addressed or not, or who is to blame for non-resolution of complaints on twitter. .
Twitter is also not inclusive. It is accessible to educated, net-connected and usually english speaking minuscule percentage of population. Any grievance mechanism cannot be exclusivist to this extent.

Strong institutional mechanism and required state capacity to address grievances/complaints needs to be built into the executive. It is a state building activity; slow but lasting. Ad-hoc methods like twitter cannot be a replacement to institutions. At best, twitter can be another input into the well designed process of grievance redressal that is handled through dedicated institutions.
Sadly, in the hope of projecting a social media friendly face, the ministers and departments seem to be missing the point.

## Aug 30, 2016

### GST and Foreign Trade Policy : Effect on exemptions and incentive scrips - Part 1

GST will be rolled out sometime during April to October 2017. This would be single most radical reform of last decade. While the GST model law has been published, further procedures are being worked out in various committees formed for specific purposes. This post (and a couple more in continuation) would analyse, in a preliminary way, as to how the GST might impact Foreign Trade Policy (FTP) and the schemes therein, and some analysis based on the information available at this time.

{A small video on the topic is also available at the link below:

Assuming that the reader is aware of FTP schemes and basics of GST as outlined in the GST model law, I would proceed.

Currently, the duties levied at the border by customs are as follows:

Total duty = Basic Customs Duty (BCD) + Additional duty of Customs (ADC, colloquially called CVD) + various cesses + Special Additional Duty (SAD, at 4%, to offset state taxes, refundable under certain conditions), + protective duties if applicable (Anti dumping, safeguard duty etc.)

The entire duty collected by customs goes into the kitty of Central Government (Consolidated fund of India). Under GST, the duties at border would be as follows:

Total duty = BCD + Interstate Goods and Services Tax (IGST) + Protective duties if applicable (Anti dumping, safeguard duty etc.)

The duties at the border would be collected by customs, i.e. central government, and the state share of the IGST collected at border would be transferred to the state where the imported goods are finally consumed. (Article 269 A.(1) - Explanation I). To this extent, states would also be directly getting a part of import duties levied at border, which was not the case till now.

#### The IGST exemption issue

As centre and states both lay claim to IGST collected by customs at the border (as with inter state transactions), any exemption or modification in rules would have to be agreed to by the centre and the states. Border exemption of duties lie at the heart of some of the popular schemes of the current FTP. The exemption would be challenging if IGST is viewed strictly in the light of Article 269 A.1 - Explanation I. That would make any exemption at border, in the current form as outlined in the FTP unimplementable under GST regime. The problem can only be overcome with the agreement of, and a push by, the GST Council. States have an important say on the matter and to that extent the job is tough. There is no clarity as of now if it would agreeable to states. Or if such exemptions at the border are being considered at all. To that extent, the current FTP's exemption schemes' fate hangs in balance.

The thinking in policy circles is to minimise exemptions as far as possible, and go with the refund route wherever necessary. Exports would be zero rated, which means taxes are not intended to be exported, and therefore all taxes paid on exported products would be refunded/credited (and not exempted) to the exporter.
There is no doubt that exemptions would be preferred over refunds by the trade, due to obvious reasons of cash flow issues and time value of money. However, refunds are better from tax administration point of view. One needs to ensure that flow of refunds do not entail delays and harassment in GST regime.
In order to circumvent the cash flow issue, there can also be an alternative approach where applicable exemptions are shown as credit entry against the importer, to be offset once the export obligation is completed. This way, the revenue collection agencies may show it as deferred collection at the same time not holding to cash flow of exporters who use imported inputs.

#### Duty Credit Scrip Acceptability and design of suitable mechanism

Currently, under FTP chapter 3, various duty credit scripts are issued (MEIS/SEIS) which can be used to pay/offset duty liabilities at customs, central excise or service tax. Being transferable in nature, they are near money in market. CBEC has issued suitable notifications in this regard.
There is no clarity if such scrips would be acceptable under GST. Assuming that incentive scrips would be made acceptable to offset atleast CGST and IGST part of liabilities, suitable mechanism in the GST network need  to be made. The scrip should be designed in such a way that they enter into the credit account of the firm under CGST/IGST credit head. That way, the deduction would be automatic. The current cumbersome process of paper scrip being issued by DGFT, followed by online transmission to DG systems at customs is buggy and harassing. It is better for DGFT to migrate to GST Network and leave behind the legacy NIC software that it currently uses. As GSTN is a private non-profit company with shareholding from Centre and all states, there is no reason why DGFT should not dismantle its NIC gradually and move on to GSTN completely. Given the way it is formed, GSTN might prove to be more accountable in comparison.

We may now look into the specific schemes under current foreign trade policy which might need readjustments under GST, assuming that indeed the GST council comes around to the enlightened view of exemptions at the borders for exporters. We need to also look at what other countries in similar situation are doing, but that would be in a later post.

#### 1. Duty Exemption Schemes under GST

The current duty exemption schemes are Advance Authorisation (AA) scheme and Duty Free Import Authorisation (DFIA) scheme.

### a. Advance Authorisation scheme under GST - direct import case with physical exports

Under Advance Authorisation scheme currently, the total duty is exempted for raw material, inputs and intermediaries as long as they are exported as final products, with a value addition of around 15%. The duty exemption is given at the point and time of import, usually before the exports are effected. The multistep process of exemption is outlined in brief below:

Step 1: Get the advance authorisation issued from the DGFT and get it registered with the customs and execute a Bond/BG/LUT as applicable.
Step 2: Import duty free inputs[This is point of exemption], incorporate into export products, and export.
Step 3: Produce export documents to DGFT and get the export obligation discharge certificate (EODC) and produce it to customs to get the bond cancelled.

The current interface between DGFT and DG Systems (ICEGate) is rudimentary. The advance authorisation details are transmitted to customs, but the exporter needs to produce the license physically at the port. The Bills of entry and Shipping Bills are not electronically linked to the EODC process at DGFT, leading to lot of avoidable paperwork. Two departments are involved in the process of implementation of this exemption scheme, and there is duplication in verification checks.

Under GST regime, this scheme's survival depends on exemption agreement on various duties levied.
If indeed total duty exemption is agreed upon, including exemption for IGST, this scheme may continue as is, with a new notification on similar lines as existing being issued in this regard.
However, if IGST exemption is not agreed upon, or worse still, if exemption (BCD+IGST) at the border itself is not agreed to, and the council goes with only refund route, this scheme will get stunted or redundant, respectively.

Scenario A: Border Exemptions are fully agreed to:

Assuming that in the interest of exports and trade, the total duty exemptions are agreed to, and states come on board, the following changes would be warranted:
• A new notification from GST council to replace the existing ones from CBEC with regard to this scheme.
• Integration of DGFT system with GST network. The exemption details under AA (credit note, direct exemption as in existing scheme or any other approach) and the debiting at the customs have to move online for smooth integration. The EODC process needs to be integrated with GSTN feeding in the export data to DGFT system. This activity has to start at the earliest and should be a co-development with the same team that is working on GST network.
Scenario B: Border exemptions are not agreed to, but refunds by Customs are agreed upon:

Assuming that all states come aboard in the interest of exports, and agree to forego their share of IGST which would then be refunded to exporters by customs (similar to drawback mechanism currenlty), a mechanism would then need to be designed to allow faster and harassment free refunds under GST Network.

• A new notification on refund process and rate of refund determination. Rate of refund may be similar to drawback or may be linked to actual duty suffered, as the data would be readily available in the network.
• Verification method, checks to prevent diversion and documentary requirements for refund. eBRC, Shipping Bills etc.
Scenario C: Border exemptions are not agreed to, but refund is mandated under revised FTP:

Same as Scenario B in terms of agreement, but the implementing agency would then be DGFT.
• FTP chapter 4 needs to be revisited to devise a mechanism to refund the duties suffered at the border.
• Refund may be upon production of Bills of entries, in the form of credit/scrip/cash, and the export obligation may be monitored by DGFT as usual post the refund.
• EODC may be issued after export obligation fulfilment, and in case of failure, refunded amount with interest would be recovered.
Scenario C entails minimum tweaks in the FTP, where the border exemption is replaced with refund by DGFT and all other details (EO monitoring etc) remain the same. Rather than getting duty exemption at border, the trade would pay the duties there, and come with bills of entries to DGFT to get the refund.
However, refunding through DGFT involves a different challenge altogether. Refund from DGFT would entail fund allocation for the purpose from Finance ministry, which involves budget approvals for withdrawal from consolidated fund of India. This would be tricky each year. Refund from tax collecting department is relatively easier to implement from this point of view, as the department that does revenue collection is the one that refunds, and thus it can do book accounting for refunds that flow out for a financial year.

Scenario D: IGST exemptions are not agreed to, BCD exemption is agreed upon:

Advance authorisation scheme loses the charm as for most of the items currently the BCD is less than 10%; and if the imports are from one of the countries with which India has signed a free trade agreement, even this BCD might be near zero. This would effectively make the advance authorisation scheme redundant.

One of the above four scenarios, or a mix of one or two above would play out in actual. The best case for the trade would be Scenario A if border exemptions are allowed, and Scenario C if refunds are chosen over exemption.

The second part of the series can be found here.

## Aug 22, 2016

### Video tutorials for export promotion

DGFT has come up with a series of video tutorials on their youtube channel to help newcomers in the area of international trade. The video series aims at providing the basic knowledge about fundamentals of international trade, such as introduction to incoterms, export import policy of India, starting an export business etc. As yours truly was deeply involved in the development of the project from the beginning, I thought of sharing some of the links here. The videos were developed in Bangalore DGFT office, and some more are in the pipeline for the beginner series. The videos will be accompanied on the official DGFT website with FAQs on various introductory topics in coming days.

Given that e-learning has been popular for last few years, this initiative was designed to produce standardised, short and easy learning modules in the area of international trade from Indian perspective, keeping in mind the unique situation of an Indian exporter/importer.

Feedback welcome on official youtube channel. Enjoy.