Dec 8, 2019

WTO moratorium on E-Transmissions and OECD Pillars for digital economy

Moratorium on Cross Border E-Transmissions

If one imports a book into India, one will pay applicable customs duty (currently 10% basic customs duty, and all applicable cess/welfare charges). However, if one downloads the same book over Amazon Kindle, one gets it duty free. Kindle books are almost always cheaper than their paper counterparts and the zero import duty is one of the factors keeping it that way, other factors being savings on printing/paper, transportation etc. This is an example of how the moratorium on international cross border taxation on Electronic Transmissions (ET), adopted by WTO in 1998 affect the prices. 

image of Digital imports in world
Share of Digitalised Products in Global Imports - as represented in UNCTAD study

Also, there is the question of direct taxation, in terms of corporate taxes or taxes on profits from the earnings made in India for companies who are highly digitalised in terms of delivery/users/markets (Amazon cloud services, Facebook, Google), and where it is not easy to actually segregate the amount of profits that arise out of operations in any particular tax jurisdiction/country. I am not aware how Amazon India accounts for the kindle sales in India, and the subsequent profits or lack thereof and whether they are adjusted against subsidised goods sales and so on while filing the annual tax statement with the Indian government. The case becomes complicated when you look at free ebooks offered under 'Kindle Unlimited' scheme.  It is not easy to establish the nexus between the operations and profits arising in any one country when the model is highly digitalised. Therefore, in a digitalised world, where companies are operating in a highly digital model, both indirect and direct taxation becomes a vexing issue. While WTO bothers more about indirect taxation such as customs duties, OECD bothers about direct taxation such as corporate tax on profits and issues related to Base Erosion and Profit Shifting. 

For those who understand how digital transmission works, the issue of tarrification of electronic transmission (WTO issue) and the issue of taxing profits of digital multinational organisations (OECD issue) are two sides of the same coin. You cannot actually isolate one without stepping into the other part. But for now let's deal with them separately and frame the policy questions in these areas from India's point of view. 

The indirect taxation issue

The matter of indirect taxation basically pertains to customs duties that don't exist currently on electronic transmissions due to a WTO moratorium agreed by members during 1998 and which continues with extensions till date. There is a now a debate about whether the moratorium needs to be ended and countries be allowed a framework to impose customs duties on electronic transmissions. At stake is the potential revenue implications which vary in calculation, with a range that varies from 280 million USD to 8.2 Billion USD per year, and which even at the higher end appears too small to actually matter. However, few countries including India wish the moratorium to end this year after it lapses leaving the members free to impose duties on cross border data and electronic transmissions. 
There is no doubt that the consumers would be at the receiving end of any such tax/duty. But more importantly we need to analyse as to whether it would work in favour or against India. There is a successful IT and ITeS sector in India that depends on electronic transmissions. If we decide to impose tariffs on certain types of electronic transmissions, we may expect reciprocal taxes from partner countries on our types of electronic transmissions, and which might damage our competitiveness in IT/ITeS. The cost/benefit analysis therefore should go beyond mere 'revenue loss' mindset and should include the reciprocation effects. Software lobbies therefore oppose the move and present cogent arguments. Also, it's not easy to determine the methodology of taxation due to origin issues. The netflix videos that one watches on the mobile/computer/TV receives packets of data. These packets arrive from nearest possible servers which need not be located in one country. A typical HD movie might get millions of packets which may be served from eight different countries. To isolate the amount of taxation for each arrival would be methodologically complex. The complexity increases with characterisation of the data being transmitted. Some data can be called services, some can be IP and some transmissions such as designs might involve a royalty. Even if a simple methodology is developed to characterise the transmission and tax them, there are chances that firms may use routing protocols to minimise border crossings and taxes. 

India's unique placement

However, despite the above challenges, India's case is unique.  India is is one of the biggest importers of digital products using E-Transmissions as can be seen below. 
WITS database - Net exports of physical digitizable products 
The UNCTAD study has arrived at a potential revenue gain of around half a billion US dollars for India if India decides to opt out of the moratorium. The number projected as India's gain is greater than sum total of gains that might accrue to all developed countries put together if the WTO moratorium ends. Also, this number is unmatched by any other developing country and explains India's position towards ending the moratorium. 

Image of Potential revenue gain by ending WTO moratorium
Potential revenue gain by ending WTO moratorium
However, the above numbers are controversial and blamed for presenting only one side of the coin. In a paper, Hosuk-Lee and Badri Narayan argue that the potential gain through revenue collection through border taxation on these activities would get offset by the losses that would accrue to the GDP due to this taxation. They summarise the losses and gains as follows: 

GDP and Tax losses upon imposition of tariffs 
In short, they argue that a tariff gain of half a billion USD would lead to a tax loss of 2 Billion USD due to decreased GDP, decreased investment, welfare loss and loss in employment. These figures are for a scenario that the authors create where other countries reciprocate upon ending of moratorium. The authors also argue that there might be concomitant employment loss of around 12,70,000 jobs upon reciprocation. They feed in the indirect taxation into direct taxation issues of corporate profits and end up painting a bleak picture if moratorium ends. 
(On a side note, the paper feels too pessimistic to read and serves as an effective counter to the UNCTAD study.)
India needs to seriously do an independent analysis of the whole issue before pitching one way or the other. Relying solely on UNCTAD study might not be enough to take a call. 

The policy question on indirect taxation 

Therefore the correct question for policymakers in the area of indirect taxation should be: "Is it really worth to trade away the competitiveness of IT sector, employment, tax losses, and consumer welfare for a potential tariff revenue in terms of customs duty that appears so meagre to start with, and which is difficult to implement?"
The question is loaded in a way that it self-answers. But if you look at it carefully, the answer is: "It depends."

The direct taxation issue and the OECD's Unified Approach/GloBE under Pillar One/Two

Coming to the question of direct taxation, OECD, while making the final report in the matter of  'Addressing the tax challenges of digital economy' during 2015 stated that "because the digital economy is increasingly becoming the economy itself, it would not be feasible to ring-fence the digital economy from the rest of the economy for tax purposes." 
From that conservative view in 2015, OECD evolved its way through the interim report on the matter in 2018 and finally a policy note in early 2019 which in turn evolved into full discussions leading to a  public consultation document titled "Secretariat proposal for a 'unified approach' under Pillar One" during Oct-Nov 2019. Under this document,  the matter of taxing digital multinationals has been pried open with the idea of taxing them based on location of revenue generating users over the earlier principle of place of physical presence of business. This will disrupt the existing tax position and settled way of working for Amazons and Facebooks. 

Chiefly, the issues being dealt by OECD under Pillar One are: 
  • the allocation of taxing rights between jurisdictions; 
  • fundamental features of the international tax system, such as the traditional notions of permanent establishment and the applicability of the arm’s length principle; 
  • the future of multilateral tax co-operation; 
  • the prevention of aggressive unilateral measures; 
  • the intense political pressure to tax highly digitalised multinationals. 

The discussion hovers around:
  • reallocation of taxing rights in favour of users/market jurisdiction over the existing principal location of business for highly digitised businesses
  • The nexus rule that would be independent of physical presence in users/market jurisdiction
  • going beyond arms length principle currently in practice for related entities across borders

The matter is work in progress. 
However, what's noteworthy is that the three corner positions on Pillar One are clear. The first corner is of US which wants taxation based on market intangibles, the second corner belongs to France and EU which wants taxation based on user participation, and the third corner belongs to India which wants the new nexus principle wherein level of physical presence is ignored in favour of amount of business generated in a tax jurisdiction. The negotiations shall evolve over time and the three corners should reach a consensus point wherein a final unified approach evolves and agreed by all. 

The Pillar Two pertains to Global Anti Base Erosion Proposal (twisted to fit the short-form: GloBE) wherein rules are being discussed to avoid multinationals in digital economy from shifting bases and profits. This is a purely a taxation matter. 

Both WTO and OECD matters are coming to an inflection point with vigorous debates/discussions/activities. It would be interesting times for trade and tax policymakers while a new legal paradise gets created for lawyers. 

Dec 4, 2019

Bonded Manufacturing Scheme - The potential game changer for manufacturing sector

Government has tweaked the existing scheme of manufacturing under bond at bonded warehouses (Section 58 to 65 of Customs Act) and has come up with a 'Bonded Manufacturing Scheme' which might revolutionise the way manufacturing units are organised among domestic tariff areas, Free Trade and Warehousing Zones, Export oriented units (EOUs) and Special Economic Zones (SEZs).

The relevant customs notification (69/2019) on Manufacture and other operations at Warehouse Regulations 2019 is at this link.
Invest India (an arm of government that encourages investments in India through realtime assistance to entities to set up business) maintains a dedicated website for information dissemination on this topic at this link and the FAQs are hosted here.
Relevant Customs Circular (34/2019) that outlines the regulatory procedural details is at this link.

image for bonded manufacturing scheme
Bonded manufacturing scheme overview - [from Invest India's Bonded manufacturing website]
The salient part of this scheme is that one may import capital goods required for manufacturing without payment of import duty and use it in the factory/premises. In addition, all raw material/inputs required can also be imported duty free for manufacturing. If one exports, no duty needs to be paid on anything that was imported. Only if the finished goods are being cleared out of bonded manufacturing zone and into the local market, duties on inputs to the extent of consumption for the cleared products to domestic market needs to be paid. Also, there is no hassle or requirement of any net foreign exchange earning, or any need to export in order to fulfil some obligation against procurement of duty free capital goods, inputs etc.  This is good enough for most of the existing and new industries to move into this new scheme being promoted by Invest India group of Department of Industry and Internal Trade (DPIIT). You get imported capital goods for free, and pay duty on imported raw material/inputs only when you clear them to DTA, thus deferring the duties till you actually sell the products. Even for import, stock and trade business model (say an e-commerce company which imports and sells here), this model makes sense as duties are to be paid only upon sale. Upon non-sale the goods can be returned back. Only if inputs are procured from domestic market, GST is applicable (and credit taken) and which I shall deal later in the post.

image for Advantages of bonded manufacturing scheme
Advertised advantages of bonded warehousing
The advertised highlights of the scheme propagates the advantage of 'no fixed export obligation' and 'deferred duty' aspect.

image for Ease of doing business through bonded manufacturing scheme
Ease of doing business through bonded manufacturing scheme
The scheme also emphasises upon the procedural ease of doing business at bonded manufacturing zones.
While not stated in the website, the circular amply makes it clear that the intention is indeed ease of doing business and therefore no prior permission of proper officer is needed for clearing the goods each time. Also, self sealing facility of goods while clearing has been allowed. Therefore, a lot of trust has been reposed on the operating business.

What are the potential downsides?

- The zone is administered under Customs Act, and therefore the zone will be under total control of customs commissioner with the commissioner (or the designated officer under him) being the sole approving person, and point of contact for  business. Many domestic firms, especially smaller ones, might not be very comfortable with the idea due to legacy reputation of customs department.

- The Annexure B format that covers incoming and outgoing goods, along with details records of consumption, is tedious to maintain. The ERP system of the firm moving into bonded zones needs to be tweaked to align with this format as any error here would lead to serious issues. Maintaining these records digitally by inputting the details manually (say with a poorly designed excel sheet without cross checks) would be a dangerous assignment as any mismatch might attract penal actions. The Annexure is to be maintained digitally as per the notification.


Policy analysis 

The positives:

As a policy measure towards ease of doing business in India, nothing beats this scheme on paper. The EOU scheme (including EHTP, BTP etc) would become defunct, given all the license era obligations of Net Foreign Exchange earnings, limited clearance to domestic tariff areas etc.
SEZ policy too would be challenged as new units may reconsider bonding under this scheme over locating into SEZs.
The Foreign Trade Policy chapters 4 and 5, wherein exemptions of duties under Advance Authorisation(AA) Scheme and Export Promotion Capital Goods (EPCG) schemes are granted for procuring raw material/inputs and capital goods respectively, would also be rendered useless when units move to bonded manufacturing scheme. In fact, with no obligations on duty free import of capital goods, there is no reason now to go under EPCG scheme for any new units being set up. EPCG calls for myriad rules and obligations for exports whereas it's much simpler under bonded zone. It also frees the units from the standard input output norms which at times are tedious to align for new products and take time for fixing of such norms as the process involves the unit, local DGFT office, and DGFT headquarters at New Delhi. Under bonded zones, the input output norms are to be self declared, and any revision of the same has to be simply notified to the jurisdictional bond officer. As long as accounts are maintained, trust is reposed on the units to comply.
The scheme, as it doesn't link exemptions to any export performance, and being made available to all, is WTO compliant in nature.

The negative: 

The scheme disadvantages domestic manufacturers of capital goods and inputs as no exemption has been given to domestic suppliers for supply to these units. GST is applicable to supplies made to the bonded zones and credits may be availed against the same which may later be used when the bonded units supply goods to domestic market. However, not having an upfront exemption would tilt the choice towards imports, assuming all other conditions being same. This goes against 'make-in-India' spirit of the policymakers.

Conclusion

Overall, it's an excellent step as it gives a practical option for investors trying to set up new units. When read in tandem with the reduced corporate tax rate (from 25 to 15% for new units), this move may indeed attract investments into India. It also makes sense for existing units who are thinking of procuring imported capital goods in a significant number to get bonded under the scheme.

The scheme deserves to be advertised widely for better information dissemination.




May 12, 2019

The interest in free trade and related matters - a silent story from google trends

Google web-search is a rough indicator of the hotness/popularity of the topic.
Here's what you get for some of the words that this blog cares about, if you see the popularity trend in Google web searches across the world over last 15 years.

1. Free Trade

2. WTO
3. Free trade agreements

4. Tariff Barrier

5. Non Tariff Barrier

6. Trade war

7. International Trade

8. E Commerce 

Mar 24, 2019

MSMEs in cross border E Commerce – Challenges, Opportunities and Trade Facilitation Measures

MSME's and E Commerce

MSMEs currently contribute to around 40% of exports of India. E-Commerce is an area that has shown tremendous potential for growth, especially for MSMEs. It is so because MSMEs suffer from certain handicaps in traditional trade models, with regard to access and scale, that are ameliorated in an E-Commerce model. This post shall elaborate some of the challenges and opportunities that pertain specifically to MSMEs when it comes to E-Commerce trade across border before deliberating on the facilitation measures specific to MSMEs.


Data from Statista show that retail E commerce trade will grow to around 4.8 Trillion USD by 2021 – around two years from now. Around 30% of this is expected to be cross border trade through E-Commerce route. Data also shows that 82% of enterprises involved in such cross border trade are micro and small scale in size (definition of SMEs vary across countries/organisations). 


image of SMEs and E Commerce


Opportunities for MSMEs in Ecommerce

E commerce creates opportunities for MSMEs through 
a)     Easier Outreach potential 
b)    Easier Market Research
c)     Easier Reputation building
d)    Easier Marketing expenditures
e)    Development of ecosystems creating synergy

E Commerce brings a paradigm shift in terms of dealing in delivery time, warehousing concepts, customized production and social marketing. The traditional model of value chains are being broken up – for example, the evolution of shipping from bulk cargo to containers of last four decades is giving way to, what one may call, "parcelization" (there’s no such word as of now in the dictionary) where individual parcels - recall the amazon box parcel you got last time around – play the role of a unit of measure in transport cargo.   

Challenges for MSMEs in E-Commerce

The efficiency of logistics and cross border procedures are yet to catch up with the blazing speed with which E Commerce has grown. The volumes of E Commerce shipments are straining the existing logistics industry and associated business costs. 

E Commerce is also challenging border regulatory agencies and they have not evolved sufficiently fast to cater to the emergence of E Commerce. The customs operates with laws made decades ago with a priority on border controls and emphasis on duty collection over trade facilitation. 

Five types of trade costs associated for MSMEs in particular that challenge the faster growth of cross border E Commerce trade are: 

a)     Tariffs and duties
b)    Technical barrier to trade – standards that are rigged against SMEs
c)     Documentation requirements
d)    Border costs – fee/charges associated with border crossing
e)    Logistics costs – transport, insurance and warehousing costs 

The cost of delay at border clearances add up to the detriment of MSMEs, squeezing their competitiveness. 

Vulnerability of MSMEs in international trade

The vulnerabilities arise due to the fact that MSME's 

a)     Need more human resource to export per unit of revenue due to scale of operations 
b)  They Have limited access to financing and costlier financing when compared to bigger corporations with better access to credit. 
c)     MSMEs trades are usually categorized under high risk items under Risk Management Systems and are subject to greater border controls 
d)    MSMEs usually cannot afford high quality logistics operators to handle their shipment leading to sub-par performance on logistics front. 
e)    MSMEs usually export small volumes of low value added products leading to longer breakeven times for the firms. 

Trade Facilitation Measures for MSMEs in Ecommerce

Trade facilitation Measures should focus on MSME's needs if India wishes to grow in this area. The bigger multinational organisations have their in-house teams to manage supply chains and optimise the operations. Giant firms operate efficiently, optimise logistics, and involve themselves with policymakers to ensure that the border policies don't harass them. The bulk of these organisations ensure that Governments heed to their demands in the interest of earnings and employments that these firms bring to the country. That's not so when it comes to MSMEs. That's where forming associations for protecting interest of MSMEs become important. Without an association or representative body, it is difficult to hear the voices of MSMEs. 

Many countries approach the trade facilitation to SMEs through a system of de-minimis where customs duties are not levied for products with value less than a certain threshold. This encourages trade while sparing disproportionate efforts by customs in collecting what in the end adds up to a relatively small percentage of revenue. India has granted certain easier tax processing and compliances for small scale industries through the composition scheme. However, for inter state and export transactions, SMEs still don't enjoy sufficient freedom. While tax evasion is certainly an issue from revenue loss point of view, but if the revenue arm enjoys overbearing say in the area of taxation of SMEs, we may end up stifling growth. While the SMEs grow, it is better to let a small bit of revenue slip in the interest of higher employment and prosperity. This, alas, is an approach that appears lost in the din for maximisation of revenue in India. 

Also, schemes that are designed for greater ease of transaction at border, such as the Authorized Economic Operator (AEO) program - a program flowing from the Trade Facilitation Agreement of WTO -  are heavily skewed to help multinationals and bigger corporations. A rethink is required to make such programs suitable to MSMEs. 

Finally, the barriers to trade for MSMEs arising out of technical and non-technical barriers erected by various governments needs a look into. As world have negotiated away the tariffs, a common way to protect local industries is through erection of the so called Non Tariff Barriers (NTBs). The rise of NTBs in recent years has affected MSMEs badly. This has carried over to the E-commerce trade. 

To sum up, trade facilitation for MSMEs needs a paradigm shift in the way the border compliances and regulatory functions are designed. Unless addressed adequately, we may end up in a situation where the bigger organisations end up gaming the cross border E Commerce and leading to an unequal, non level playing field for SMEs.



Jan 31, 2019

Understanding beef-ban, prohibition and prostitution in India through repugnant market theory

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Bans are not always effective as we know. Gujarat's prohibition has lead to a thriving black market for liquor, whereas the ban on prostitution has held up relatively well in India with only a small steady state black market that has not grown bigger. Selling and consumption of beef on the other hand, where banned, has been effective to a large extent - to the determent of the health of cattle and leather industry - as was witnessed during recent ban on cow slaughter in Uttar Pradesh.

Bans are always blunt instruments. It is necessary for a public policymaker to study the effects from the prism of effectiveness of achieving policy objectives of a ban, over the negative externalities, and also lack of effectiveness arising due to administration issues. It is not that a stiffer punishment would automatically lead to desired outcome. To cite an extreme example, rape in India attracts imprisonment of 7 to 10 years. Murder attracts life term or hanging. If the punishment of rape is increased to life term or hanging, as was being mooted in media for cases of child rape, it might lead to adverse result where the rapist kills the victim as the punishment doesn't increase by the additional act of murder, whereas the killing of victim may eliminate the witness!

Such analysis may be grown rigorously. An interesting recent paper tackles such questions from a game theory point of view for market of repugnant transactions. Co-written by the noble prize winning author Alvin Roth of Stanford, it tries to measure repugnancy along two dimensions of extent and intensity and tries to predict the outcome of banned activities with certain assumptions on initial conditions and progress. In the words of the paper:

This paper proposes a simple, stylized theoretical model to help understand why some transactions can be effectively eliminated by legally banning them, while others are more resistant, to the point that they may be impossible to extinguish or even suppress to low levels, so that it might be wise to consider different goals for dealing with them.

The paper takes the example of drug market to develop the analysis. However, the results generally hold good across various examples including prostitution, banned meat trade and so on. An interesting result along the way is that the existence of a market before banning plays a role in the effectiveness of the ban subsequently. In the words of the authors: 

...Before beginning the analysis, consider how policy makers could have some control over the initial states. One example would be the regulation of synthetic drugs. When a new synthetic drug becomes available, it takes time before it can be banned. The number of users it attracts before it is banned may be an important factor for the prospects of extinguishing the market. So the speed of initial regulation may be consequential, and there may be markets that could be successfully prevented only by prompt action, and not when they have become well established...

I quote some of the analysis and results below: 


...if the market is insufficiently repugnant in extent or intensity, even substantial legal penalties “on the books” may be insufficient to deter participation if those penalties cannot gain enough social support to be reliably enforced. Note also that if the feasible punishment is not too large, and if the extent of repugnance among the population is low, then even the maximum intensity of repugnance among those who wish to ban the market may be insufficient to control the blackmarket. And as an illegal market becomes larger, it becomes more likely that those who wish to participate in it can do so without encountering those who would penalize them. Consequently, black markets that have operated successfully for a long time become increasingly hard to eliminate if the underlying social parameters and legal punishments cannot be changed.


But changing social repugnance, and even increasing legal punishments in an ef- fective way, may be difficult. Policy makers may be able to influence the extent or intensity of repugnance by education and public relations. But because legislators don’t have easy or direct access to who feels how much repugnance, this is not likely to be anywhere near as easy as passing legislation. At the very least, chang- ing widespread attitudes takes time. And increasing mandated punishments beyond what social repugnance will support can be counterproductive if it makes citizens less likely to report illegal transactions and juries less likely to convict.  So we may never be able to completely eliminate some markets, despite the fact that they cause considerable harm. Hence harm reduction should be in our portfolio of design tools for dealing with repugnant markets that we can’t extinguish despite the harm they may do.


Therein lies the lesson for a public policymaker. 

Jan 8, 2019

GVCs and the tariffs - a simple fact the free traders miss

A common argument of free trade supporters runs this way:
  1. Tariffs create barriers to movement of goods - India has high tariffs on various goods 
  2. Global Value Chains(GVCs) operate better with low barriers for movement of goods
  3. Therefore high tariffs are responsible for India's lack of integration into various GVCs
In principle the argument is correct.  For a graduate student who has completed a course on International Economics, the above argument is obvious. This belief carries over to the practising economists, and journalists who consult the economists. That's why we read a lot of criticism of the government when tariffs are raised - as they lead to breaking away from GVCs, or rather in India's case, not getting integrated into them.
A simple case where a duty of 10% is levied every time a component crosses the border in the journey through the value chain, where a value addition of 30% takes place at each step, leads to a situation where the prices build up pretty fast as can be seen in figure below. Starting with an initial value of 100, the component start showing significant difference in price by the time it crosses a dutiable border the third time, showing that a country with even a 10% duty at border becomes a drag in the value chain, and is liable to be opted out of the chain. Thus the logic holds.

image of GVC value chain tariff duty competitiveness
Effect of duty cascades with each border crossing making the duty levying participant uncompetitive in GVC

In practise the above argument is not as parsimonous. The argued tariff effect on GVC participation is exaggerated. Lest I be misunderstood, let me state here that high tariffs are always a blunt instrument to use and I am not a supporter of blanket high tariffs on goods, especially the ones that are part of GVCs.  However, the argument that tariffs at the border are sole reason for India not getting into GVCs is flawed. Here's why.

India, and most other countries, work under the principle that "Goods are exported, taxes and duties are not" when it comes to exports. One may call it by various names ranging from 'zero rating of exports' to 'duty nullification schemes', but the fact remains that policy practitioners all around the world understand this problem and devise means to counter this effect when it comes to goods that are re-exported with/without value addition. Such schemes also do NOT run counter to the Agreement on Subsidies and Countervailing Measures (ASCM) at WTO.

India has mainly three ways of handling such border crossings without penalising the imports that are meant for GVCs/re-export with/without value addition -
a) Advance authorisation scheme - a popular duty nullification scheme where duties are not collected at border with an assurance of re-export of goods with a minimum value addition of 15%
b) Duty free import authorisation scheme - same as above with a value addition of 20%
c) Dedicated duty free enclaves such as Special Economic Zones and bonded manufacturing zones such as EOUs.
I am aware of such schemes being run in many countries and there can't be any objection of these schemes at WTO. In addition, India also enters frequently into various trade agreements with partners where duty free access is provided.

I consider the non-tariff barriers (NTBs) more important than tariff measures which are countered through these schemes. In addition to NTBs, India also suffers from relatively poor infrastructure, longer distance and hence travel times, poor investment in industries, and lack of economies of scale in manufacturing sectors where GVCs are prevalent (e.g. electronics/semiconductors) and such other factors that matter more in GVCs than a simple border tax that the free trade theorists abhor.

The above needs to be kept in mind when we argue against a mere border tax effecting our chances at participating in GVCs. 


Excel workbook for the above picture is attached for reference below:

Dec 23, 2018

Ease of Doing Business and States export performance

Do business reforms lead to better export performance? Are there any other measure(s) that correlate with export performance by Indian states? We can measure merchandise export performance of states against Ease of Doing Business and also against the Logistics Ease Across Different States (LEADS) index for some preliminary understanding of the matter in Indian context.

India has a Business Reforms score that measures the individual states in terms of ease of doing business, on similar lines as that of World Bank's (WB) Ease of Doing Business (EoDB). This is to help identify the reforms required to make doing business easier. The score card - let's call it EoDB for the sake of the simplicity - is maintained for all states and union territories of India.

LEADS index is relatively new. It has been created on the lines of World Bank's logistics performance index and covers various states and union territories of India. The 2018 report prepared by Deloitte for ministry of commerce can be found here.

The below table (mostly self explanatory) of various states with their merchandise export intensity with respect to their GDPs is compared with LEADS and EoDB scores shows that there exists a stronger correlation with respect to LEADS and merchandise exports (correlation coeff. of around 0.65) and lesser with regard to EoDB (correlation coeff. of around 0.4).


Even visually, it can be seen that LEADS scores seem to better correlate with export performance over EoDB score. This may be primarily due to the inherent methodology differences. LEADS covers an important determinant of export performance - the ease of logistics.

One more figure to ponder from the LEADS report:

image of logistics leads eodb states india export performance
A better LEADS performance indicates better exports and better GDP - not necessarily causation but good correlation






Dec 15, 2018

November numbers for foreign trade - some points

The November 2018 numbers for India's foreign trade are here. The summary for April-Nov 2018 is as shown in the figure below:

image for India foreign trade statistics
Trade stats of India - Summary
At this rate, we would end up with an annual deficit of around 192 Billion USD, a significant jump from a deficit of around 162 Billion USD during last financial year.

The below are the numbers for last financial years imports listed in descending order of value of imports (excel online may take time to load).


The first item in the list, the mineral fuels and oils, is a necessary need as India doesn't produce any oil. Out of the imported crude coming under this chapter, we refine and export around 38 Billion USD refined petroleum products. Thus the net deficit is around 94 Billion USD. This is the fuel oil bill for India every year.

The second item in the list, the pearls precious stones and metal, mainly constitute of imports of diamonds and gold. India is the largest diamond polisher, and one of the biggest gold importer for domestic consumption. Under this chapter, India exports out around 42 Billion USD, bringing the net imports to around 32 Billion USD.

The third item in the list is worrisome. The import bill is around 48 Billion USD, and growing each year, and we don't have any significant exports in this chapter. The main imports under this chapter pertains to mobile phones and other consumer electronic equipments which contributes to roughly 25 Billion USD. The entire import is almost a deficit, making this chapter the second biggest net import item for India.
image of Mobile phone imports into India 21 Billion US Dollars
Split of major imports under Chapter 85 - Mobile phones contribute around 21 Billion USD

The fourth item in the list belongs to the capital goods, engineering equipment, and machinery where we have significant imports at around 38 Billion USD and exports at around 18 Billion USD. So the deficit is around 20 Billion USD.

Of the above, the urgent and important area for attention is the third item - the electronics. Despite efforts and incentive, this area is taking time to catch up. The efforts till now consisted of four noticeable steps:

- Incentives to invest in electronics through schemes such as M-SIPS
- Tariff barrier for completely assembled electronics imports
- Efforts to simplify policies for electronics sector
- General efforts towards ease of doing business

One wonder what more should be done, after missing out on the scaling up at the right time. A solution could be to think about the new technologies that would emerge in next 20 years and start investing early. The policy measures to support infant electric cars industry is bang on.

Dec 11, 2018

Dhaka Vs Ranchi - a post GST scenario analysis of apparel imports

Under the existing system of trade and indirect taxation prevailing in textile and garment sector, does it makes more sense for a Bangalore stockist of apparels to import from Dhaka in Bangladesh over buying from Ranchi? Here's the self explanatory calculation.

Assumptions: Bangladesh usually sources fabric from China while an Indian supplier sources fabric from an Indian supplier based in Gujarat/other states. I shall assume that the price at the factory gate of fabric manufacturer for both Chinese and Indian fabric is same - usually Chinese fabric is cheaper. The transportation cost from China to Bangladesh is same as that from Gujarat/other states to Ranchi - usually Chinese transport cost would be smaller. I shall also assume, for sake of simplicity that labor cost in Bangladesh is same as that in Ranchi, while a ballpark analysis tells that Bangla labor is cheaper by 40% over Indian labor.

(Excel online may take some time to load the table below - I shall be thankful and glad to correct any errors if pointed out)



From the above, it appears that Dhaka has a clear advantage over Ranchi despite adverse assumptions towards Dhaka.

Before GST, the IGST component paid at border was not refunded to the importer. That barrier was significant.

Did all this add up in the end? Did the imports really rise for apparels after introduction of GST? The below graph for pre and post GST quarters of import under ITC-HS 61 and 62 (apparels) from Bangladesh into India is self explanatory. The red tick is the point where GST was introduced.

image of apparel imports from Bangladesh into india
Apparel imports (ITC-HS chapters 61 + 62) from Bangladesh into India - Before and After GST


image of post GST rise in  imports after GST

Looks like Dhaka is indeed making sense over Ranchi and all other apparel cities of India.

Edit 1: Thanks Moin for pointing out the error in calculation. Rectified now. 




Nov 9, 2018

MSME support and outreach - The 100 districts 100 days initiative

On 2nd November 2018, the Prime Minister of India launched schemes for Micro, Small and Medium Enterprises (MSMEs) which he termed as the Diwali gift for the hard working honest entrepreneurs of India. It was termed 'Support and Outreach' initiative for MSMEs. The initiative was launched for 100 districts to be continued for 100 days. 

MSMEs are important for the growth story of India. There is no certain way to measure the number of MSMEs. The numbers given out by various agencies varies from 60 million units (CII) of operational MSMEs to 120 million units (NSSO). They are supposed to contribute around 7% to the GDP through manufacturing activities (share of manufacturing in GDP is around 26% in India), and 25% to GDP through services (share of services in GDP is around 58%).  MSMEs contribute around 40 to 45% in total exports from India based on various reports. This number too has unsure origins. Nevertheless, even with the data inaccuracies, there is no doubt that MSMEs contribute in a big way as these cover all the mom and pop businesses in the economy. The unfortunate part is that they are not adequately covered under the Goods and Services Tax (GST) and therefore we cannot expect the GST returns to cover them for raw data purposes.

The prime minister launched the so called twelve initiatives to support MSMEs in India, and termed them as his Diwali gift to the MSMEs. It is a known fact that demonetisation and GST has adversely affected this sector and given the approaching elections it was important to address this issue at the earliest. In addition, the credit squeeze the banks are facing in the light of Non Performing Assets (NPAs) hitting the balance sheets is hurting MSMEs the most. However, what came as a surprise is that none of these initiatives, barring an interest subvention and some ease of procedures, adds anything significant to the lives of MSMEs. Interest subvention is a kind of subsidy and any subsidy is a sure shot political winner at any point of time, albeit at a great cost to the taxpaying public. However, what's moot is how much these initiatives would actually help MSMEs in surviving the downturn and actually grow.

image of MSME support and outreach
MSMEs support and outreach - 12 Diwali gifts


The most celebrated of the initiatives was the 'loan under 59 minutes' scheme where MSMEs would get 'in-principle' approval for loans under 59 minutes when they apply through a dedicated web portal (www.psbloansin59minutes.com) developed for the purpose. This portal works by linking the MSMEs with the GST portal and bases its credit worthiness on GST returns, income tax returns on owners, bank statements of last six months and other KYC details. MSMEs who file regular GST returns and have good income tax return profiles of the owners constitute a small minority among the MSMEs. This minority never faced credit crunch in the first place. So one wonders which MSMEs pain is this initiative trying to ease. And the in-principle approval by the public sector bank is only 'in-principle'. One still has to visit the bank physically and submit all relevant details in paper form again to the bank for final approval which would take more than a week. The pain lies in the approval process. Given the credit squeeze the banks are facing, and the fear of enquiry the bank managers face if a loan goes bad, the banks shun lending to anything even slightly risky.

While not entirely new, some initiatives are laudable. Various clearances such as separate water and air pollution clearances have been merged into one, and this can be now based on self-certification for a majority of MSMEs that don't fall in hazardous material zone.  Also, the bill discounting through TReDS platform, which is in place for more than a year, is also a good move.

Overall, while there was nothing new in the announcements apart from the interest subvention, the PM did a good job in enumerating the steps taken towards ameliorating the pains of MSMEs.

I was one of the officers in my area who was given the task of inviting the MSMEs to come and listen to the announcements being made for them through video conference. A union minister was also deputed along with a senior officer from Delhi to overlook the preparations. The convention hall was filled up with bank employees (banks were the main coordinators for the program) and random public who were hauled up in the last minute to ensure that the hall doesn't look empty. As the video conference began, the snacks arrived, and with it most of the public vanished. By the end of the announcements, there were only few rows of bank employees, government officials, and a few uninterested press reporters who were left. Of course, there were some MSME owners among us who wondered what's all the fuss about.




Oct 18, 2018

The mid year review of Foreign Trade Performance of India

India's financial year is counted from April to March. That makes it out of step from regular calendar year followed at most places. The September numbers for foreign trade is here. So that makes it a half year data being available for this financial year. The brief summary from the official report is as follows:

image for India's foreign trade statistics
India's foreign trade summary - April to Sept 2018

Imports over the period has grown faster than exports of merchandise and services. To that extent, the trade deficit worsens. What is noticeable is that even in services, the trend is following merchandise in terms of imports growing faster. India maintains an overall services surplus of around 70 Billion USD per annum that helps bridge the merchandise trade deficit of around 200 Billion USD (other gap-filling coming through various forms of capital flows).

Since 2013, when the exports last grew significantly, we are stuck in doldrums in the range of around 300 Billion USD exports. The government has exhausted all traditionally available means of cajoling exports to grow. The exports has simply not grown. Also, the constituents of exports have also not changed significantly. As I predicted, the weakening of rupee has not made exports grow; it takes more than a year before weak currency effects starts to show on actual trade.

I have a feeling that we squandered away the recent good three years of global export growth wave when many countries saw their export boats getting a lift. Demonetization and lack of sensitivity towards exports while launching GST were two contributing factors, apart from credit squeeze in Indian market.

Meanwhile, we are approaching headwinds in exports, or rather, international trade and growth in general due to:


  • Trade appetite wane in general, trade wars, losing significance of WTO and its appellate mechanism
  • Out of sync monetary policies in US (tight) and other countries (loose) leading to dollar appreciation and its spillover effects which will wash ashore everywhere in next 6 months to a year
  • Possible financial recession, it's been a good ten years now since the financial crisis. The trigger could be anything from Italy's budget, Saudi Arabia/Iran/Middle East, US/China tensions, Latin America, or even a botched up Brexit. 


Here are the items that grew in terms of exports and imports during September.

image for Commodity export growth India
Commodity groups showing positive growth in exports during September

image for Commodity import growth India
Commodity groups showing high growth in imports during September




Sep 12, 2018

NAFTA Rebooted - some points

How do you stop the President from tearing up a trade deal. As per Bob Woodward in his new book Fear:Trump in White House, by simply pulling out the signing paper from the desk. The President simply forgot that he had to unsign the NAFTA deal, or rather sign a NAFTA withdrawal (someone please do that for RCEP in India). While the deal break never happened (or engineered to not happen), the revised onerous negotiations on NAFTA wound their way to give the world a glimpse of what makes the US President happy when it comes to trade deals. Mexico has hammered out a deal that's acceptable to the US President. And going by the look of it, Trump loves trophies. He got his wall sponsored. Well almost. Canadians are still thinking, and bargaining. 

One can understand the Canadian negotiators' dilemma. There's noting on the table for Canadians if they sign. But if they don't, they have things to lose in trade and economic growth. US is their biggest trade partner with more than 3/4th of Canadian exports headed to USA, thanks to NAFTA and friendly border compliance procedures. They also import more than half of all their import needs from US. Of particular interest is automobile trade that makes almost one fifth of the total trade between them. This would change if NAFTA changes. 

Automobiles are interesting in NAFTA. NAFTA changed the way auto majors operated in north American market. Auto components shuttle across NAFTA borders around 7 times on an average before coming out inside a car. Many carmakers shifted assembly bases to across border Mexico where wages were cheap, almost tenth of that in US. I had blogged earlier about the preposterousness of Trump's demand to have the cars assembled by workers who earn atleast 16 USD per hour (Mexican assembly workers earn around 2 USD per hour). I thought that's a deal breaker. I was wrong! Trump has pulled it off in the first round as Mexicans have agreed to the condition of more than 40% of final assembly to be done by workers earning 16 USD per hour, and for the condition that the share of USA in car components to increase from almost 60% currently to 75% after the reboot of NAFTA. If that jacks up the car price by a thousand dollars, so be it. It's an 'America first' world after all. 

It's not that Canada is not warming up. Their dairy sector is thinking of opening up for US imports after years of resistance from Quebec farmers; Canadian dairy sector has protectionist tariffs that would put India's dairy product tariffs to shame. The investments in Canada are already taking a hit due to uncertainty around NAFTA and due to the revised corporate tax rates in US.  At this time, Canadians seem to focusing too much on dispute resolution mechanism, the chapter 19 of the deal, that shouldn't bother so much during normals times; but given Trump's record at WTO dispute body Canadians are right to try and play safe here. Given the overall loss Canadians stand to suffer if the deal falls apart, it won't be a surprise if Canada decides to play ball after all.

There's time till September end to strike out a deal and make the rebooted NAFTA a union of original three. Otherwise, going Trump's way it would be a bilateral US-Mexico deal, on Trump's terms. Well almost.