Jun 14, 2012

Banning second hand capital goods, the policy perspective

There was an article in the Economic Times today, regarding India mulling about banning imports of second hand plant and machinery, basically capital goods. You can read the full article here. It says:

A panel headed by cabinet secretary AK Seth has decided to ban import of machinery more than five years old. "The big worry is that such imports would impact overall productivity and erode competitiveness of the manufacturing sector," said a government official privy to the development.

The domestic capital goods industry says imports are partly responsible for the drop in output; a contention supported by government data that showed production of capital goods contracted 4.1% in 2011-12.

and about the current situation of usage of such goods, it says:

The usage of second-hand machinery is high in certain sectors. For instance, industry estimates show that use of second-hand shuttleless looms constitute about 80% of equipment purchases in the textiles sector.

While the share is 40%-45% in the case of machine tools equipment, it is a high of about 80% for construction equipments such as cranes.

The current foreign trade policy of India allows import of second hand capital goods under para 2.33 as reproduced below:

(a) Import of second hand capital goods including refurbished / reconditioned spares, except those of personal computers / laptops, shall be allowed freely...

This issue is interesting because you can have good arguments from two opposing sides. 

The people who want the ban  give the following arguments (you can also see the CII report here for more points). 
  • Infant industry argument, that our domestic capital industry needs time to mature. 
  • Second hand goods are of lower technology (as they are older and not from the latest generation) 
  • They are less energy efficient
  • We lag in technology up-gradation of our production industries due to usage of these old machines. 
  • Such imports kill our local capital goods industry. (This is basically due to low cost Chinese capital goods that are increasingly flooding India markets. How Chinese keep it low-cost is a different story that will be discussed some other time)
The points seem repetitive, but they all work in tandem to build up the argument of ban supporters. 

The opposing parties give the counter arguments:
  • It is against free-trade principles
  • Our domestic capital goods manufacturers are not able to meet the demand
  • The domestic CG manufacturers don't have the technology to make such machines, even equal to the ones that are supposedly old and second hand. 
  • If a ban or heavy import duty on second hand CG is levied, then our production ability would suffer esp in sectors like textile that rely on such captial goods. They cannot afford costly new capital goods, especially when they are to be imported. 
  • Second hand goods need not mean worn out goods. They can be decent machines of three or four years old that are of fairly good technology. 
Our domestic ability to produce quality capital goods (as per industry requirements) is poor. You can read an interesting report prepared by PwC titled Global competitiveness of Indian Capital Goods industry. As per the report, the Revealed Comparative advantage of our industry is poor, when compared to the countries from where  these goods are being imported. 
However, RCA cannot tell the complete story, and the report goes on to list the factors that has lead to lack of competitiveness, and what steps needs to be taken. DIPP has hosted this report on their server, and I hope that means that they are working on it. 

I was looking at the New trade theory (by Krugman and others) which actually supports a view of protecting domestic infant industries. This part by Korean economist Ha-Joon Chang was interesting:

Japanese companies were encouraged to import foreign production technology but were required to produce 90% of parts domestically within five years. It is said that the short-term hardship of Japanese consumers (who were unable to buy the superior vehicles produced by the world market) was more than compensated for by the long-term benefits to producers, who gained time to out-compete their international rivals.

Your blogger has presented the points. The readers can draw their conclusions. 

Jun 8, 2012

Foreign Trade Policy Reloaded - The blogger's review

The FTP annual supplement is out. It's 3 days since and your blogger was going through the details. It took time as the entire policy document and procedure handbook was revised and updated, and the annual supplement was incorporated into it. The two manuals ran into more than 300 pages. It was a good move, as there were hundreds of notifications and couple of annual supplements that had come since the last time the policy and procedure manuals were released. So, the manuals were to be read along-with these notifications and supplements. The new manuals are now up to date, and include the current annual supplement. 

Now, the review about the latest annual supplement and views. You can read the official highlights here.

The good points:
  • You can read some good points from news sites here, here and here
  • Overall, the policy supplement was better than expected and is being welcomed by exporters and consultants.
  • Additional incentives were announced in focus market and focus products. Some markets and products are added. 
  • Added thrust to green technology in form of incentives.
  • North eastern industries to be incentivized under chapter 3 for export promotion.
  • Interest subvention scheme of 2% continued for another year. Some additional sectors added
  • The duty scrips earned through exports can be used for paying excise duty. This is to give a boost to local manufacturing. Till now, these scrips could only be used for paying customs duties while importing. 
  • 0% EPCG scheme reintroduced to help upgrade the technology. Post exports EPCG introduced.
  • Handlooms, handicrafts and Gems and Jewellery, leather and marine sectors to get additional focus.
  • Electronic and IT hardware will be incentivized under Focus Product scheme.
  • Procedural simplification at places like chapter 5 for EPCG. 
  • Chapter 4 procedural simplification for advance authorization. 
  • Couriers and e-commerce brought under exports benefits.
  • Introduction of e-Bank realization certificate, which will be made mandatory next month onwards. This is one additional step towards paperless office. 
  • Introduction of ITC HS based import policy search on DGFT website. Key in the HS code and you get the import policy for that item. 
The bad points:

There is nothing bad as such in the policy document or intent. However, it fails to get the big picture of trade and its promotion. As has been pointed out, it's not an incentive here and a procedure there that is holding up exports. Most of the exporters have a margin that is way above the additional percentage point of incentive that is provided. The review discusses it in detail below. 

The review:

Export performance cannot be seen as a standalone entity that responds to bare incentives. Other factors such as a vibrant industrial base, infrastructure base like ports and roads, the procedural simplifications, and policies that create a trade friendly environment etc, influence export performance in a big way. These enabling factors, in tandem with the human resource, create a competitive advantage in international markets. The human resources, in turn have their feeder enablers such as education, health and family welfare. An economy with slow growing industrial base, suffering from poor infrastructure problems, cannot be expected to deliver great export performance in tough global conditions. 
The trade policy making appears to have zeroed in on the incentives as the most important way of boosting the exports. This view needs some rethinking. Is export performance really a direct function of increasing incentives, in the way the trade policy makes us think? If yes, is there a way to find out as to where the marginal returns of such incentives start diminishing? And are we doing the required number crunching to arrive at the optimal allocation of incentive funds, to those sectors that have the maximum impact on exports, if that is the goal of incentives. The distribution of incentives for the cause, be it employment generation, capturing new markets, export product diversification, or capacity building should be supported by background research. In order to determine the effects of such incentives on exports, one needs to have good data at sectoral levels, on export performance, and link it to incentives. A good amount of research needs to be done to link incentives to export performance in order to justify them. There is a serious lack of such studies in India. In the absence of good data and studies, incentives just boil down to doles handed out to lobbies that bargain hard.
It is not the job of trade policy to address all the enabling factors such as infrastructure and industrial base. However, the trade policy should go hand in hand with other policies that are closely linked to its success. A few measures in the trade policy, in a standalone manner, to help manufacturing sector or infrastructure, are not going to change things. The incentives on export performance can only be the last measure that boosts the exports by giving them an additional edge in international markets. Even then, they need to be targeted towards the sectors that can maximize the results, based on back end research. Incentives cannot be the starting point for boosting export performance. This is not to say that the current policy is out of place. It is just that, the need of the hour is to look at the policy making in an integrated manner, given the challenges we face.

Jun 4, 2012

Waiting for the foreign trade policy

Tomorrow, on June 5th, the honorable Minister of Commerce will unveil the annual supplement to the Foreign Trade Policy. I keep my fingers crossed and I pray for some creative measures to boost exports. I wonder what measures would I take if I was the chief consultant or something like that to the minister. To put things in perspective, the key points in current scenario while making the policy are:

  1. A merchandise trade deficit of more than 180 billion USD.
  2. An increasing gap between exports and imports year on year, with imports showing highly inelastic behavior. 
  3. A decreasing global demand for our exports, with no signs of turnaround anytime soon.
  4. The real/perceived policy paralysis and lack of confidence in the markets. 
  5. The threat of loss in employment if growth (including trade) suffers.
  6. The exchange rate that is deteriorating, which on surface, seems to be helping exporters, but makes the imports costlier putting further pressure on Current Account Deficit, which is already hovering towards 5% of GDP.
  7. Incentive schemes that somehow seem to fail to make the exports grow faster than imports.
  8. The services exports that are doing reasonably well as of now but are difficult to predict in future.
  9. The challenge of expanding export market to new destinations and diversification of export products basket.
  10. Generation of more employment through exports and earning more forex. 
So those are some of the points that might be on the minds of people making the policy. There is no simple answer that can balance and meet all expectations. The export promotion bodies would have made their pitch in the last couple of months, the industrial bodies would have tried turning the right levers in the administration and the administration itself would have tried to strike a balance between the budget outlay and the balancing of all interested parties. 

So, yours truly waits, to see what comes out. Given the situation, a regular approach of 1% incentive here and 2% there, would not work. A creative approach is required that can bring on a paradigm shift about how we think  about foreign trade policy. I shall write my review once the policy is out. To be on record, all views expressed are strictly personal.