Dec 30, 2014

Peak Trade and Make in India

For the past few decades, upto the financial crisis, international trade grew at a rate of around 7% a year, which was almost double the rate of growth of world GDP. Post financial crisis, the trade growth was sluggish, and for the last couple of years it has grown at around 3 percent, lesser than the pace of world GDP growth. In terms of trade to GDP share too, the world trade rose from around 40% of world GDP in the early 90s to peak at around 61% in 2011. It has now fallen to around 60%. This had lead to the theory that the world trade has peaked.

Paul Krugman doesn't agree. He says that trade outgrowing GDP is not a natural law and we should neither be amazed nor disturbed if it stops happening. Some other economists chime in saying that it might just be a cyclical phenomenon and not a structural shift. However, there is good amount of evidence that the international trade growth, as we know it, has indeed peaked. And the reasons are structural and not just cyclical. That's a cause for concern for countries like India that are thinking of giving a push to the manufacturing sector, with a significant outward focus. Krugman can afford to the dismissive as his country is the biggest market for the world. We can't.

Coming back to peak trade issue, the long term trade elasticity to income has decreased when compared to the 90s. A rise in 1 percent in global income would have lead to around 2.2 percent of increase in world trade in the 90s, but it hardly lead to a growth of 1.3 percent in the 2000s. This has fallen further after the financial crisis, indicating a deep structural shift, in the sense that the responsiveness of income growth to the growth in international trade has somehow derailed from the traditional way it behaved for decades.

There might be several reasons for this, but the most plausible one is about the global supply chains getting saturated. Especially the supply chain trade between China and the US, the main drivers of international trade, apart from EU.

During the 90s, there was a rapid expansion of global supply chains that took place. China was at the centre of it, including some east asian economies. The parts, components and such intermediates trading across borders rose significantly. There was also the WTO deal that acted as a catalyst in the process. The phenomenon continued for almost couple of decades. This has run its course and now we see that the process has peaked. China has slowly reached a stage where it's domestic contribution has increased significantly and has plateaued. In short, whatever integration had to occur, has occurred, and there is not much scope for further integration, in the existing merchandise trade area. This, is just one of the reasons.

Other reasons, that might be contributing are the compositional shift in the share of world trade that is slowly shifting towards services, such as software and information technology. Also, there are theories that countries have erected non tariff barriers and other protectionist measures after financial crisis. However, to me, the theory of global chain saturation tops the list, for the simple reason that it appears to explain the general observation better.
For those interested further on peak trade topic, this IMF paper discusses the Peak Trade issue in detail.

It is in this context that we need to strategise carefully about "Make in India" initiative. There is no doubt that we need to launch such an initiative to give a fillip to our manufacturing sector. And also to focus attention on the bottlenecks that hold back India's manufacturing potential. However, if we are thinking of making one more China out of India, it is time to think as to where all the demand for our made in India stuff would come from. The RBI governor probably had this in mind, when he spoke about an inward looking manufacturing policy.

However, all is not bleak even if we decide to force an export led manufacturing growth story. Probably, the new deals at WTO, specifically the trade facilitation agreement concluded recently and the future IT agreement might give a boost to the international trade, leading to some gains. Also, EU might recover eventually. Some more areas for trade, such as farm and services might open up further. And so on. However, to hinge the hopes on international developments is risky. And that's reason enough to focus on what can be done in the existing situation where the international trade has supposedly peaked.

I believe that Make in India campaign should focus on few things when it comes specifically to international trade, to start with. (notwithstanding other never ending suggestions on improvements in other areas such as labour productivity, capital, land, credit and so on which are general in nature). One, to see if we can integrate better with the existing global value chain setup. For example, we are non existent in electronic hardware supply chain, one of the biggest areas that we lost out due to poor policy making.  Two, our ports and supportive infrastructure are shoddy, cutting us out of world markets as ships avoid calling directly, leading to transhipments through Singapore, Dubai and even Colombo. Third, the paperwork and bureaucratic procedures related to international trade in our country is cumbersome and frustrating.
Any effort to send our manufactured products in international markets should focus on the above issues. I didn't mention quality of our products as there is an automatic market mechanism in place to punish bad quality products and Govt can hardly do much about it anyway. So the effort should focus on policies to catch low hanging fruits of global value chains like hardware manufacturing, improving infrastructure for international trade, and easing trade procedures.
This would ensure a better integration in the existing setup, and keep us ready when, and if, the world gets ready for another peak trade in future.

Dec 29, 2014

Professional Integrity in public positions

Jonathan Burrows was a managing director at Blackrock, a giant asset management firm. Though he earned a million pounds salary, he avoided paying around 14 pounds of rail fare for daily commute in London, and instead chose to dodge ticket barriers. His total fare avoidance added to around 43000 pounds over five years.
He was caught one day. He not only lost his employment, but was also banned from the financial industry altogether by the regulator in UK, viz. the Financial Conduct Authority. You can read details on the specific event here
There was no direct link between how Jonathan behaved in the office (his record in office was impeccably clean), to his fare avoidance behaviour outside it. However, Jonathan committed the dodge knowing well that it was unlawful to do so. And that is what the FCA was not happy about. In a terse statement FCA said, "Jonathan's actions fell short of standards we expect in the financial industry." Jonathan handled public investments and his integrity of character was not beyond doubt, prompting the ban by the regulator.

In  positions that handle public affairs in the government, the official chosen should muster a pass in the test of integrity of character. Unfortunately in India, neither the current method of selection at UPSC, nor the subsequent annual appraisal reports of the officers check this aspect. UPSC doesn't do any kind of psychometric tests while selecting the candidates, and instead relies on rote learning and mastery of obsolete theories, which might not have any relevance in assessment of character or the functions in day to day activities of public officials. Once in the govt job, the integrity column in the annual appraisals of officers are usually filled will mumbo-jumbos such as "Nothing adverse has come to my notice." Also, the vigilance actions and departmental enquiries leave a lot to be desired as they can be misused to harass an honest officer.

In the absence of any guidance in the matter, it becomes difficult to weed out people with loose morals from reaching top levels in the administration. Any level of competence cannot justify a lack of integrity of character. A society that accepts this without protest will suffer longer than usual. 

Nov 30, 2014

TFA deal at WTO - A victory for India?

I had blogged earlier about the matter regarding objection of India to sign Trade Facilitation Agreement(TFA) at WTO, as agreed at Bali ministerial. India has now agreed to sign the agreement as I had predicted in that post as one of the likely outcomes. However, when I see what is being signed, I wonder if it was worth to take the fight to this level. There is hardly much change, as far as I understand, from what could have been signed then, and what is being signed now, despite what our media projects as a great victory without any compromise. 

India's objection to TFA was linked to following issues:

  • that Agri negotiations (on public stockholding for food security purposes) are not going at the expected pace and direction. As Agri is part of the package, there is no meaning in signing only one part of the package, i.e. TFA, while the other part, i.e. Agri negotiation, is still in its infancy at the table. 
  • Specific inside the Agri negotiations, India had various issues, from the method of subsidy calculation, the base year taken as reference, the agreed cap on acceptable subsidies, and so on. These issues would take time to resolve and India wanted it to be fast paced. 
  • There was a peace clause in the agreement that lasted till 2017 and India was not happy with this, as in the lack of an agreement by 2017, one was not sure if the peace clause still holds. 
  • TFA being a bargaining chip, there is no point in throwing it away without getting some returns  at Agri negotiations. 
  • Indian farmers and poor developing countries would be adversely affected. 
At the same time, India had no objection to TFA text as such. Despite what the commerce minister of India claimed about the support it got on the above points by other LDCs or developing nations, there was absolutely no vocal or visible support.

After the visit of US Trade Representative Michael Froman earlier this month, India and US had resolved the differences, though not many details of it were shared with the media. 

And on 27th November, the TFA was agreed by all WTO members, with a "peace clause" in perpetuity for developing nations till an agreement on agriculture is finalised. The details on the peace clause is reproduced from WTO site below:

On 27 November, the General Council adopted decisions that would allow the trade facilitation text to go ahead, clarify the public stockholding proposal and allow work on it to continue and allow a programme for completing the Doha Round negotiations to proceed, almost six months later than originally envisaged.
On public stockholding, the “peace clause” was confirmed, but the way it was described was now firmer: members would “not” challenge these programmes legally under the Agriculture Agreement — the original decision said they would “refrain from” doing so. The conditions also remained unchanged: Governments seeking the shelter of the peace clause had to avoid distorting trade (ie, affecting prices and volumes on world markets) or impacting other countries’ food security, and to provide information to show they were meeting those conditions.
Members clarified that the “peace clause” would remain in force until a permanent solution was agreed, even if that meant going beyond the 2017 deadline. Although the reference to the 2017 Ministerial Conference remained, members also agreed to strive for a permanent solution by the end of 2015.

And the reading of above text is both heartening and disappointing. Disappointing because:
  • India, it appears, is ready to sign TFA without any firm assurance on Agri negotiations. A dilution from its earlier stand that without Agri, it won't give away TFA. Bargaining chip, Indian farmers, and concern for poor countries were all silently relegated under for unknown reasons.
  • Peace clause, though extended perpetually, is still challengeable under the guise of trade distortion or impacting other countries and such, as implied from copied text above. 
The heartening part is small. India could get the word "refrain from challenging" converted to "not" challenge when it comes to agri subsidies. So that means, others countries who would earlier "refrain" from challenging India's food security program, would now "not" challenge. Go figure. 

My point is simple:

If this is what India wanted, I don't think there would have been any objection during July. We could have had TFA much earlier, and avoided the chest thumping drama that Indian media creates every time India takes a stand at international level, stupid or otherwise, to support the stand. 

I am happy that we are signing TFA. Its needed urgently in India. 

Food security in India, as I understand, is in bad shape due to mismanagement and inefficiency in public administration and domestic policy making, than any capping clause arising from international agreements.

Nov 28, 2014

Gold import control goes

I had blogged about the matter of controlling gold imports into India initially here, and then here when RBI relaxed the controls to include star export houses. Now the RBI has cleared out all such controls through this notification, and gold is free to be imported, after payment of required customs duty which is around 10 percent. 


1. Alarmed by rising current account deficit and rising gold imports during early and mid 2013, RBI, in consultation with the Govt., used provisions of FEMA to bring out a circular to curb gold imports during August 2013. Some supplementary circulars were later on issued to clarify the matter, effectively making it clear that no one, including banks, could import gold for domestic sale. The language of the circular effectively led to a ban on import of gold. 
2. This resulted in significant decrease in import of gold into the country. However, the gold imported for export purposes was out of purview and such gold was still being imported, to be exported later on. 
3. There was an artificial price distortion in Indian domestic gold market due to this. Smugglers invented ingenious ways to bring gold into the country. The policy of wait and watch continued till elections got over.
4. RBI brought out a circular, in late May 2014,  partially relaxing the gold imports to include star and premier exporters (with more than 2500 crore turnover over last three years) leading to a surge of imports by such big exporters. This partial relaxation lead to windfall chance for such established big exporters, as they alone were allowed to import gold into domestic market while all others were not allowed to do so. This was as good as allowing a quota to these few exporters, while shutting out all others. At the time of issue of this partial relaxation, there were hardly four or five such entities in the country who could qualify to gain from this arrangement. 
5. Today, RBI got out of all such controls on gold by issuing the latest notification. 

This would not have been a blog post, but for the timing of this announcement. 
RBI is getting out of such controls at a time when the gold import has surged significantly. In fact, during the month of October 2014, the gold imports surged by more than 250% over last year, and there were some concerns about this rise in gold import. In fact, a senior in RBI was quoted just last week saying that RBI is thinking of bringing in more controls to curb gold imports. That's why this move is significant. 

However, I believe that somewhere, sane forces prevailed over control masters when it came to making this decision. I reason thus:

  • First, there is no need to feel concerned about y-o-y increase this year as there is base effect in play. Last year this time, we had tight gold controls in place. Any relaxation shows up as a spike naturally. 
  • Second, gold imports are price inelastic in India. 
  • Third, such full and partial controls helps none but smugglers and a closed group of big exporters. The price distortion in market due to such controls leads to additional incentive to such elements. 
  • Fourth, we are in a relatively comfortably position when it comes to current account deficit and rupee stability. 
  • Fifth, it was a policy nightmare to understand and practically implement schemes such as 20:80 that these circulars mandated. It lead to inefficiency, corruption and crony capitalism, and not to mention overtime work for customs and DRI which went after smugglers, with mixed results at success. 

In light of above, I laud RBI, and the Govt that it probably consulted. 

Oct 19, 2014

Ease of doing business - Ease of filling forms

I got a mail from the NSDL about the national insurance repository, using which, I can hold all my insurances in the demat form, rather than having it in paper form. The initiative sounded attractive enough for me to explore. When I visited the page, the sheer volume of work that the required forms generated, including proofs etc, put me off and I postponed it for some other day. I had the option of continuing with the existing way of managing insurances, but it is not so when it comes to thousands of other forms that businesses and citizens cope with. 

The doing business report for 2014, released few months ago, has generated a lot of heartburn and movement at the Govt. India was placed at 134th position out of 189 economies, down 3 ranks from last year. The split up of ranks under various heads is as below: 
World bank Doing business report - 2014 - India

Some govt. departments went into denial mode. Mainly the commerce ministry which contented the rank under the head 'trading across borders' and declared it wrong. India was placed at 132nd position. The ministry officials went on overdrive to collect their own data to contend the ranking. 
After some time, the govt came up with an overall two pronged strategy to improve ranks, with the help of states. The link here talks more about it. 

It is good to note that there are efforts in the right direction. However, there is one initiative that needs to be undertaken. And that is to simplify the forms. 
In the above case of demat insurance, the NSDL asks three proofs with the so called simplified form. A date of birth document, a KYC document and an address proof. Why can't we go with self declaration in such cases. I can't think of situation where someone tries to fudge their details or give wrong ones. This is just a repository of insurances and there can't be multiple claims on a single unique PAN number. And if someone is out of cheat for whatever reasons, all the above documents can be fudged easily. In short, the system is not fool proof, yet, harasses genuine applicants. 

I must add here, I had picked up the above example on random, the mail came yesterday. One can see any govt. form for that matter. Typically it would involve supplying proofs for everything you mention, right from your birth date, to your residence and so on. And attesting signatures on each of them. And a standard declaration that everything you have declared is correct and you are liable if something is wrong. And such. 

One broad initiative to simplify such nonsense would go a long way. I like the income tax saral form for that matter. Most of the tax paid details are linked to the PAN already, and one just has to fill up the income details. As far as ordinary salaried taxpayer goes, it is quite simple, except for the last part in which one has to take a paper printout, sign it and post it, again with the standard declaration, that I, the wife/son of so and so, solemnly declare (solemnly? seriously?) that all the above is right and such. 

Entire machinery of the state is full of such forms. Hundreds and thousands of them, asking for proofs, and creating new files, that take up space, and make the system inefficient. What gets my goat is that many so called online forms, ask me to fill it online, take a print, sign it, attach all the proofs, with the photo, and send it to the department by post or hand it on the reception counter of the office.

I am all support for linking everything related to a person through a unique ID such as aadhar, similar to the social security number system in US, and make all the forms begin by quoting this number, making most of the current queries on the forms redundant. 

I hope we launch a drive to ease the process of filling forms. "Saral forms abhiyan" anyone? 

Sep 4, 2014

The quixotic quinquennial Foreign Trade Policy making

The new Foreign Trade Policy (FTP) of India will be released anytime soon. India's FTP is quinquennial in nature. It undergoes major revision every fifth year. The last one was the FTP 2009-14. The new one will be for the period 2014-19. Every year, a small supplement to the FTP is released after the union budget, by the commerce ministry, in order to accommodate incremental need for adjustments. 

I hear that this time the FTP will contain two parts. The first part will contain more of a policy intent and direction and would detail India's approach towards various international trade related issues including FTAs, SEZs, service sector, branding and so on. The second part would contain the policy instruments, such as incentive schemes. All these years, the second part alone was called foreign trade policy. There was no first part detailing the direction and approach. That's what I hear. And if so, it's welcome news. 

However, what's also interesting is that there is hardly any news in the mainstream about what's the current status on FTP release. One has been hearing for the last three months that the FTP is in the making and will be released soon. This kind of closed door approach, I thought, belonged to the last century. Especially after the father of five year plans, the planning commission got an unceremonious burial recently. I was wrong. The FTP makers at commerce ministry still vouch for this style. So be it. 

Ideally, the instruments of export promotion and the FTP should be two different entities. FTP need not articulate in detail about what instruments to use for trade/export promotion. The FTP document should be broad based, giving general directions and should be perpetual in nature. Any revision should be based on major directional change in the way the government thinks about international trade. 

Instruments for export promotion are a function of budgetary allocations and taxation structure. Budgetary allocations determine as to how much can be spent on various export promotion schemes and on assistance to states and councils towards increasing export potential. The taxation structure determines the refund and exemption schemes to nullify export of taxes and to ensure level playing field for domestic manufacturers. Such instruments of export promotion can be revised year on year and need not be constant. All these years, we called these instruments as the foreign trade policy, which actually is misleading. I hope this time it is corrected.

There are two more things I hope the FTP finally takes care of. First is 'not' to keep a target of 'x' billion dollars of exports in 'n'th year. Like the last FTP in 2009 had set a target of 500 Billion USD of exports by 2014. This is ludicrous as we finally saw that we reached around 300 Billion USD due to global slowdown. You can have a system of improving export performance, but the actual figure that finally gets exported, is a function of global demand conditions and various other factors. As long as the system is working fine, and helps improve exporting environment, there is no need to worry about the numbers.

Second, there is an urgent need to setup some kind of evaluation mechanism for the instruments we use for export promotion. I hope the FTP creates such evaluation mechanisms which can then be fed back into the policy making. Currently it's an open loop policy making for promotion instruments, with some occasional feedback coming from the so called experience that relies on word of mouth and grey hair. The export promotion councils (around three dozen of them) who should ideally do the feedback and evaluation work, have turned into poor jokes and waste of money. The agency that majorly implements the instruments (DGFT) is understaffed and demotivated to see beyond the files and paperwork. There is no number crunching on the effectiveness of the schemes. It's a challenging task to set up such evaluation systems, but we need to develop in this area if the instruments are to indeed becomes vehicles for export promotion. It's not a matter of choice if we are serious.

Finally, I hear that someone in commerce ministry has come up with a bright idea of launching an 'export import app' for FTP which will help navigate the policy book and also to file applications. Unfortunately, the current system developed by NIC that interfaces the DGFT with the exporting community is found wanting on many counts. The emphasis should be to get the basics right before getting into smartphone apps and such. However, an app makes for a nice PR exercise when the policy is launched. It sounds modern. I hope the noise is accompanied with substance in the new policy. I am positive. Fingers crossed.

Aug 14, 2014

The late comment on India's veto on Trade Facilitation Agreement

India declined to sign the Trade facilitation agreement (TFA) on the ground that there has been no progress on the issue of public stockholding for food security purposes. TFA would facilitate trade by adopting better and common customs procedures for trade facilitation. This would ease the hassles in cross border movement of goods. India needs easing of customs procedures given that we rank 132nd in ease of trading across borders as per world bank's doing business report. 

The official explanation given to the parliament by the Commerce minister on the stand taken by India, is here. It's an interesting read as it appears that we stood on behalf of developing countries, which includes the least developed countries, the so called LDCs, and all the poor of the world. That would mean that we must have been supported by them at the WTO. I checked up. It was not so. 
We had three supporters on this matter. Cuba, Venezuela and Bolivia. And if a country is known by the company it keeps, I think there is some trouble here. No LDC or any developing country supported us. Apparently there was some tacit support, but it never came out in open. What came out in open was an attempt to leave India alone and push ahead with the deal, and other attempts to try out the TFA at plurilateral level with most of the countries, minus India and the Castro bastions. 

Let me make few things clear. One, I support the stand we took, for reasons I shall explain. Two, I don't subscribe to the nationalistic tone, bordering on jingoism, attached to this defiant stand by the Indian media. The media was initially skeptical for days while the deal hung in balance, and then, as if on a cue, went on an overdrive to defend our side when the deal fell through. The tone was simple, Modiji has saved millions of poor farmers with this one stroke. How? That was to be answered some other day. People gave theories of whatever suited them, including ridiculous reasons such as TFA would lead to increase in current account deficit, a comma usage being blamed on deal falling through, and so on (link here, here). The media lapped up anything remotely positive said about India on the matter, by any agency/expert from abroad. If you know you are right, why look at endorsements?

My support stands on following grounds. Bali package had four major components. They were TFA, Agriculture (including food security), Cotton and Development/LDC issues. It was a package. So all points needed to be arrived at simultaneously. Or at the least, a roadmap should be ready before one of them is finalized and signed off. TFA was ready, agricultural issues were not, and India has a problem with that. Fair enough.

Agricultural issues will always be difficult to negotiate. To expect them to be completed along with something simpler like trade facilitation is not correct. What India was dismayed with, was that there was no progress at all on agri and food security issues, whereas people were jumping over each other to pass through the TFA. It concerned India as India has landed up in a tricky situation after the National Food security Act of last government, which mandates huge subsidy expenditure on food in future. WTO limits such expenditure and India can be brought to dispute panel ending up with penalties. This is worrisome. The Bali package had agreed to give a window of 4 years, a kind of amnesty, for negotiations on the matter. So India started looking at TFA as more of a bargaining chip than as a facilitative multilateral agreement. That's a very insecure way of looking at things, but going by the past experience, India has good reasons to be skeptical. The exploitative IP agreement is a case in the point. Agricultural subsidies is a sensitive subject. There are many contentious issues when it comes to food security, right from fixing of magnitude of food subsidy, correcting the base year for consideration of subsidies, the nature of such subsidies and the methods and so on. The negotiations will take time, and might eventually never materialize. And so it makes sense to use TFA as a bargaining chip.

So on the basis of above points, I would say that though India needs TFA as much as any other country, to boost its trade, we can afford to hold it without substantial loss till our concerns are addressed.

Food security is an important issue in India as we still have a substantial population of poor, who are dependent on subsidized food. India has a ridiculously inefficient food procurement and distribution system. That needs to be urgently fixed. Only then we will have a fair idea on the working of food subsidy and the methods of implementing food subsidy programs. The sense of timing was never this urgent but I hardly see much movement in this area at domestic level.

Anyway, now that India has taken a negative stand the following possibilities arise:

First, if TFA falls through at WTO, the momentum generated at Bali will be lost and WTO will slowly start its decline into oblivion, which will be sad. US/EU and other nations are already building the world trade rules, the way they want it, through trans-pacific and trans-atlantic arrangements. India will not be part of them. And if and when we wish to join such new arrangements, we will be made to sign the dotted line. That's doomsday scenario, but can be a situation if WTO withers away.

Second, there might be some middle ground that might be broken in coming months, with some assurance to India about a roadmap regarding food security negotiations, and TFA might be signed. There are already such talks around this idea.

Third, there might be some kind of plurilateral arrangement involving most of the nations except few like India. This would again feedback into the first situation, with similar outcomes. The regional arrangements will grow stronger.

Anyway, TFA or no TFA, we need to align to easier customs procedures and improve from the 132nd rank in trading across borders if we are to become a serious global player in trade. We also need to fix what's wrong in our system when it comes to food security. It can't work with the existing way of doing things.

Otherwise, we will continue punching above our weight at multilateral bodies, and someday, someone will call the bluff. That would end the game.

Jul 21, 2014

Revenue forgone or Industry forgone?

In the book 'an uncertain glory', Jean Dreze and Amartya Sen (p. 90) write this:
'The pernicious role of regressive subsidies applies not only to those that are visibly and explicitly given, such as subsidies on diesel or fertiliser, but also to implicit subsidies, notably those arising from what the Finance Ministry calls 'revenue forgone' - tax revenue that could have been collected, but was forgone on account of various exemptions and incentives. Some of these are justified, but many others are nothing more than disguised handouts to powerful lobbies, especially corporate lobbies'
So far so good. Then they go on to say,
' ...the subsidies include more than Rs 57000 crores of custom duties forgone on 'diamonds and gold' alone...'
and question such subsidies that can't be justified in an economy struggling with basic needs in terms of food security, health, sanitation and education.

In a later chapter, (pp. 271-272), Dreze and Sen return to this number and juxtapose it against the debate about the bill of Rs 27000 crore on food subsidy that might follow the National food security Act. They wonder as to why there is so much debate about this 27000 crore when no one questions the 57000 crore being lavished as tax exemption on rich jewellers and the associated lobby.

To be fair, Sen and Dreze acknowledge that the figure of 57000 crore might be an overestimate as '...those imports would probably decline if a duty were to be imposed, and also since some of the imports may be used for re-export after work on them for making jewellery...'

Before proceeding further, let me update the numbers. The revenue forgone data is published with the annual union budget as annexure 12. The latest figure given for revenue forgone on account of diamond and gold is around 47000 crore (2013-14). This is a sharp decrease from last year's figure of around 62000 crore rupees (2012-13). The figure quoted by Sen/Dreze is for the year 2011-12. Sen/Dreze narrate the incident as to how the Govt had to roll back a hike in excise duty on gem and jewellery sector amid protests whereas a similar attention is not bestowed on food sector. They conclude that '...the biases in public attention and protest clearly have serious consequences...'

That conclusion is tinted in welfare economics, and is premature. 

In any case, there are multiple problems with both the data that is put out in this form, and the way it is interpreted. 

Let's take the revenue forgone statement. There are two types of exemptions that we are talking about here. One is the exemption in the import duty due to various notifications, and another is the tax nullification schemes on export products in order to keep the products internationally competitive. 

When a rough precious stone is imported into the country for polishing and re-export, it is exempt from import duty. The logic is simple. Any duty on export product will add to the final cost of export product, making it increasingly uncompetitive in international markets. Most of the countries nullify the domestic taxes on export products, including nullifying any import duties, if levied. The idea in taxation parlance is simple: 'Goods are exported, Taxes are NOT.' Duty nullification schemes are designed to meet this goal. 
Imports for re-exports in India are usually duty exempted through schemes such as replenishment schemes or advance license schemes run by the DGFT. Thanks to such schemes, India today has the biggest polishing industry in the world, cornering almost 95% share in this sector. It is highly employment intensive, employing around a million people directly. 

The other type of exemptions arise due to notifications that exempt additional customs duty/countervailing duties. Levying duties on diamonds or gold beyond a certain point is counterproductive in terms of increase of smuggling of such goods. The govt. can rise the customs duty upto a level where smuggling premium equals the customs duty. The customs duty is safely around 10% on gold for example, as of now, which seems reasonable. Beyond this, it gives diminishing returns. The purpose of countervailing duty is to negate the effect of domestic excise duties on local firms, thus giving a level playing field for local firms against cheap imports. In case of gems and jewellery, most of it enjoy nil excise duty, thus leaving no scope to impose an unjustified countervailing duty on imports. 

Finally, the value addition in polishing sector is hardly 10%. This number is the bottom edge of margin at which any industry can survive. Any attempt to levy a duty on import of stones would kill the polishing industry which survives entirely on exports of imported content. This would also lead to great loss of employment.

Revenue forgone statement, unfortunately uses a lame formula that takes into account the above mentioned types of exemptions. It makes it appear like some handout subsidy, which is not the case. 

The entire gems and jewellery export industry exists solely due to such revenue forgone. Rather, there would be no revenue to tax if it is taxed. 

Someone needs to tell this to those who prepare the revenue forgone statement.  And Sen/Dreze need to stop using such statements to prove their point. Their points on welfare are well taken without such shoddy comparisons.

May 26, 2014

International trade dispute settlement between small private parties without arbitration clause

In my day job, I come across complaints from various small time exporters and importers of goods regarding cheating/dispute by their overseas counterparts and vice versa. The overseas complaints usually get routed through the commercial or diplomatic consulates or Indian missions abroad. Indian complaints pour in through various export promotion bodies, export inspection agency, DGFT and so on. Usually, the complaints might be related to quality or payment. The payment related disputes are usually rooted again in quality or quantity related disagreements. 

A recurrent feature I have observed in these complaints is that there is no good commercial contract agreement, in writing, between the parties. At times, parties do have a contract, but they lack an arbitration clause in case of dispute. Trade is usually based on trust in such cases. Emails or telecons are usual methods of sealing the deals. Many a times, I have seen disputes arising after the parties have been dealing with each other for years. They shrug when I question as to why there is no arbitration clause in the contract. We trusted each other, is the usual reply. Trust is in short supply when it is actually needed. 

I would address in brief as to how such cases are handled and what can be done in case disputes arise when an involved party belongs to India (as an exporter/importer). I must add here that cases where the contract includes arbitration clause follows an entirely different path. India has a reasonably sound 'The Arbitration and Conciliation Act 1996', drawn on the lines of UNCITRAL model law. After the recent judgement by Hon'ble Supreme Court of India in the BALCO case (pdf judgement in the link), it has acquired significant teeth. Arbitration decisions seated in India, as well as those abroad, are honoured by Indian courts if the contract is properly drafted with clear arbitration clause. The problem arises when there is no arbitration clause in the contract, or if there is no formal contract document at all, and a dispute arises. 

India has established a reasonably fair mechanism to address trade grievances by the method of setting up of what is known as Regional Sub-Committee on Quality Complaints (RSCQC). This is a formal body under the Foreign Trade Development and Regulation Act (FTDR), deriving its power from its various sections directly or indirectly. You can read more about this mechanism here. It addresses following three types of complaints against Indian exporters/importers:
(i) Quality complaints;
(ii) Complaints other than quality complaints against registered exporters; and
(iii) Complaints other than those at (i) & (ii) above. 
Well the third one is funny but it covers wide range of disputes. One can go through the details of dispute resolution mechanism here. The RSCQC committees have enough teeth to punish erring exporters/importers if required. It has been functioning well in recent days and trade disputes, outside the arbitration, are being resolved through this. 
The 'Regional Committees' are composed of:

1. Joint Director General of Foreign Trade -Chairman 04
2. Bureau of Indian Standard-Member
3. Office of Agricultural Marketing Advisor-Member
4. Small Industries Service Institute-Member
5. Reserve Bank of India-Member
6. Officer-in-charge of Export Promotion attached to the office of Jt.DGFT-Member
7. Export Promotion Council/Commodity Board/Trade Association-Invitees
8. Export Inspection Agency-Member-Secretary. 
The above committee is usually adequate and competent to understand international quality (and other) disputes and come to a reasoned conclusion in the matter. Having been part of such committees, I am reasonably sure of the efficacy of the mechanism. 

However, there is no better better cure to international disputes than having a good contract with a fair arbitration clause. 

This is about India's mechanism to address international disputes that lack arbitration clause. I wish I had a link to see the mechanisms adopted by all other countries at one place. 

May 22, 2014

Gold import control relaxed?

RBI (and the Govt.) has managed yet again to continue to tie itself in knots over the policy issue when it comes to Gold import controls relaxation. I had written about futility of Gold control measures earlier when the controls were introduced. Now they are being relaxed. RBI has come up with this circular that relaxes the 20:80 rule to include star and premium trading houses (big gold exporters basically). The rule operates as follows:

Revised working example of the operations of 20/80 scheme for import of gold: 

1. A Nominated Bank / Agency / any other entity, ABC, imports say 100 kg of gold, which shall be routed through custom bonded warehouses only. If considered necessary, the lot can be procured through two invoices – one for exporters (i.e. 20%) and the other one for domestic users (80%).
2. Out of the above import of 100 kg, 20 kg gold held in the bonded warehouse can be got released, in part or full, to be made available to the exporters of gold against an undertaking to Customs Authorities as is the practice now.
3. The balance 80 kg can be sold / lent in part or full to domestic entities engaged in jewellery business / bullion dealers/ banks operating the Gold Deposit Scheme (GDS) and Gold Metal Loan (GML). The sale of imported gold will be against full upfront payment, except in the case of GML, where nominated banks can give GML  to domestic jewellery manufacturers to the extent of GML outstanding in their books as on March 31, 2013. In other words, no credit sale of gold in any form will be permitted for domestic use, except for GML. In case, the Nominated Bank itself is operating the Gold Deposit Scheme and extend Gold Metal Loans out of gold mobilized under GDS, the bank will be permitted to use, out of 80 kg, a portion for replenishing gold given as GML.
4. Next lot of import of 100 kg of gold by ABC shall be permitted by the Customs Authorities only after the proof of export (i.e. 20% of the imported lot) is submitted.
5. Import of gold in the third lot onwards will be lesser of the two:
i) Five times the export for which proof has been submitted; or
ii) Quantity of gold permitted to a Nominated Agency in the first or second lot.

The idea is, only those exporters who can export to the extent of 20% of imported gold should be allowed to sell the remaining 80% in the domestic market. Earlier, big exporters were kept out (premier and star trading houses were not allowed in this scheme). This new notification allows them to come in and operate. In effect, earlier, almost no one could import gold as there are hardly any significant small players who can manage to meet the conditions laid above. That lead to a significant fall in legal import of gold. 

I don't see any point in such cumbersome measures and procedures. Under this so called relaxed scheme, the Gold importer has to maintain multiple detailed documentation as required by customs, DGFT, RBI and such agencies and also has to manage his business.
Also, no one becomes a Gold exporter overnight and achieves the status of premier trading house (a turnover of Rs 7500 crore over 3 years is required to become a certified premier house). So this relaxation is blatantly in favor of existing major players. 

Finally, what's the whole idea of such complex policy making. If I was asked to make Gold import control policy, I would use the following logic:  (it's bad idea anyday to control imports, but then...)

1. I would first check if it helps to increase import duty. Ans: probably no, as gold demand is inelastic. So in effect, the domestic prices will shoot up without much change in demand. Also, it might lead to smuggling and hawala payments for smuggled gold. 
2. Next, Can I make some kind of import quota? Ans: Yes, seems workable, but the quota should not benefit private parties as it usually happens, like in the case of 20/80 principle currently being followed. 
3. Finally, the modus operandi: I will set a target monthly quota for gold imports (depending on CAD etc). Then set up or choose an existing public sector body such as MMTC to import the monthly quota of gold. Auction this gold in domestic market to highest bidders and pocket the premium as tax collected into Govt. account. The premium should ideally match the smuggling premium, which is basically the difference between domestic and international prices. 

Some more tweaks might be required but the idea can be worked on with the above 2 points. Smuggling and hawala will still continue but atleast in this case, the rules are simpler and Govt gets to earn some money out of selling the quota. It would also ease the documentation burden. 

If there's a better logic, due to which GoI/RBI is doing what it is doing, I am not aware. 

Mar 29, 2014

Sugar export subsidy, WTO objection and elections in India

Raw sugar is brownish in colour due to presence of molasses, considered an impurity in this case, and tastes almost like white sugar, except for a weird, but not unpleasant, aftertaste. It's crunchier too, which makes it a great topping on some bakery products. Also, its considered healthier than the white sugar as the refining process uses more than 50 different chemicals to make the sugar white. That's a myth. Raw brown sugar is as unhealthy (or as healthy) as white sugar as there's enough chemical processing on cane juice to obtain the raw brownish sugar. Anyway, the option of using brown sugar is not easily available in India as we usually get only white sugar in the market. The baking variety brown sugar is quite costly. I have seen it at reasonable prices in US supermarkets though, probably indicating the health revolution that lead to the switch of customers' tastes from white to brown. Raw sugar is produced in most of the sugar mills across India and they are supplied to sugar refineries to convert into white sugar. Many sugar mills also have sugar refineries and some of them are integrated plants where activities from cane crushing to final white sugar is done in one single plant. The mills are mostly concentrated in North Karnataka, Maharashtra and some parts of UP. Some refining mills, such as Renuka Sugars - the leading sugar manufacturers in India, also import raw sugar from countries like Brazil and refine them here for exports.

Sugar was tightly controlled commodity in India due to its linkage with farmers at the backend and the consumers at the front end, both sensitive to the price of sugar, but in opposite directions. There is a directorate for sugar under Ministry of consumer affairs, food and public distribution, which is responsible for controlling sugar related matters. Every step of sugar value chain was tightly controlled till last year, right from production to consumption and international trade. The mills are given licenses to operate, and are given captive areas for cane procurement from farmers. The farmers must give the sugar only to the marked mill of their area and not to any other mill. The govt. fixes the price to be given to the farmers. The mill licenses are not easy to come by due to byzantine laws, and most of the mills are owned by local politicians or highly influential people of the area. The sugar mills had to mandatorily surrender 10% of the sugar produced to the government at almost half the market rates, as fixed by govt. for public distribution purposes. The rest 90% of sugar couldn't be sold in open market. The govt. used to, till last year April, issue 'release orders' on a monthly or quarterly basis to each mill for supply of sugar to market. This was to keep prices under check in domestic market. Also, depending on available quantity of sugar in the mills, the domestic demand projections, and world market prices, the govt. regulates the exports/imports. Trading is tightly monitored and controlled though licenses. Such off/on policies on international trade of sugar from India adds to uncertainty in this sector. The control even extends to the byproducts of the mill such as bagasse, molasses etc. The world price of raw sugar is around 35 to 40 US cents per kg in the last few months.

The sugar industry was partly decontrolled last year and 10% levy was removed. Also, the release order mechanism was eased. Now the Govt lifts the sugar from the market and bears the subsidy burden on public distribution system of sugar directly.  The Rangarajan committee's report in this regard was the guiding light for these partial reforms.

It is in this background that we need to see the recent incentive announced by the Govt. of India on exports of raw sugar from India. The incentive circular is here. The notification allows an incentive of Rs 3300/metric tonne of raw sugar exported, directly or indirectly, from India. That works out around 10% of international price of raw sugar.

This incentive has been opposed at WTO by Australia, Columbia, Brazil, EU and others. The WTO link for this issue can be found here. The objections are primarily due to subsidising nature of this export incentive. India had agreed not to subsidise exports as per WTO rules.  In reply to the objection, India has stated that this policy intends to diversify India's sugar exports from white to raw and as of now, no payments has yet been made. The dispute is on, and so is the incentive scheme.

One has to see the incentive from the point of view of domestic compulsions too. There are national level elections due in April/May. The payment to the farmers, a significant vote bank, has a lag which varies from mill to mill. After supply of cane, the farmer has to sometimes wait for months in order to get the payments. The mill owners depend on govt for release orders for sale. The release order depends on supply and demand in the market and this builds up a cycle of lags. One way of accelerating the money to mills and farmers is to allow exports. Not many mills refine the sugar. So, allowing raw sugar exports is a good idea. This would let the money into mill owners hands and in turn into farmers hands, and who would in turn, apparently, vote favourably in coming elections. Such is the logic that must have flown in the govt circles while making this policy, as the document makes it amply clear with these statements:

"The incentive due to a sugar factory shall be utilized for making payment to the farmers...The amount shall be utilized by the factory to make payment of cane dues of the farmers within three months of receipt of the incentive amount and a utilization certificate to this effect shall be submitted within one month of the receipt..."

This is understandable. The measure is temporary, as seen from the document, and is not perpetually export subsidizing. Given this, and the fact that such stop-gap incentives will lose favour once elections are over, it would not be very difficult to deal at WTO. By the time the battle lines are drawn at WTO, the incentive in question might have ceased to exist.

However, the pain points remain, such as the payment to farmers not reaching on time due to myriad controls and regulations, the still existing restrictions on sugar industry and the uncertainty arising due to socialist style departments going about implementing control ideas on this commodity. Hope the elections bring more than just a windfall of one time payments.

PS: Trivia from wiki:

PPS: Special thanks to Shri K M Harilal, Dy Director General of Foreign Trade, for pointing out decontrol of sugar industry which I had missed in the post. 

Feb 25, 2014

Export promotion subsidies and incentives - Justified?

The question regarding benefit accruing out of providing export incentives/subsidies to firms involved in exports has been debated since Bhagwati's time and earlier. The idea of providing such subsidies and incentives have come under strong criticism from economists such as Arvind Panagaria in the past. You can read a working paper by him in the world bank series on the topic, here. (year Y2K)
Arvind goes about demolishing all the arguments related to export subsidies and incentives in the paper. Talking about the argument of export products and market diversification related subsidies (the mainstay of our incentive schemes under India's foreign trade policy), Arvind has this to say:

I have not come across any quantitative study which does a proper analysis to show that export subsidies, in general, and export-credit subsidies and export-credit insurance, in particular, are a part of the least-cost package for achieving a certain level of export expansion or diversification. Most authors, who are enthusiastic about these subsidies, go only so far as to argue that when combined with other export-friendly policies, these subsidies can be an effective means of export expansion. This is a rather weak claim since any failures can be blamed on the absence of complementary policies while successes may be the result of other sound policies. Moreover, even when export expansion is helped by the subsidies, as is likely if one believes in supply response, it is necessary to know what their cost is.
The above holds true about incentives and subsidies given in any repackaged form. India's foreign trade policy is providing such subsidies in the name of offsetting infrastructural inefficiencies, increasing market presence (Focus market schemes) or to boost employment in small scale sector (Focus product schemes), promoting agricultural exports(VKGUY) and so on. Apart from these, various other schemes are run by different export promotion councils, under Ministry of Commerce, in the name of Market Access Initiatives and Market Development Assistance. Also, interest subvention schemes are run by the banks under RBI mandate. The amount spent on these schemes adds up to around Rs 3000 crore (USD 500 million approx). Source here.

One of the major reasons why there are not many quantitative studies in this area (across the world) is the difficulty in isolating the effect of the export subsidies on export performance. One interesting classic study in this area was conducted by Julio Nogues in 1989 titled "Latin America's experience with export subsidies" which surveyed the Latin American countries. Nogues study indicates the poor returns out of export promotion schemes. Among the countries, the effect in Brazil and Mexico has been somewhat positive, but Brazil's advantage was countervailed by the US, significantly increasing the cost when compared with Mexico. Even for Mexico, there remains a question mark on the absolute returns of such schemes. In case of Argentina, these schemes lead to rent seeking behavior, bribery and corruption. Nogues doesn't deny the effect of such schemes outright, but cautiously adds the effects of supporting enablers such as infrastructure and policy regimes.

It is in this light that a recent study conducted by the World Bank in Tunisia, titled "Are the benefits of export support durable" gathers importance. The study can be accessed here. The study is interesting because it tries to isolate the effect of export assistance given, under a program named FAMEX in Tunisia, to different sized firms over a period of time. FAMEX grants were used mostly to co-finance the cost of technical assistance and marketing services provided by local and foreign experts. Five types of activities were financed: (i) market prospection, (ii) promotion, (iii) product development, (iv) firm development, and (v) foreign subsidiary creation.

The study finds that relative to the control group (which was not given the FAMEX treatement), the experiment group showed statistically significant improvement in export performance. However, this advantage was lost over a period of four years and firms in the control group caught up. There was also an effect of the size of the firms in question. The medium sized firms retained better performance over period of time, over smaller and larger firms. The spillover effect (from treated firms to the control group firms) was shown to be non-existent. In the words of the paper:

...the paper considers also the longer-term impact.....beneficiaries initially see faster export growth and greater diversification across destination markets and products. However, three years after the intervention, the growth rates and the export levels of beneficiaries are not significantly different from those of non-beneficiary firms. Exports of beneficiaries do remain more diversified, but the diversification does not translate into lower volatility of exports. The authors also did not find evidence that the program produced spillover benefits for non-beneficiary firms. However, the results on the longer-term impact of export promotion must be interpreted cautiously because the later years of the sample period saw a collapse in world trade, which may not have affected all firms equally....

The above study raises interesting conjectures. In my experience, I have observed that most of the export promotion schemes run in India are actually benefiting the existing, established exporting firms and not the new, breakaway firms that are looking to grow in international trade. I also occasionally come across small exporters who have narrated experiences where financial incentives are factored in costing and help them undercut competition, thus helping them at international markets. Such cases need to be studied closely to find out the exact category of exporters (and the product groups). This is the job of export promotion councils. Unfortunately, the multiple export promotion councils in India have ended up as lobby groups of leading exporters. DGFT, the apex govt. body for trade policy making and promotion, has now started a program under a scheme called 'Niryat Bandhu' to train/enlighten new firms about these schemes, and handhold them during their initial breakaway period. Niryat Bandhu scheme sounds a lot like the FAMEX, if executed well.

That leads us to the half a billion dollar question, literally. Is the spending for such schemes, as they exist today in India, justified? I hope the makers of the next five year trade policy, which plans to roll out after elections, are pondering over this point.