The planned changes to the customs tax regime may appear small at first glance, but a closer examination of products reveals an increasing convergence between India’s industrial and trade policies, as well as a focus on making India a prominent player in Global Value Chains (GVCs).

The recently released budget, which coincided with the third wave of Covid-19, encountered a slew of issues. While it handled most of these issues in a pragmatic manner, experts and business channels focused on the traditional tradeoffs between growth and welfare, as well as fiscal conservatism vs economic stimulus. A far greater but understated reform in the country’s customs tax policy occurred amid the typical post-budget hubbub. The planned changes to the customs tax regime may appear small at first glance, but a closer examination of products reveals an increasing convergence between India’s industrial and trade policies, as well as a focus on making India a prominent player in Global Value Chains (GVCs).

Since the 1980s, advances in communications technology and lower transportation costs have enabled companies to geographically disperse their manufacturing operations, resulting in a decentralized, but efficient structure of GVCs. While classical trade theory suggests that countries should manufacture goods in which they have a comparative advantage, the decentralized system created by GVCs has allowed countries to ultra-specialize their expertise and actively participate in global trade by focusing on specific product categories or components. For example, Taiwan significantly controls the semiconductor industry, which is a vital component in the manufacturing of all electronic items in the world, but it rarely has a global consumer brand radiating from its territory. Similarly, despite having limited intermediate goods manufacturing capability, Vietnam is quickly emerging as the ideal destination for constructing final product assembly lines due to its low labor costs and liberal import policies.

According to the World Development Report 2020, GVCs now account for roughly half of all international trade. The majority of GVCs are controlled by Multinational Corporations (MNCs), which make strategic investment decisions based on a variety of criteria, the most important of which being the cost of production. While many elements influence the final cost of production, such as land, labour, infrastructure and energy, import policy (customs duties) has a significant impact on the cost of manufacturing within GVCs. Moreover, customs duties are a very significant factor for countries which operate at the downstream of the value chain.

Within GVCs, countries and companies are categorized into two types of value chains: upstream and downstream. Upstream economies are technological leaders and manufacture high-value intermediate goods that are used in the manufacturing of final products. In Asia, Taiwan; South Korea; and Japan are examples of countries in this group. Downstream economies are those that process inputs from upstream countries and turn them into finished goods. Labour cost arbitrage tends to benefit the downstream economies. Downstream economies are able to attract these final product assembly/manufacturing units into their region by providing proper physical infrastructure, liberal import trade policy and a business-friendly environment. India also currently falls under this downstream value chain. Approximately, less than 12.5% of India’s merchandise exports fall under the high technology category.

The value chain of a downstream country depends heavily on imports of intermediate goods. Take for example, the manufacturing of bicycles. Bicycles are hardly high-tech products, but they are widely traded all over the world (45 bn USD). In the overarching scenario of GVCs, consider the role of various countries in this manufacturing process. Bianchi (an Italian firm) is in charge of bicycle design, prototyping, and conception. Gears, brakes, and pedals are all made in Japan. China and Vietnam are the countries that produce the frames. Italian and Spanish saddles are used along with French and Italian wheels for making a final bicycle. As a result, a bicycle made in let us say Netherlands uses 33% of its components from other nations. 13 percent of these come from the European Union, 11% from Asia, 5% from North America, and 4% from the rest of the world.

In the above scenario, Customs Duties of a country can play an important role in manufacturing within Global Value Chains. Let us consider this with another example of a bicycle manufacturing company that must choose between India and Vietnam for an investment of an assembly plant.  For manufacturing, the company plans to import 50% of the components and source the balance locally. Assuming all other factors remain unchanged, India has a 10% customs levy on bicycle components and Vietnam has none. In this basic example, the cost of manufacturing the completed bicycle in India will increase by 5% (50 percent *10) making India an unattractive investment destination. Table 1, which shows the increasing percentage of import content as a percentage of gross exports further reiterates this point.

Table 1 Percentage import content as a percentage of gross exports

The absence of an intermediate/component manufacturing ecosystem, coupled with high tariffs on the import of intermediate goods were key causes for India’s low GVC participation. Majority of the production of intermediate products is currently concentrated in high-tech countries such as Japan, Korea, and Taiwan. Hence, it is natural that high levels of imports of intermediate goods would be required for India to strongly integrate into the GVCs. Vietnam, which is emerging as an Asian manufacturing hub, allows substantially more foreign content in its manufacturing process. The recently announced budget sets right this anomaly.

In recent years, important legacy issues such as land, labour, electricity, and infrastructure have been addressed in a systematic manner. Under the auspices of Ease of Doing Business, procedural and regulatory hurdles have also been lowered. In addition, the government also launched its ambitious production linked incentive scheme (PLIs) providing support to 14 key sectors.  While these reforms significantly decreased the cost of doing business in the country, trade policy relating to customs taxes, which is a substantial component of cost inside GVCs, was continually under explored. The latest budget takes a bold step in this direction by lowering import levies on intermediate items for the steel, electronics, leather, and jewellery industries. The selection of products and the varying use of customs duties indicate the vision of easing the imports of intermediate goods while encouraging manufacturing of low value manufacturing (umbrella imitation jewellery, and agricultural products). This approach will help India build a footing in the global GVC map by lowering the cost of doing business within GVCs.

https://www.financialexpress.com/budget/budget-2022-23-nudging-india-towards-a-place-in-the-global-value-chain-map/2430240/