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    Why India needs to stop betting on MEIS scheme to boost exports

    Why India needs to stop betting on MEIS scheme to boost exports

    Scratch your head about this for a bit. India's average import tariff is, by far, the highest for any country with both imports and exports of at least $100 billion a year. Additionally, since the World Trade Organization (WTO) came into being, India has initiated more anti-dumping investigations than any other country.

    The Indian government clearly understands the difference between export promotion and export subsidies, and accounts for them separately in its own books. Despite this being true, policymakers continue to look for new ways around the WTO guidelines in order to subsidize exports by terming them 'incentives', particularly when subsidies are being withdrawn, or at least rationalized for domestic consumers.

    Old wine, new bottle

    When the Nirmala Sitharaman-led Ministry of Commerce and Industry took almost a year in office to introduce the new Foreign Trade Policy (FTP) in 2015, there were expectations that it would usher in a new era in India's trade. After all, India's merchandise exports had remained stagnant in the preceding two years and the merchandise trade deficit was threatening to shoot past an unsustainable $200 billion per year. But, while the goals set were lofty - $900 billion of exports by 2020 -the policy unfortunately failed to deliver, and it was unable to inspire much confidence in the country's chances of achieving such a herculean target.

    In fact, even the main highlight of the FTP 2015-20 - the introduction of the Merchandise Exports from India Scheme (MEIS) - was nothing more than the amalgamation of several existing schemes like Focus Market Scheme (FMS), Focus Product Scheme (FPS), Vishesh Krishi Gramin Udyog Yojana (VKGUY), etc., making the duty credit scrips issued under these various offerings fully transferable. Like the FMS and FPS, under MEIS too, an exporter was provided with duty credit scrips of a certain percent of the value of his/her exports. The difference was that the scrips under MEIS were fully transferable and could be used to pay a whole host of taxes and duties unlike earlier when there were several end-use restrictions. Policymakers, however, failed to realize that irrespective of what we call them, all these schemes were essentially ways to provide export subsidies and were in violation of the WTO's Agreement on Subsidies and Countervailing Measures (SCM Agreement).

    The beaten path

    Like many protectionist economies around the world, India too has an instrument to promote exports while continuing to restrict imports - Duty Drawback (DBK). Under the scheme, all taxes and duties paid on input components of export products are remitted back to the exporter. This not only helps a country's export products remain competitive in the international market, but also ensures its tax policy for domestically consumed goods,including those imported, is not affected at all. Schemes like DBK have made countries like China, Taiwan and South Korea the leaders of exports of manufacturing goods by essentially giving their export-focused manufacturers an entirely separate ecosystem that is completely immune to their own tariff barriers.

    India's FTP also has other duty exemption/remission schemes like Advance Authorization (AA) and Duty-Free Import Authorization (DFIA) under which the government basically allows for the duty-free import of input components used in export products.

    It's easy to see how schemes like the MEIS and its predecessors, all part of Chapter 3 of the FTP, are different from schemes like AA, DBK and DFIA, which are all part of Chapter 4 of the FTP. While through the latter, the government is essentially paying an exporter back the taxes it has already collected from him/her, or refraining from imposing duty on the imported components of an export product, the former are clearly handouts 'contingent upon export performance', and nothing but subsidies.

    The US dragged India to the WTO's dispute settlement body alleging that almost all the schemes under the latter's FTP - from Export Promotion Capital Goods (EPCG), Special Economic Zones (SEZs) and Export Oriented Units (EOUs) to MEIS and DFIA - are in violation of the SCM Agreement and provide subsidies to exporters. However, only the MEIS has been found guilty of the same - one could argue justifiably.

    Misplaced Priority

    The Indian government clearly understands the difference between the FTP's export subsidy schemes and all other export promotion schemes. In fact, even in the Union Budget, while reporting the revenue foregone due to such schemes, the government clearly accounts for the incentive schemes separately from the others, which it terms 'input tax neutralization or exemption schemes'.What's puzzling though is the fact that despite them being clearly non-compliable with the WTO guidelines, the government, over the last few years, seems to have become keener on pushing the subsidies, at the cost of the export promotion opportunities - despite empirical evidence that it's the latter which help boost exports and not the former.

    In the five years from the end of FY2009 to the end of FY2014, India's merchandise exports shot up by a stunning 126%. Over the same period, while the revenue foregone due to incentive schemes was an average of just Rs. 8,198.6 crore, the revenue foregone due to the input tax neutralization or exemption schemes, excluding DBK, was an average of Rs. 47,130.2 crore. But instead of betting more on the latter, the government, through FTP 2015-20, doubled down on the less effective incentive schemes.

    As a result, over the next five years from the end of FY2014 to the end of FY2019, while revenue forgone due to incentive schemes shot up by 178.9% to an average of Rs. 22,868.6 crore, the average revenue foregone due to input tax neutralization or exemption schemes, excluding DBK, dropped 15.4% to Rs. 39,865.8 crore. The consequence? Merchandise exports in the five years from the end of FY2014 to the end of FY2019 grew a measly 21.1%! In fact, the last two years have, for the first time, seen the annual revenue foregone due to incentive schemes exceeding the same for input tax neutralization or exemption schemes.

    Give a fish or teach to fish?

    Having crossed the $1,000 per capita income level over half a decade ago, it's unlikely that India will be able to subsidize its exporters for much longer. It can appeal, delay and fight it out at the WTO, but it's clearly a question of when - and not if - the subsidies are stopped. But then why should India even try to delay the inevitable when data clearly proves that such subsidies aren't really helping exports?

    The answer is that we shouldn't. History has repeatedly proven that all subsidies do is misallocate capital and other valuable resources. They make those that are subsidized dependent on handouts, are against the basic tenets of free-market capitalism, and lead to inefficiencies. Instead, what the government should do is put faith back on input tax neutralization and exemption schemes as it used to do earlier.

    Stop guessing

    The DBK scheme, which has helped other Asian countries flourish as global leaders of exports of manufacturing goods but has done precious little for India, needs a complete overhaul. In India, the DBK rate of an exported good is a percentage of the exported price, but with a cap. For example, the current DBK rate of a mobile phone exported from India is 3.9% with a cap of Rs. 150.4. This basically means that irrespective of the value of a mobile phone exported by an Indian manufacturer, and notwithstanding the customs duty paid for the import of some of the phone's input components, the maximum DBK the manufacturer can get is just Rs. 150.4. What, then, is the motivation for an exporter to manufacture a high-end phone and export it at Rs. 40,000, for example if a competitor can earn the same DBK by exporting a basic phone at one-tenth the price? Don't such value caps dissuade Indian manufacturers from importing the best components and using them to manufacture and then export high-value products?

    In India, the DBK rates on various products and their caps are calculated based on what the Directorate General of Foreign Trade (DGFT) calls 'SION' - Standard Input-Output Norms. For example, let us consider a product A, with input components X, Y and Z. Essentially, what the government does is assume that the manufacturing of product A requires the import of inputs X, Y and Z. The total customs duty paid on the import of X, Y and Z is then calculated and the same is used to arrive at a DBK rate.

    It doesn't take much to realize just how unscientific this whole exercise is. Firstly, how can the government know for sure that only X, Y and Z are used in the manufacturing of A and not more input components? Secondly, while the government knows what the rate of customs duty on X, Y and Z is, how can it figure out the actual duty paid to import them? After all, there may be several varieties of X, Y, and Z available in the international market at various price points. In fact, if one does a detailed study of the SION on different products and the range of prices at which the input products are being imported, one will realize that the DBK rates arrived at are little more than guesswork and often remit just a fraction of the duty paid in importing the input components of an export product.

    Capital concern

    The government also needs to urgently look at the reason behind a once-popular scheme like the EPCG suddenly not finding enough takers in the last few years. For instance, while the revenue foregone due to the EPCG scheme was Rs. 7,833 crores in FY2009, further rising to Rs. 11,218 crores in FY2013, provisional figures suggest that the same has dropped to just Rs. 3,220 crores by FY2019.Under the EPCG scheme, the government allows for the duty-free import of capital goods, provided that the importer ensures a certain amount of exports over a period. Therefore, this drop in the revenue foregone due to EPCG reveals that Indian manufacturers are increasingly spending less on procuring capital goods to manufacture export products.

    Above all, the government needs to understand that export competitiveness, just like the competitiveness of a product in the domestic market, isn't just a function of pricing. If that had been the case, countries like Germany and Switzerland wouldn't have been the exporting giants they are today. Exports are also a function of quality, and that requires the government's help to improve the skill and technological standards of our manufacturers. It's not an easy ask, but is perhaps the only way forward.

    *(This article was first published on economictimes.indiatimes.com)

    Pushkar Mukewar
    Pushkar Mukewar
    Co-founder and Co-CEO, Drip Capital
    9 min read