For a free trade pact within India
Dated 10th May, 2016
India’s merchandise exports have fallen over the last 16 months. Future prospects look bleak as ever due to sluggish global demand accentuated by a slowing China, and India being blocked out of regional trade deals such as TPP.
On the other hand, despite all policy attempts, corporate investment has not picked up. That calls for urgent internal actions to sustain growth momentum. One such action could be tapping indigenous sources of growth. Are we really doing that ?
It’s worth repeating that India is a full-fledged member of WTO. It is negotiating a series of bilateral, regional and trans-regional free trade pacts with Asian, African, European and Latin American countries. However, trade within India is fraught with a series of impediments that inhibit seamless movement of merchandise across states and UTs. That limits India’s potential growth at a time when the global environment is not conducive to rising exports and protectionism is on the rise.
It’s easier to bring in or move out merchandise from outside than from within the country. It won’t be wrong to say that India itself is not a free market area. India Inc. often complains of underdeveloped transport infrastructure and a complex tax regime that aids cascading of taxes. Over regulation of inter-State trade with frequent checks, stoppages and inspection at State borders often leads to delays in moving merchandise from one State to the others.
These factors add to the cost of doing business in India (against the spirit of Make-in-India initiative) and escalate the final price of finished goods. That encourages imports from countries like China.
What shackles India internally ?
A series of market distorting rules and regulations impede India’s evolution as a nationally integrated market. For instance, under the Essential Commodities Act (ECA) the government can declare any commodity as essential and impose stocking limits, creating uncertainty in the market.
The Agriculture Produce Market Committee (APMC) Act mandates purchase and sale of agri commodities in government regulated local mandis only. That inhibits farmers from selling their produce in markets located outside their districts/States. Many of these challenges might be addressed if the NDA government’s flagship initiative of setting up of national agricultural market is efficiently implemented.
Multiplicity of taxes levied on manufactured goods in India has fragmented India into numerous State-level sub-markets. Despite VAT, the cascading effect of taxes persists.
For instance, VAT charged by a State on sale of a product includes excise duty levied by Centre. Similarly, excise duty charged by the Centre on the raw material used in manufactured goods has already been charged with State VAT. Simply put excise duty is charged on the VAT element and vice versa.
Further, Central Sales Tax (CST), a tax levied on the inter-state movement of goods, is not integrated with the VAT, making it ineligible for input tax credit. Moreover, variations in VAT and other tax rates across States lead to trade diversion, rate wars and a shift in manufacturing activities on non-economic principles.
Entry and exit taxes
Entry and exit taxes, and formalities required for inter-State movement of goods, add to manufacturers’ woes. For instance a Gujarati manufacturer who sources inputs from Maharashtra and then exports the finished good to Mumbai pays State and CENVAT, and a Central Sales Tax of 2 per cent on purchase of inputs from Maharashtra. Also, CST does not qualify for input tax credit for him.
On entering Gujarat, inputs are subject to an entry tax. CST is again levied on the finished good “exported” to Maharashtra at the time of exit. On entering Mumbai an octroi is levied on the finished good. This makes the good “imported” into Maharashtra more expensive than locally (in Maharashtra) manufactured goods. Therefore, the manufacturer in Gujarat is discouraged from sourcing inputs from other States.
To avoid this, the seller makes a stock transfer by setting up a warehouse in importing state (Maharashtra) and then makes a sale locally. In addition, manufacturer also has to pay service tax on transportation charges. This results in inefficiencies in supply chain impacting inter-State trade.
The Arvind Subramanian committee report suggests that in six States namely Maharashtra, Andhra Pradesh, Karnataka, Gujarat, Tamil Nadu and Kerala, stock transfers, on average, account for as much of inter-state trade as the trade subject to the CST. Inter-state stock transfers in Andhra and Gujarat are more than double (2.65 and 2.14 times respectively) of their inter-state trade subject to CST, to avoid taxes. That is why even a 1 per cent CST for a limited period of time in order to compensate the States will dilute the essence of GST.
India’s poor transport infrastructure also hampers seamless movement of merchandise within the country. World Economic Forum reports that “a truck carrying goods from Gurgaon to Mumbai has to pass through 36 checkpoints and takes up to 10 days. While 57 per cent of goods in India are transported by road, the most inefficient, expensive and emissions-intensive mode of transport, the figure in China is just 22 per cent”.
Further, TCIL has noted that road-freight volumes are growing at a CAGR of 9.1 per cent while growth of road networks lags at 4 per cent. District and rural road network which accounts for 95 per cent of India’s total road network is fairly underdeveloped. State border check-posts further add to delays. The result is: Indian trucks cannot move beyond 20 km/h on average.
Around 40 per cent of the time lost on road is due to stoppages at state border check posts, as per Ernst &Young. Inter-state regulatory requirements requiring detailed documentation like permits, waybills, forms, tax invoice, delivery notes leads to delays and increase in transaction cost. World Bank estimates that simply halving the delays due to road blocks, tolls and other stoppages could cut logistics costs by 30-40 per cent. India spends roughly 13 per cent of its GDP on logistics compared to 7-8 per cent in developed countries.
The way forward
Given the size and complementarities of its provincial economies, an early implementation of GST will create a pan-India common market of $2 trillion GDP and 1.2 billion people — a big attraction for any investor — and add as much as 1-2 per cent to GDP by creating a nationally integrated market. Yet, ruling and opposition parties are not able to reconcile their differences on GST.
Singh is a former government official and currently a corporate economic advisor based in Mumbai. Prachi Priya is Asia economist for a top corporate house. The views are personal
(This article was published in The Hindu Business Line on May 10, 2016)