Mini-Budget puts capital goods business out of alignment

The mini-Budget has attempted to benefit almost all sectors but this has not been possible without hurting a key sector "" capital goods.

This is true even theoretically since Pareto Optimality demands that in a given situation of resource mobilisation, at least one person will be a loser if others benefit.

In this case, the user sector of capital goods has benefited but the producer sector has been correspondingly hurt. Now that customs duties have been brought down so that inputs become cheaper for the manufacturing industry, imported capital goods will be cheaper than the indigenous ones.

Capital goods imports have been made cheaper in general because of a reduction in the peak rate duty from 25 to 20 per cent, the abolition of the Special Additional Duty of 4 per cent, a reduction of duty on project imports from 25 to 10 per cent where the investment is more than Rs 5 crore and on the capital goods for the manufacture of electronic goods.

The domestic capital goods industry has a substantial presence in terms of investment and spread. Over a period it has built expensive and sophisticated manufacturing facilities and acquired modern technology for supplying a complete range of projects for fertiliser, power, oil, gas, refinery, coal mining and so on.

Technologically, the capital goods industry is not exactly lagging behind. On issues of quality, companies in this industry are no less than their foreign counterparts. They have made huge investments partly by borrowing funds from international organisations and partly from local resources.

That is why sluggish performance by the capital goods industry has recently been worrying economists. Why has growth been so slow? The reason has to be found in the very large number of exemptions at nil, 5 and 10 per cent to capital goods imported by the user sector.

Consider the present customs duty rate structure (see table). It shows how capital goods for different projects enjoy a lower rate of duty and particularly those covered under the notifications have created unequal competition in an already ailing industry.

Indian capital goods manufacturers can take on their foreign competitors if the protection level is average or even less but not if it is brought down to nil, 5 or 10 per cent. In fact, they do not ask for high protection, just an average level of protection.

They have not been opposing a reduction in the peak tariff of 25 per cent to 20 or reducing the high rate of 20 per cent to, say, 15 per cent. What they have been asking for is the abolition of the many exemptions at the nil and 5 per cent rates so that the general rate becomes to 15 per cent or higher.

By increasing the number of exemptions at 5 per cent or zero, the government has given the manufacturing industry a boost by making imported machinery available cheaper to them but at the same time making indigenous machinery uncompetitive with the imported ones.

The local industry's cost disadvantage is largely due to inadequate infrastructure, local taxes such as octroi and entry tax and the higher cost of financing, all of which together amount to about 20 per cent "" even more in some cases.

The logic forwarded in favour of continuing these exemptions is twofold. One is that the World Bank or UN agencies would like to bear the basic cost of a project and not the customs duty. This argument is fallacious. The World Bank can as well fund the project cost and have the importer pay for the customs duty.

The second argument is that if the customs duty is added, the project cost will increase. This argument is also incorrect. The domestic industry's competitiveness cannot be compromised in the name of reducing project costs.

There are several ways to rectify the situation, which have been suggested here.

• All the different rates, including machinery and project rates of customs duty, should be equalised and brought to 20 per cent, which is the peak rate. No exemption should be less than 15 per cent. This will reduce the need to give the very large number of exemptions that now exist in the machinery chapters in the customs tariff.

These exemptions are full of long lists and longer conditions, which have made the working of the tariff extremely difficult exercises. The fact that neither the power sector nor other industrial sectors have done well in spite of so many exemptions proves that giving exemptions is not the best way to boost them.

• The countervailing duty (CVD) of 16 per cent should be levied uniformly so that the question of refunding the terminal excise duty (which is associated with this issue) is eliminated. There should be no exemption from CVD either, except where the projects manufacture items that are not excisable (that is, where they do not get Cenvat credit).
• Price preference to public sector undertakings should be discontinued.

All these measures will ensure the creation of a level playing field between the indigenous capital goods industry and the foreign suppliers of capital goods. But, as of now, the former has enough to complain of, being discriminated against on their home turf.

The existing tariff was disparate. Now it has become even more so. What we require is equilibrium between the user and producer sectors of the capital goods.