Among the various policy recommendations made to the finance ministry prior to the Budget announcement, one of the most contentious this year relates to excise duties. While industry has asked that the status quo be maintained, various reports suggest that an increase is imminent.
The argument justifying an increase in excise rates goes as follows: since the rate was reduced as part of a stimulus package for industry during the global financial crisis of 2008, it is time for it to be reversed. This argument has little appreciation for the problems that the Indian economy, or indeed the global economy, continues to face in the aftermath of the global crisis. Global economic growth has turned out to be much lower than earlier expected and the latest estimates factor in a recession in Europe in 2012.
In India, the manufacturing sector is facing near-stagnation, with the third quarter GDP data attributing merely 0.4 per cent growth to this sector. Industrial growth, as measured by the Index of Industrial Production, has fallen to 3.6 per cent during April-December 2011, compared to 8.3 per cent in the same period last year.
Before going ahead and increasing tax rates, it is worth examining why industrial growth is falling several years after the 2008 global crisis. The feedback from small and large players in manufacturing is that they are saddled with a huge increase in costs — ranging from the cost of raw material to that of labour and interest. With industry not being able to pass on these cost increases, they are facing a squeeze on profits, a situation which discourages investment and growth. An increase in excise duty at this point would only add to industry’s cost burden and further discourage growth.
The reason behind this increase in cost pressure lies partly in the dynamics of the global economy. As economic growth remains subdued in developed countries, many of their central banks have been pumping in liquidity to keep interest rates low. This surplus liquidity often finds its way into global commodity markets, putting pressure on the price of raw materials such as oil and metals. The Reserve Bank of India is then forced to raise interest rates in order to fight inflation, further discouraging growth and investment.
To add to the difficulties, India along with other emerging markets faced a bout of capital outflows last year which resulted in the exchange rate depreciating considerably and further raising the price of imported inputs for the manufacturing sector.
While the current situation, fraught with fragilities at both domestic as well as global levels, does not justify an increase in the duty, we also need to consider whether an increase is justified in the longer term, when industrial performance has improved. For this, it is imperative to understand the process of indirect tax reform that has gained some momentum in the country.
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It is well known that the Central government is ready to implement the goods and services tax (GST) but is unable to move ahead because the state governments are withholding their consent. It is proposed under the GST that the rates for both Central and state GST should converge to 10 per cent. This is a strong justification for not raising the duty beyond 10 per cent now, when the intention of the government is to implement GST as soon as possible.
Several discussions on India’s indirect tax rates have come to the conclusion that Indian manufacturing suffers due to the high level of taxation in India. In addition to value-added tax imposed at the rate of 10 per cent by the Central government, industry also pays VAT to state governments at rates varying from 12.5 to 14.5 per cent. Central sales tax (CST) at 2 per cent is also imposed on inter-state transactions.
This last one is particularly onerous for manufacturers as it needs to be paid at every stage of production without any refund of the tax paid at the earlier stage. CST was proposed to be done away with — but, while it was brought down from 4 per cent to 2 per cent, it is not likely to be removed fully till GST is brought in.
In the face of various difficulties posed by the federal structure of India’s taxation system, the Central government has been going ahead with the reforms where it can take unilateral action.
For example, it has been reducing the number of items on which excise duty is exempted in order to align it with the VAT structure and prepare the ground for GST. Such actions display its seriousness in going ahead with the GST reforms. Any move to deviate from the proposed GST rates at this stage will send out confusing signals and weaken the Central government’s position in its negotiations with the states.
By framing the debate in terms of an intransigent industry refusing to accept the rollback of stimulus and depriving the government of its legitimate revenue, we are missing an opportunity for reform.
The writer is director-general of the Confederation of Indian Industry