Tariff uncertainty

Tinkering with rates will put off investment and hurt exports

Another Union Budget has deepened the turn towards protectionism, which began a few years ago. Union Finance Minister Nirmala Sitharaman said in her Budget speech that the Customs duty policy “should have the twin objectives of promoting domestic manufacturing and helping India get on to the global value chain”. But these twin objectives run directly counter to each other. Promoting domestic manufacturing through trade policy inevitably leads to dissociation from the modern system of just-in-time manufacturing, which demands flexibility and access. In spite of the ample evidence that these two objectives cannot be simultaneously achieved, the finance ministry persists in trying to tinker with tariffs in a manner that dis-incentivises domestic productivity, leads to enhanced lobbying by interest groups, harms consumers, and creates overall uncertainty for investment.

Some defenders of the government, including senior officials, have pointed out that Customs duties on some goods were lowered alongside others being raised. Yet a closer look reveals that their point has weak foundations. Some steel products, for example, found their tariffs reduced. But, as the finance minister said in her speech, this was in response to demands from “MSMEs [micro, small, and medium enterprises] and other user industries”. Meanwhile, it should be noted that steel tariffs were raised some time ago in response to demands from domestic iron and steel producers. This chain of lobbying and policy adjustments is the inevitable consequence of a policy that seeks to “promote” manufacturing through tariff barriers. When prices of imports are raised, some are helped and some are hurt. The eventual winner will be whoever lobbies latest and most effectively. No doubt at some point in the future, the MSMEs and component industries that have been helped by a reduction in tariffs will have to face lobbying from their customers to reduce tariffs on the products they produce with imported steel.

India has refused to join the Regional Comprehensive Economic Partnership. It has stalled negotiations with the European Union and with other possible trade partners. It has stood aside while the United States removed it from a list of countries given preferential access to the US market. It is hard to believe, therefore, that Indian officials genuinely want to become part of global value chains. It appears instead that they have given in to pleas by domestic interest groups and have determined that only tariff barriers will allow for output growth by domestic manufacturing. India has, however, five decades of history showing that such actions lead to productivity stagnation and to sharp decreases in consumer welfare.

Further, the finance minister announced that consultation on hundreds of tariff exemptions would take place over the year. This is not just a giant signal for policy uncertainty, which will put off investment at precisely the time private capital is needed for fuelling India’s recovery, but it has raised the stake in terms of lobbying the government. To its credit, this government has sought to minimise the appearance of giving in to domestic lobbies of any sort. But such a large-scale revision will give the opposite impression, and should therefore be quietly abandoned. To rejoin post-pandemic global value chains, the government should give up tinkering with tariffs and commit to a stable and low tariff regime across the broad. This will provide policy certainty, and pay dividends in the coming years.