Import competition

The sharp surge in corporate profits, in relation to sales growth, has meant that profits (after tax) now average a handsome 10 per cent of turnover""up from 7 per cent not so long ago. There could be several reasons for this. One obvious explanation would be that companies are benefiting from having achieved economies of scale, and fixed overheads are therefore being spread thinner over greater volumes. If companies are operating at or close to the limit of their production capacities when demand is buoyant, there would be no incentive for them to try and win more customers by dropping prices and accepting lower margins. In other words, pricing power has returned to Indian companies, and this explains the accelerated inflation rate for manufactured products in recent weeks. This situation may not last, though. The sharp surge in the growth of the capital goods industry in recent quarters suggests that new capacities are being built""and since capacities come bunched while demand grows incrementally, potential supply in many sectors could soon exceed even rapidly growing demand. From the perspective of the prices of manufactured products, therefore, the pendulum may swing back in favour of the consumer.

If the government is concerned about inflation, meanwhile, it should consider how to strengthen the forces of competition in the system""an objective that could also spur growth. The country's import basket suggests one course of action""the overwhelming bulk of India's imports consist of intermediate products, which go into final products. The biggest items of import are petroleum and products, engineering items, minerals and metals. Finished products figure very little, except when it comes to electronic goods and technology-intensive items for which India still has a weak manufacturing base. If the imports of more finished consumer goods were to be encouraged, it would add a new element of competition in the Indian marketplace""and discourage producers from jacking up prices when margins are already comfortable. This suggests sharp tariff cuts as the required course of action. The government has already moved in this direction recently, but more can and should be done""judging by companies' profits to sales margins.

The other reason for encouraging more imports is that capital can be expected to flow into the country in even greater quantities, following the economy being bumped up to investment grade by Standard & Poor's (Moody's did it two years ago). Sterilising the dollar inflow will be a challenge to the Reserve Bank of India, which is already grappling with the issue of monetary growth of 20 per cent. The natural balance is when the surplus on the capital account is matched by a deficit on the current (trade) account. This latter figure is now between 1.5 per cent and 2 per cent of GDP. Given the scale of capital inflow, and the cushion provided by foreign exchange reserves, the case can be made for targeting a higher current account deficit. That means encouraging more imports.

The finance minister could argue that India's tariffs are already comparable to those of some countries in East Asia. That may well be the case, but it remains true that India's average tariffs are higher than the global average, and there is no shortage of non-tariff barriers. Corrective action on both fronts would help balance external flows and prevent a monetary over-run, while also spurring competition for markets.