Budget 2022-23: Pushing India to a place on the global value chain map

The planned changes to the customs tax regime may seem small at first glance, but a closer look at the products reveals a growing convergence between India’s industrial and trade policies, as well as a desire to make India a player in leader in global value chains (GVCs). .

By Kannan Kumar and Badri Narayanan Gopalakrishnan

The recently released budget, which coincided with the third wave of Covid-19, encountered a host of problems. Although he dealt with most of these issues pragmatically, experts and business channels focused on the traditional trade-offs between growth and welfare, as well as fiscal conservatism and economic stimulus. A much larger but low-key reform of the country’s customs tax policy occurred amid the typical post-budget brouhaha. The planned changes to the customs tax regime may seem small at first glance, but a closer look at the products reveals a growing convergence between India’s industrial and trade policies, as well as a desire to make India a player in leader in global value chains (GVCs). .

Since the 1980s, advances in communications technology and falling transportation costs have allowed companies to geographically disperse their manufacturing operations, resulting in a decentralized but efficient structure of GVCs. While classical trade theory suggests that countries should manufacture goods in which they have a comparative advantage, the decentralized system created by GVCs has allowed countries to specialize to the extreme and participate actively in world trade by focusing on specific product categories or components. For example, Taiwan significantly controls the semiconductor industry, which is a vital component in the manufacture of all electronic items in the world, but it rarely has a global consumer brand radiating from its territory. Similarly, despite a limited capacity to manufacture intermediate goods, Vietnam is quickly emerging as the ideal destination for the construction of assembly lines for finished products due to its low labor costs and its policies of liberal imports.

According to the World Development Report 2020, GVCs now account for around half of all international trade. The majority of global value chains are controlled by multinational corporations (MNCs), which make strategic investment decisions based on various criteria, the most important of which is the cost of production. While many elements influence the final cost of production, such as land, labor, infrastructure and energy, the import policy (tariffs) has a significant impact on the cost of manufacture within GVCs. In addition, customs duties are a very important factor for countries operating downstream in the value chain.

Within GVCs, countries and firms are classified into two types of value chains: upstream and downstream. Upstream economies are technological leaders and produce high-value intermediate goods that are used in the manufacture of final products. In Asia, Taiwan; South Korea; and Japan are examples of countries in this group. Downstream economies are those that process inputs from upstream countries and turn them into finished products. Labor cost arbitrage tends to benefit downstream economies. Downstream economies are able to attract these end product assembly/manufacturing units to their region by providing appropriate physical infrastructure, liberal import trade policy and business friendly environment. India also currently falls under this downstream value chain. About less than 12.5% ​​of India’s merchandise exports fall into the high-tech category.

The value chain of a downstream country is highly dependent on imports of intermediate goods. Take, for example, the manufacture of bicycles. Bicycles are not high-tech products, but they are widely traded worldwide (45 billion USD). In the global GVC scenario, consider the role of different countries in this manufacturing process. Bianchi (an Italian company) is in charge of designing, prototyping and designing the bikes. Gears, brakes and pedals are all made in Japan. China and Vietnam are the countries that produce the frames. Italian and Spanish saddles are used with French and Italian wheels to make a final bike. As a result, a bike made in the Netherlands, for example, uses 33% of its components from other countries. 13% of them come from the European Union, 11% from Asia, 5% from North America and 4% from the rest of the world.

In the above scenario, a country’s tariffs can play an important role in manufacturing within global value chains. Consider this with another example of a bicycle manufacturing company having to choose between India and Vietnam for an investment in an assembly plant. For manufacturing, the company plans to import 50% of the components and source the rest locally. Assuming all other factors remain unchanged, India has a 10% customs levy on bicycle components and Vietnam has none. In this basic example, the manufacturing cost of the finished bike in India will increase by 5% (50% *10), making India an unattractive investment destination. Table 1, which shows the growing percentage of imported content as a percentage of gross exports, reiterates this point.

Table 1 Import content as a percentage of gross exports

Country 1995 2005 2018
Vietnam 22.9 36.6 51.3
Hong Kong – China 31.6 29.7 30.1
China (PRC) 14.9 22.9 17.8
India 9.6 16.4 19.8
Germany 14.5 20.5 23.6
Singapore 40.1 48.8 47.5
Taiwan 33.9 41.9 39.8

The absence of an intermediates/components manufacturing ecosystem, coupled with high tariffs on the importation of intermediates, were the main causes of India’s low participation in GVCs. The majority of intermediate product production is currently concentrated in high-tech countries such as Japan, Korea and Taiwan. It is therefore natural that high levels of imports of intermediate goods are necessary for India to integrate strongly into GVCs. Vietnam, which is becoming an Asian manufacturing hub, allows far more foreign content in its manufacturing process. The recently announced budget corrects this anomaly.

In recent years, important legacy issues such as land, labor, power and infrastructure have been systematically resolved. Under the auspices of the ease of doing business, procedural and regulatory barriers have also been lowered. In addition, the government has also launched its ambitious Production Linked Incentives (PLI) program providing support to 14 key sectors. Although these reforms have significantly reduced the cost of doing business in the country, trade policy relating to customs duties, which is a substantial cost component within GVCs, has been continuously under-explored. The latest budget takes a bold step in this direction by lowering import levies on intermediate goods for the steel, electronics, leather and jewelery industries. The selection of products and the variable use of tariffs indicate the vision of easing imports of intermediate goods while encouraging the manufacture of low-value manufactured goods (imitation jewelry umbrella and agricultural products). This approach will help India gain a place on the global GVC map by reducing the cost of doing business in GVCs.

(Kannan Kumar is Public Policy Analyst and Dr. Badri Narayanan Gopalakrishnan is Senior Advisor and Head of Trade and Commerce, NITI Aayog, Government of India. The views expressed here are entirely their own and not those of their employer, NITI Aayog. Opinions expressed are personal and do not reflect the official position or policy of Financial Express Online.)

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