In a speech at an industry body function on May 17, the CEO of NITI Aayog (CNA) shared insights on India’s possible path forward on tariffs, free trade agreements (FTAs), non-tariff barriers (NTBs), emerging trade issues, the EU’s green measures, global value chains (GVCs).

These suggestions ignite a debate about what is best for India. Let’s examine each suggestion in the light of prevailing global and Indian practices.

Tariffs

CNA said India should pursue low tariffs to join GVCs. Most trade economists agree. However, we have both positive and negative examples of impact of tariff cuts on manufacturing and trade.

Globally, low tariffs led to the shutting down of most manufacturing in the US and EU and increasing reliance on imports from China. Now, wanting to make critical products at home, the US has regularly increased tariffs and other restrictions since 2018, especially on Chinese imports. The US now uses high tariffs and subsidies to boost local manufacturing, a strategy India is also adopting.

Indian tariffs are on the higher side compared to developed country averages. Over the past decade, India’s simple average tariffs have risen from 13 per cent to 18.1 per cent. But a simple average tariff is not a good measure as it ignores trade values. So, what are effective tariffs in India?

In FY 2023, the government collected ₹2,18,680 crore in customs duties on imports worth ₹57,49,801 crore, indicating an effective import tariff of 3.8 per cent. This rate is low because imports used as inputs for exports are not charged a tariff, but tariffs are high for the same products when imported for domestic use.

High tariffs on raw materials have a cascading adverse impact on the economy, but we are not in position to eliminate high tariffs on crude oil and many industrial raw materials.

In India, high tariffs worked well for many sectors. India became a small-car hub due to high import duties (70-125 per cent) on automobiles and lower duties (5-15 per cent) on auto components. Conversely, Australia saw the disappearance of all car makers when it gradually cut import tariffs from 45 per cent in the early 1990s to 5 per cent, 10 years later.

Any talk of lowering tariffs hits a roadblock of possible disruption in schemes like the Production Linked Incentive, which work on tariff arbitrage. For instance, smartphones have a 20 per cent tariff, while most components have 7.5-10 per cent.

Today, about 85 per cent of customs duty collections come from less than 10 per cent of tariff lines, while the bottom 60 per cent of tariff lines contribute less than 3 per cent of revenue. With some work, we can reduce the average import tariff from the current 18.1 per cent to less than 10 per cent without affecting important products. An inter-ministerial exercise may be carried out to simplify tariff structure and also avoid adverse global glare. Remember, Donald Trump called India tariff king.

EU’s carbon tax

CNA said the EU CBAM is not intended to hinder trade and urged domestic industries to adapt to these changes to remain competitive. Let us see the counterpoint.

CBAM, when fully implemented, will result in a 20-35 per cent import tax on Indian firms. A firm has to share all plant and production details with the EU. Also, firms may need to run two production lines to be effective. Expensive yet greener products for exports to EU countries and standard products for rest of the world.

CBAM is one of at least five EU measures hitting trade. Indian firms must comply with EU requirements. But government must hit imports from the EU in equal measure.

Labour, environment

CNA said that labour, environment, and similar issues are integral to society, and if societal conditions impose standards in these areas, the Indian industry must adapt to remain competitive.

Higher environmental standards of the US or EU are designed for domestic application in countries with a per capita income of $50,000. The problem lies in forcing countries with a per capita income of $2,000 to adopt these, which will halt most economic activities.

Developed countries often use these standards to restrict trade. For instance, the United States-Mexico-Canada Agreement (USMCA) prescribes that an auto component must be made by workers earning at least $16 per hour. This disqualifies all such production in Mexico, where the minimum wage is $8 per hour.

India cannot afford to implement the same stringent labour and environmental standards as advanced countries. It must evaluate whether it is ready to make binding commitments in new domestic policy areas such as the environment, labour, gender, digital trade, data governance, and more.

Global value chains

CNA underscored the need to reduce tariffs and streamline procedures to integrate into GVCs. We notice that despite offering zero-tariff access to most industrial product imports from ASEAN, Japan, and South Korea for a decade, India has not become a significant part of GVCs. An important reason is long port clearance times and a low ease of doing business.

Free trade pacts

CNA advocated the need for India to sign more FTAs with key trade partners. The Secretary of the Department for Promotion of Industry and Internal Trade (DPIIT) also stressed this point. India has 14 FTAs with 22 countries and is now negotiating new FTAs with 49 more countries.

Before moving ahead, we must know if our past FTAs have benefited us and if there are lessons from these in new FTAs.

Trade economists suggest that to boost growth, a country should lower import tariffs, create more free trade agreements (FTAs), and integrate into global value chains (GVCs).

However, these strategies will only be effective if the country first reduces costs and improves its business environment.

Currently, high tariffs prevent India from joining GVCs, but simply lowering tariffs without improving business conditions could result in more imports replacing local manufacturing. Serious efforts are needed to enhance the business environment to benefit from these trade strategies.

The writer is the founder, Global Trade Research Initiative