Exports and economic growth go hand in hand. India’s most recognised period of economic growth after the 1991 reforms saw exports rise from just 7% of GDP to 25% over 20 years. Poverty fell from 50% to 20%. The rapid growth phases of every country in the recent past have shared this feature.
Being competitive in the global market requires sellers to keep costs as low as possible, especially for inputs and raw material, as these often make up a substantial proportion of the cost. Since many inputs may need to be imported, the cost must stay low even if the source is a different country. China, a country hailed as an export powerhouse with over $3 trillion in exports, also imports about $2.5 trillion worth of goods.
Economists have thus long pointed out the detrimental effect of import tariffs on a country’s exports as they make local exporters less competitive. Instead of cutting tariffs, policymakers have offered duty drawbacks as a “trusted and time-tested scheme…to promote exports.” But what are duty drawbacks and are they a solution for exporters?
A mobile phone maker who imports key components and assembles them in India for export would get a percentage of the export value as the duty drawback. There are three key issues with duty drawbacks that prevents them from working as intended: the amount recovered, the time taken and the opaque nature of the process.
The first issue with duty drawbacks is the limited amount of duty recovered. The exporter can opt for an All Industry Rate which is calculated every few years based on a weighted average of the duty paid on the material that makes up the exported good. For example, the drawback rate for mobile phones is 4%, along with a cap of INR 350 per unit. On a phone with an export value of Rs 30,000 this cap results in an actual drawback rate of just over 1%. Given that import duties on mobile phone components are often in the range of 15-20%, the rate is insufficient to recover the duty paid.
For exporters not satisfied with this rate, there is an option of the “Brand Rate”, which is a special exporter specific rate that can be applied based on certain conditions and should be fixed within a month. A CAG report from 2011 noted a delay in 96% of Brand Rate cases in Mangaluru with the average time taken to fix a Brand Rate being a year. In fast moving industries with complex global supply chains, such delays make India a very uncompetitive place to do business in.
Another significant issue is the delay in settling a drawback claim. While all drawbacks must be paid within one month in theory, the same CAG report found significant delays. In Andhra Pradesh, half of the 10,000 cases were processed in more than three months, with one-fifth of these claims taking longer than a year. Such delays in settling duty drawback claims tie up crucial working capital for exporters.
The final issue with the scheme is the overall difficulty in finding information related to it. Various government and private sources have separate lists of documents needed to apply for the scheme, with some listing 17 different documents. Moreover, there is little clarity on when the AIR is revised and often the latest revisions are difficult to find. Given the issues surrounding duty drawbacks, they are not the best solution for exporters.
How to promote exports, then? The solution is hiding in plain sight. Reduce tariffs on imports of equipment and parts and help build an eco-system that increases the competitiveness of Indian exports.
Increasing exports will scale-up domestic ecosystems, just as they did in Vietnam. From 2001 to 2010, their tariff rate on manufactured imports more than halved from 16.6% to 6.6%. From 2010 to 2020, their high-tech exports as a share of total manufactured exports went from 13% to a staggering 42%. There is no reason why India cannot emulate this.
(The author, Yuvraj Khetan, is Senior Programme Associate, Foundation for Economic Development)