R
ecently the US raised concerns at the World Trade Organisation on issues relating to a number of export subsidies provided by India to its industries, which the U.S. argued were prohibited under the Agreement on Subsidies and Countervailing Measures (ASCM). The US in March 2018, challenged five Indian export-related subsidies: (1) the Export Oriented Units Scheme and sector specific schemes, including Electronics Hardware Technology Parks Scheme, (2) the Merchandise Exports from India Scheme, (3) the Export Promotion Capital Goods Scheme, (4) Special Economic Zones, and, (5) Duty-Free Imports for Exporters program. A decision by the US to establish the Dispute Settlement Panel at the WTO has now led to the next step that is the composition of the Panel. This Panel, established on 23rd July 2018 by the WTO Director General, will address the issue of India’s export subsidies in general (i.e. for all industrial sectors). However, for textiles and apparel, the situation is different from other export subsidies.
An analysis by the WTO Secretariat in 2010 showed that India had reached export competitiveness as defined in Articles 27.5 and 27.6 of the ASCM, viz. a share of at least 3.25% in world trade of a product for two consecutive years (see Annex 5 for the text of these Articles). Under these provisions, when a developing country has reached export competitiveness in one or more products, export subsidies on such products have to be removed over a period of eight years. The minutes of the Committee on Subsidies and Countervailing Measures record India’s agreement to phase out export subsidies on textiles and apparel by end-2018 (see Annex 6). While it may be possible to extend these subsidies for some time, especially as India’s national elections are due around the beginning of 2019, these subsidies will have to be phased out in the not too distant future. The export subsidies that will be phased out will have to be replaced by new or improved schemes that are consistent with WTO.
This is a crucial time for the Indian apparel sector as it has experienced a significant decline in exports, and several factors relating to its major competitor countries make India less competitive. For example, as an LDC, Bangladesh has duty free access to a number of international markets, including the EU, until about 2023. Similarly, Vietnam’s Free Trade Agreement with the EU will begin phasing-in duty free access of Vietnam’s exports to that market. In addition, each competing country provides significant subsidies to their exporters of apparel. Taking account of the various factors which result in erosion of competitiveness for India’s exporters, this report has calculated that if tariff preferences, subsidies and other operational factors of competing countries are aggregated, India’s disadvantage may be as much as 17-19%.
On the other hand, India has a big opportunity as China’s global market share has decreased, creating space for India. However, India’s competitor countries have been able to take greater advantage of this gap by increasing their market shares. Last fiscal year (2017-2018), India’s exports of garments fell by 4% in US$ terms, while those of Bangladesh went up by about 10%, and of Vietnam by about 8%. While introduction of GST and a shrinking UAE market may be significant reasons for India’s immediate export decline, there are a number of structural issues that need to be addressed to provide a positive momentum to India’s apparel exports.
This paper has simulated two scenarios; one, the impact of removing the prohibited export subsidies presently provided to Indian exporters and the second, where support that the Report suggests, is put into effect. The estimated effects of removal of export subsidies that have been challenged in the WTO, are as follows:
- Exports from the Indian apparel sector fall by 5.9%; they range between 5.6% and 6.3% for different destination countries.
- Output from the Apparel sector in India falls by 2.63%
- Employment in the Apparel sector falls by 2.71% in unskilled labour and 2.58% in skilled labour.
- Cost of production of apparel that gets exported, rises by 1%
- Prices of apparel increase by 0.08% (while we may expect a fall in prices, it increases because of the cost pressures shown above).
- GDP falls by 0.03%.
- National employment of unskilled labour falls by 0.06% and skilled labour falls by 0.04%.
Thus, in this difficult phase, a removal of export subsidies will further exacerbate the Indian industry’s delicate situation for apparel. These subsidies need to be replaced by new, WTO-consistent subsidies. In addition, the new subsidy schemes and facilitation policies have to be made more efficient and effective. At the same time support has to be commensurate in impact, compared to that given by other countries, even if the exact nature and amount are not the same.
The recently introduced GST scheme has led to a reduction of financial support and incentives that were provided earlier. This and the delay in GST refunds have added to the cost of the garment exporter. Credit crunch from late refunds of GST and rebate of state levies (ROSL) is a major burden, especially for many small producers, who constitute a very large part of the industry. Back of the envelope calculations show that overall costs may have increased by around 2-4% if we assume a three-month delay in GST disbursement to garment exporters. However, garment exporters have reported that between 7-9% of their FOB value is stuck because of late GST refunds. Lower rates of refunds under the duty drawback and ROSL schemes, as compared to the pre-GST period, mean that manufacturers and exporters are now more vulnerable to market fluctuations, as they are working on very thin profit margins.
In addition, there are long and complex procedures in place that require considerable time, cost and effort to avail subsidies in India. A common concern of firms is that even though the system has been digitised and thus simplified in principle, firms have to approach consultants to help them manage the complex processes and transactions. This leads to further inefficiency in the performance of the industry. Many firms complained of increased administrative costs and a lack of efficient interconnected or consistent system operated by the main Government agencies involved in trade policy and processes, including databases operated by different institutions. Small firms were of the view that the effort to claim subsidies cost them up to 3% of the total subsidies due to them.
Other major issues faced by exporters include relatively high labour and infrastructure costs. In this context, it is significant that the productivity of Indian labour is low and thus productivity adjusted wages are higher in India than in Vietnam or Bangladesh. As compared to its competitors like Bangladesh, the Indian industry is at a disadvantage even in terms of absolute wage levels. Companies have mentioned labour laws as barriers for export, especially to establish a large scale of production that enables better links with export markets. At present, some States have introduced a number of financial and institutional support policies. It would be useful to learn from the implementation of such policies and examine ways of making them simple and more effective. Policy lessons and insight can also be developed from the practices of India’s main competitor countries, such as Bangladesh, China and Vietnam. This Report has focused on both these aspects.
It is imperative that skills and technologies be improved in the sector for both larger employment and greater competitiveness. This requires subsidies for training workers, to reduce costs, enhance labour skills and productivity, and expand to new markets emerging due to changes in demand patterns and new types of fabrics and garments. Financial support could be provided also to reduce the incidence of costs on account of important inputs such as labour, electricity and costs and delays due to inefficient logistics. Customs and clearance procedures in India are more time consuming than in countries like China. For example, the movement of apparel, made-ups and textiles from China’s Xinjiang province to Shanghai for shipment outwards takes 4-5 days from end to end (from mill to ship leaving the port), compared to 10+ days in the Indian context.
Another barrier to the apparel sector in India arises due to fragmented production chains amongst clusters. There is little or no clarity for the buyers when it comes to identifying the clusters in terms of specific products that they want. Competing countries like Bangladesh and China offer clear understanding of the products they can deliver. Furthermore, whereas 80% of Indian exports are from firms with a turnover of less than 250 crores, 80% of China’s exports, and most of Vietnam and Bangladesh’s exports are from firms with a turnover of over 250 Cr. The turnaround time required to meet an export order is roughly double or sometimes triple that of Vietnam and China, and roughly one fourth more than Bangladesh. This not only adds to the cost but also makes India uncompetitive in the export market.
Bangladesh, China and Vietnam support their apparel industries through a variety of financial support programmes. In general, these subsidies aim to achieve the national objectives that are emphasised as part of the development policy of the country. Unlike India, its main competitors like Bangladesh, China and Vietnam emphasise exempting or sharply reducing income tax. This is normally done for new investment, with emphasis on investment which meets certain important national objectives. In addition, these countries facilitate the remission or exemption of indirect taxes, including import tax and VAT.
Most of the subsidy regime in Bangladesh is oriented towards enterprises under the “Free Trade Zone Regime”, which is the mainstay of Bangladesh’s export and investment promotion strategy. This regime provides specific incentives to those who are eligible to participate in the zones. China has emphasised the apparel sector for employment, domestic value chain and export growth for about three decades. Support to apparel is provided both by the central government as well as the provincial government, sometimes with an overlap. In the case of China, such support is provided by policies specific to the sector, or by policies that are aimed at broader objectives, at times not directly focused on the sector. For instance, subsidies provided for employment of migrants from rural areas may not be directly connected with textiles and apparel, but these sectors are the obvious choice for support under the objective of employment generation due to its low training requirement and relatively higher employment per unit investment. Likewise, subsidies provided to high technology industries, energy-saving or environmental protection projects, and the infrastructure sector also benefit inter alia the apparel sector. Thus, the apparel sector is a significant recipient of subsidies which aim at employment, regional development and building domestic value chains. Certain categories of apparel are part of the encouraged industries under the national Catalogue of Industries for Guiding Foreign Investment. Apparel has much more comprehensive emphasis under certain regional initiatives, for instance under the Catalogue of Priority Industries for Foreign Investments in the Central and Western Region.
Vietnam’s major incentives are focused on investment promotion in specified sectors, economically weak geographical regions, large scale of operation, provision of high levels of employment, or to encourage important high technology areas. Examples of their key investment incentives include inter alia:
- Exemption or reduction of corporate income tax for considerable periods of time
- Exemption or reduction of import tax on goods imported to create fixed assets, raw materials, supplies and parts used to implement the project;
- Exemption or reduction of land rents, land levy and lower power costs.
In the case of both China and Vietnam, the Provinces play a significant role in determining and providing financial and other support to the industry. The final decisions reached on subsidy provided depend on specific negotiations and may be company- specific and not entirely transparent.
Costa Rica is among those countries which have actually phased out its export subsidy regime and introduced WTO-consistent subsidies some years ago. The subsidies in Costa Rica are provided to encourage a number of national objectives, like employment, regional development, exports and encouraging certain important sectors. The steps taken to introduce WTO-consistent subsidies include:
- Changing the eligibility criteria for companies admitted to a new concept of “Free Trade Zone Regime” (RZF). The benefits were decoupled from export performance. The decoupling was achieved by introducing a new category of processing companies which may belong to the Free Trade Zone, irrespective of whether or not they export.
- The coverage of RZF includes groups of companies that are not limited to a geographical region. These companies are eligible for the specific incentives and benefits granted by the Costa Rican government if they make new investments in the country and meet certain specified criteria relating to investment level, employment and improving the possibility of investment in preferred areas that are the focus of dispersion of economic activity.
- The minimum amount of investment required for getting the incentives depends on the company’s location, either within or outside an industrial park, or outside or within the established Expanded Greater Metropolitan Area.
- Differentiated tax incentives encourage businesses to invest in less developed areas and to make large-scale investments.
- Tax credits for staff training.
- In addition, policy support is provided to reinforce production chains and develop local suppliers.
Based on the experience of these countries, the Report suggests that India focus on some key objectives, such as promoting:
- Jobs, with an emphasis on Female Employment
- Large Scale of operation
- Meeting relevant compliance requirements that enable better possibility of linking up with international value chains
In this background, this Report suggests establishing the eligibility criteria to get financial support as follows:
- Firms meeting compliance criteria, in particular the conditions specified in domestic law for operating within India.
- Emphasise employment objective by starting by focusing on industries with above average employment per unit investment for the manufacturing sector, with industries defined at NIC 2-digit categories from NIC 10 to NIC 33.
- Within this set of Industries (excluding tobacco products), begin by focusing on the industry with the highest share of female employment in total employment. This is the apparel industry.
- Create another category of support in terms of firms with a large scale of operation. The minimum number of employees to qualify for scale would be 250 for each firm in non-urban area and 300 in the urban area.
Two alternative financial support schemes are suggested. One will replace the percentage subsidy on f.o.b. exports to a subsidy provided as a percentage of an “eligible turnover” of the firm. The eligible turnover would be calculated in terms of the average turnover per employee for the industry multiplied by the number of EPF registered employees of the firm. The other option for financial support would aim to partially reduce the cost burden for wages, training, housing and transport of labour, R&D and product development, compliance with standards, cost incurred due to logistics and delays, interest and capital cost for equipment and working capital, and technology upgradation.
Based on the suggested policies for financial support, the Report has carried out a second set of simulations to examine the impact of these suggested support policies mentioned above. The results are as follows:
- Exports from the Indian apparel sector increase by 6.8%; they range between 6.5% and 7.3% for different destination countries.
- Output from the Apparel sector in India rises by 2.98%
- Employment in the Apparel sector rises by 3.15%for unskilled labour and 3.08% for skilled labour.
- Cost of production of apparel that gets exported, falls by 1.03%
- Prices of apparel decrease by 0.15% (while we may expect a demand-pushed rise in prices, they decrease instead because of the lower cost pressures shown above).
- GDP rises by 0.03%.
- National employment of unskilled labour rises by 0.07% and skilled labour rises by 0.05%.
Thus, replacing WTO-inconsistent subsidies with those suggested in the Report would enhance exports, reduce costs and promote employment. In that sense they would be ‘smart subsidies’ and close to ‘revenue neutral’ too.
Implementation of the subsidy scheme would be by the agency designated by the Ministry of Textiles. The subsidy could be distributed for instance in the form of scrips or certificates distributed by the Textiles Commissioner or the DGFT. These scrips or certificates could be used for paying direct and indirect taxes by the firm concerned.
A simple and timely implementation mechanism cannot be over-emphasised. For this, the industry associations in close collaboration with the Government, should monitor the difficulties that arise in practice. This would help evolve robust processes to address implementation issues as they arise.