Economic Outlook, Prospects, and Policy Challenges

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Box 1.4: Make in India Not by Protecting but by Eliminating Negative Protectionism
Eliminating all the exemptions for the countervailing duty (CVD) will eliminate the negative protection facing
Indian manufacturers, and help the Make in India initiative, without violating Indias international obligations.
There is one response that would help manufacturing and the Make in India initiative without being as difficult
as improving the business environment, and as controversial and expensive as the industrial policy or protectionist
response: eliminating the exemptions in the countervailing duties (CVD) and special additional duties (SAD) levied
on imports. Why will this help?
It is a well-accepted proposition in tax theory that achieving neutrality of incentives between domestic production
and imports requires that all domestic indirect taxes also be levied on imports. So, if a country levies a sales tax,
value added tax (VAT), or excise or GST on domestic sales/production, it should also be levied on imports.
Indias current indirect tax system, however, acts sometimes to favour foreign production over domestically produced
goods.
The CVD, which is levied to offset the excise duty imposed on domestic producers, is not applied on a whole range
of imports. These exemptions can be quantified. The effective rate of excise on domestically-produced non-oil
goods is about 9 percent. The effective collection rate of CVDs should theoretically be the same but is in actual fact
only about 6 percent. The difference not only represents the fiscal cost to the government of ` 40,000 crore, it also
represents the negative protection in favour of foreign produced goods over domestically produced goods.
Three important nuances need to be noted here. First, it might seem that CVD exemptions on inputs help manufacturers
by reducing their input costs. But under the current system and in future when the GST is implemented, the CVD on
inputs can always be reclaimed as an input tax credit. So, CVD exemptions do not provide additional relief.
The second relates to a situation when both the excise and CVD are both exempted. This may seem apparently
neutral between domestic production and imports but it is not. The imported good enters the market without the
CVD imposed on it; and, because it is zero-rated in the source country, is not burdened by any embedded input
taxes on it. The corresponding domestic good does not face the excise duty, but since it has been exempted, the
input tax credit cannot be claimed. The domestic good is thus less competitive relative to the foreign good because
it bears input taxes which the foreign good does not.
Third, the rationale advanced for exempting many imported goods from CVD is that there is no competing domestic
production. This argument is faulty because the absence of competing domestic production may itself be the result
of not having the neutrality of incentives that the CVD creates. Domestic producers may have chosen not to enter
because the playing field is not level.
Indian tax policy is therefore effectively penalising domestic manufacturing. How can this anomaly be remedied?
Simply by enacting a well-designed GST preferably with one, internationally competitive rate and with narrowly
defined exemptions. In one stroke the penalties on domestic manufacturing would be eliminated because the GST
(central and state) would automatically be levied on imports to ensure neutrality of incentives. In effect, India would
be promoting domestic manufacturing without becoming protectionist and without violating any of its international
trade obligations under the World Trade Organisation (WTO) or under Free Trade Agreements (FTAs).
In the meantime, the effect of the GST can be partially simulated by eliminating the exemptions applied to CVD. The
default situation should be an exemptions-free regime. If particular sectors seek relief from the CVD, they should be
required to make their case at the highest political level.
In a sense, India finds itself in a de-facto state of negative protection on the one hand, and calls for higher tariffs on
the other. It is win-win to resist these calls that would burnish Indias openness credentials and instead eliminate
unnecessary and costly negative protection.

later, stabilizing at around 5 just prior to the financial

crisis. Thereafter, it has been in steady decline and
the most recent estimate suggests a buoyancy of
27

one. The pattern is broadly similar for manufactured

exports, although it was less buoyant than services
in the boom phase.27

The declining elasticity of global trade to global growth is documented in Constantinescu, C., A Mattoo and M
Ruta (2015) The Global Trade Slowdown: Cyclical or Structural? World Bank Policy Research Working
Paper, WPS-7158.