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Government Hikes Custom Duty, But to What Effect?

Professor of Financial Economics and Part-time Value Investor, Transfin.
Oct 16, 2018 11:01 AM 3 min read
Editorial

Last week, in an attempt to rein in the country’s widening current account deficit (CAD) and shore up the depreciating Rupee, the government increased custom duties on telecom equipment including components for mobile devices. The move comes shortly after the Centre hiked import duties on 19 non-essential goods last month, including air conditioners, washing machines, refrigerators and aviation turbine fuel (ATF).

 

Here’s discussing how the imposition of these import duties may or may not be able to achieve their said objective, that is, bridge the widening CAD.

 

Let’s begin with some background.

 

For the first time in over six quarters, the balance of payments turned negative in the April-June quarter – reporting a deficit of $11.3bn, compared to a surplus of $11.4bn last year. The Rupee has lost more than 13% since the beginning of this year.

On back of escalating crude oil prices, higher interest rate environment in the US, and instability in the global economic order (IMF lowered global growth estimates for 2018-19 to 3.7% as opposed to a previous estimate of 3.9% in April, citing “rising trade protectionism” and the effects of US-China trade war), the Indian Rupee has lost more than 13% since the beginning of this year, hitting an all-time low of 74.45 against the US Dollar last week.  

 

In an attempt to rein in the widening CAD and curb the outflow of foreign exchange from India, the Government recently announced an increase in custom duties on 19 non-essential goods. This included air conditioners, washing machines, refrigerators, ATF and even footwear.

These items accounted for an import bill of over INR86,000cr ($11.8bn) in FY2017-18. With an increase in the import duty, the prices of these goods are expected to rise, dampening demand, thereby lowering imports. Considering the average spike in proposed new custom duties amounts to 5-6% on a potential import bill above INR86,000cr (assuming FY2018-2019 to bring in atleast as many imports as FY2017-2018), the relief would amount to $600-700mn, fairly marginal vs. the total.

 

Shortly after, the government announced a 10% increase in import duty on 15 items on telecom equipment including components used in mobile phones.

Interestingly, mobile phones and their components make up the third-biggest chunk of import bill after crude oil and gold.

 

However, it remains to be seen as to how effective the second spike would be.

 

Many items included in both the lists are price inelastic. For instance, the list of 19 non-essential items included a 5% import duty on ATF. Integral to the aviation industry, it is unlikely that its import can be slashed.

No wonder in retrospection, the government reduced excise duty on ATF to 11% from 14%, resulting in an effective increase of 2% in price.

Some other items like parts of precious metal, cut and polished diamonds are eventually used for exports.

To that extent, a hike in import duty may end up exerting inflationary pressures on the affected industries. Furthermore, with the festive season in the offing, it is likely that consumers will buy more of the “non-essential” goods such as air conditioners, washing machines, refrigerators and footwear.

 

Moreover, CAD is not just reflective of the imbalance in import and export. It should be viewed as an imbalance in the savings and investment of the country. Any attempt to bridge the gap should see efforts across all three fronts – monetary policy, fiscal policy and exchange rate.

 

While some steps have already been taken to this effect such as removal of 20% exposure limit of FPI's corporate bond portfolio to a single corporate group, exemption from withholding tax for Masala bond issuance for the current fiscal year and introduction of an NRI bond, they appear mere band-aid solutions in the grand scheme of things.

 

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