High manufacturing costs may erode India's gains from reforms, trade deals

What should we do to address the tariff challenge? The problem is a symptom of a deeper underlying issue: Our farms and firms are simply not productive enough, and the cost of business is not low enough for global markets. Solve this problem, and others will become redundant. 

 

Post-tariffs, a slew of reforms have been proposed by many commentators, and indeed almost all of those would be welcome. A range of global trading agreements, whether bilateral or regional, have also been proposed and those are welcome as well. But how would the government address the underlying problem — that of lower productivity and higher costs? This problem causes the government to take a defensive stance in global interactions, protecting our productive entities rather than promoting them globally. If we don’t solve this, make Indian producers competitive, all global agreements will eventually become quite pointless.

 

So what should the policymaker do?  First, recognise that we can’t do everything at once. Policy needs to focus, achieve early successes, build momentum, and then expand its scope. I would start with strengthening the firms that are the most productive and globally competitive — these happen to be the exporting firms and also the ones most impacted by Trump tariffs.  Second, I would focus on a few sectors where early gains are possible. Interestingly, most of these sectors are highly labour-intensive. And finally, the hard part of reforms has to be done. But even there, we would achieve greater success by focusing on a few elements rather than attempting systemic reforms all at once.

 

There can be no doubt that with the 50 per cent additional tariffs, many businesses are going to see an immediate fall in orders, and even those that have long-term contracts will be unable to meet the tariff requirements. Revenues will fall and many production lines will need to be paused, and some units will be forced to close down. Bankers will resort to tightening credit and working capital allocations to the impacted sectors. What makes it more unfortunate is that the firms most hurt will be the ones that are more efficient, export more, and are better able to compete globally.

 

There are a few micro and macro mechanisms for these exporting firms, including lower or no tariff on their imports, and loan repayment holidays.  Another option could be for the government to absorb the US tariffs on a time-bound basis, until firms are able to find alternative markets. Taken together, the hit on the exchequer cannot be more than $20 billion. Make these benefits available for a year and you have given the best of Indian businesses breathing space to do what they do best — compete in global markets.  

 

Having taken care of the immediate, adopt a focused approach to sectoral policy for the medium term. Among the sectors worst hit by the tariffs are apparel, jewellery, shrimp farming — perhaps fisheries in general — footwear, light engineering, furniture, handicrafts, and a few others. Almost all are highly labour-intensive, and it is encouraging that at least some Indian firms in these domains are efficient enough to compete globally.

 

How would we support these sectors? Ensure that the exporting sector’s inputs are free of tariffs. Remember the firms that they are competing against in global markets are receiving these same inputs at low duties and with few government hurdles. Second, in interactions with the United States, Russia, China, the European Union, and developing countries such as Brazil, Indonesia, I would open up Indian markets in areas where India is less competitive. Note that all geoeconomic negotiations today are as much about imports as they are about exports, and imports can be a powerful negotiation tool, as Donald Trump has just taught the world. If India does need to import, it is better to import products where Indian firms are relatively less productive. This will help support the downstream units be more competitive in global markets

 

Third, the cost of business is high in India and this needs to be addressed. One way is to reduce the value of the rupee enough to price away India’s inherent inefficiencies. This will mean rupee devaluation. The problem with devaluation is that the advantage remains only for a little while. Eventually the inefficiencies will eliminate that benefit. Another option is to provide targeted subsidies with a sunset clause, similar to the production-linked incentive (PLI). But how many products can the government support this way, and for how long? PLI appears to work better for units with a single product; therefore, it may not be as effective for items such as garments and jewellery, where products are highly varied.

 

The most difficult and yet the most powerful part of India’s focused approach will be costs. Over the past decade, the government has made many all-round efforts at creating a better business climate. Yet manufacturing investment has been found wanting. The ease-of doing-business (EoDB) efforts dealt with many parameters and sub-parameters.Yet more remains to be done. Take any representation from industry, and the checklists of what is required run into hundreds of items. This strategy towards greater EoDB is clearly not going to work for what India needs.  In the long run, India has to work on the cost of doing business (CoDB) by reducing both direct costs and business uncertainties. What might these include?

 

One, on labour: India has to empower businesses by eliminating the Industrial Disputes Act (IDA), especially the part constraining owners from rationalising workers, and replace it with unemployment insurance. Protect the workers’ consumption, not their job.

 

Two, on land: Land is expensive in India, large parcels are difficult to access, and facilitative infrastructure is mostly missing. An industrial parks (IP) policy is critical, where land costs are absorbed by the government but industrial parks compete with one another on the services they provide to their units.  Currently, most are run by government departments, this asset needs to be unlocked and new IPs need to be created near major demand and service centres for MSMEs to become low-cost productive powerhouses.

 

Three, legal delays: In India, they significantly ramp up the cost of doing businesses. Such delays should not be acceptable in any civilised society.  While we need three times more judges and courtrooms, we also need the judiciary to take responsibility and give far fewer adjournments, and avoid frivolous cases, reducing them at least by a factor of four.

 

Four, electricity costs: India needs to let everyone pay the actual cost, rather than overcharging manufacturing and subsidising other sectors, including households.

 

And finally on cost of capital: Why do banks have such high margins, or why do tax authorities go overboard on reassessments?  Who would take responsibility over the cost build-up because of these?

 

In sum, India needs to focus on a few things and clean up the clutter that stands in the way of productive low-cost farms and firms. If we cannot do that, then high costs will eventually negate all the good that ease of doing business or international trade agreements can potentially bring.

 

The author heads CSEP Research Foundation. The views are personal