Disrupting international trade through technology and a few policy level changes

Are we ready for the GST roll out? This is the billion dollar question consuming citizens across the country as they prepare for the long-awaited tax reform. Mamtha Reddy,Head of Government and Public Sector at Centre for Executive Education at ISB recently had the opportunity to interact with Ajay Srivastava, an ISB alumnus from the Founding Class, who offered some insights into making India Inc. GST ready and combining it with a well articulated ‘Make in India' strategy.

In the early days of his career as Indian Trade Service officer (Group A Civil service), Ajay was part of the team implementing trade policy reforms during the India’s economic liberalisation experiment. After two decades of service, Ajay joined ISB with the expectation of interacting with the some of the brilliant minds in the world of academia. He recollects being overwhelmed by the experience: “It was like drinking water from a fire hydrant”. This is perhaps why, during our interview, Ajay expressed his view that “a healthy engagement between academics and policymakers is essential to the provision of informed, focused, world-class policymaking”.

Post-ISB, he continued his career in the Indian Trade Service, but with a change in his assignments.  Today, Ajay is part of India’s negotiating team for the WTO and Free Trade Agreements. He is currently part of the team responsible for foreign trade policy formulation and GST implementation for exporters.
He has recently authored a book titled “The GST Nation – A Guide for Business Transformation”.  He is also starting a Master Series though a leadership column on this subject, which will be published by The Times of India. We asked Ajay for his insights on how policy reform can help to make India globally competitive in manufacturing and foreign trade.

Mamtha Reddy, Head of Government Relations at Centre for Executive Education at ISB in conversation with Ajay Srivastava, PGP Alumunus, Founding Class. Mamtha has also guest edited the July - September 2017 edition of Alma Matters.

“Make in India” strategies

Mamtha : There is lot of buzz around “Make in India” strategies and boosting foreign trade at the same time. What is the missing link in India’s manufacturing story today?

Ajay Srivastava :  The finance minister, while delivering this year’s budget address, grimly observed, “Our third major challenge is that manufacturing has declined from 18% to 17% of GDP as per new GDP data, and manufacturing exports have remained stagnant at about 10% of GDP.” While everyone agrees that manufacturing requires an enormous thrust to reach 25% of GDP by 2025, do we miss something vital while discussing solutions? 

A comparison of India’s manufacturing sector with those of China, Germany, Japan, Malaysia or Thailand provides the clue. Indian manufacturing is marked by its near non-participation in most of the global value chains (GVCs). India does not manufacture most electronic, telecom or high-tech products as manufacturing of these products requires participation in GVCs. India imports these in large quantities.

Becoming part of high value-added activities of GVCs is critical for Indian manufacturing as the products manufactured in GVCs constitute a 70% share of world trade in non-fuel manufactured products. However, we have rarely explored serious participation in GVCs as a policy option.

About GVC Operations

Mamtha : India does not participate in GVCs due to issues around quick export-import clearances. Why is this critical to GVC operations?

Ajay: Manufacturing of most technology products is a multi-stage process involving production collaboration among firms located in several countries. To ensure an efficient production process, the system binds all participants to just-in-time production and supply schedules. This requires quick export import clearances at each stage. Any delay at one port or customs may disrupt subsequent stages of production. Obviously, both the defaulting firm and country may risk being tossed out of the network in such a scenario. 

The message is clear. A country cannot think of participating in GVCs unless it has a high-quality customs and port infrastructure capable of providing fast export/ import clearances. China, Japan, South Korea, Thailand and Malaysia have become technology products manufacturing nations through the quality trade infrastructure route. India could not, as it does not meet the benchmarks for efficient entry/exit at most ports and customs.

Ensuring Ports/ Customs deliver at world-class benchmarks

Mamtha : How can we ensure that our ports/ customs deliver at world-class benchmarks? 
Ajay : The task can be accomplished in project mode through dedicated teams drawing experts from government and private sectors. Three steps will radically improve the system:

1. Make all export/ import services available online with minimum human contact and clear export/ import consignments in less than a day. Despite large-scale connectivity, hundreds of ports, airports, customs stations, central excise offices, inland container depots and container freight stations are still not connected and rely on standalone processing and manual documentation. We are far away from the integrated, paperless environment required for faster clearances.

We should be under no illusion; incremental approaches, limited scope single windows and quick fixes may improve ease of doing business to some extent but will not create the conditions essential for participation in GVCs.

2. Allow green channel clearances based on self-declaration at the factory and port. This will ensure quicker transactions and better use of infrastructure. We may make a beginning by scanning the profile of the top 11,000 exporters that account for 85% of India’s exports. For defaulters, the penalty may be kept steep.

3.  Upgrade physical facilities at the five major ports so they meet the global best parameters in timely delivery. Also, set up three new world-class port-cum-industrial complexes. These will be the new manufacturing-cum-export hubs for technology products, free from the limitations of weak domestic infrastructure. China benefitted from this model and, as a result, products in China travel only a third of the distance that products in India do between factory and port.

Aggressive revamp of the trade infrastructure will create the necessary conditions for India’s participation in GVCs. This will spur domestic and foreign anchor firms to set up manufacturing facilities for production of not only electronic and telecom equipment but also high-end engineering and complex machinery. A large domestic market, competitive vendor base and advanced R&D capabilities will help India-based firms target higher value-added areas of operations. With multinationals’ compulsion to relocate production elsewhere as China becomes expensive, this is an opportunity India cannot miss.

About GST

Mamtha : GST is effective from July 1, 2017.  Can you share your thoughts on how to combine GST with a sharp “Make in India” strategy to convert India into a global manufacturing hub?

Ajay : For most industrial products, GST rates have been slated at 18%. Today, a manufacturer pays about 28-30% as taxes, so this means an average saving of around 10%. The lower tax rate is not the only benefit GST offers.

It will provide a push to manufacturing in three big ways.

1.       GST replaces eight central and nine state taxes such as central excise duty, service tax, state VAT and entry tax. This means the end of an era of multiple taxes levied at central, state and local levels, each with a different tax compliance system.

2.       GST reduces the cascading effect of taxes. An example will explain the current system. A manufacturer pays central excise at 20% on a shirt of a value of Rs 100. Next, the state government charges VAT not on Rs 100 but on Rs 120, which is the value of shirt and the tax already paid. The VAT rate of 15% in effect becomes 18%, leading to the higher price of the shirt. GST resolves the issue by integrating the tax systems of the centre and state. Also, GST is to be paid only on the value addition and not on absolute value.

3.       GST would lead to lower transportation and distribution costs. Currently, firms spend a high 5-8% as product distribution and warehousing cost. The main reason for the high cost is the expense incurred on branches and warehouses that exist due to tax saving rather than business considerations. This would further reduce cost.

The lower taxes, simplified tax structure, seamless tax credit facility and technology-driven easy tax compliance system offered by GST provide an ideal platform to increase manufacturing’s share of GDP from the current 17.4% to 25% by 2025.

Way Forward for India through a focused approach.

Mamtha : This would require India to expand its manufacturing value add to $837.7 billion and manufacturing gross output to $3.8 trillion by 2025. These are ambitious targets.  Is there any focused approach to achieve this?

Ajay : Getting there would require a laser-like focus on the following four manufacturing categories.

First, develop a plan to facilitate manufacture of factory machinery — the machinery that makes the goods. No nation becomes a manufacturing power without manufacturing capital goods. We can focus on semiconductor making equipment (SME), which is at the heart of most import products/ sectors today: computers, mobiles, telecom, automobiles, and now, Internet of Things. Part of the technology for such products can be obtained through licences or outright purchase. But most critical will be to develop in-house industrial R&D centres.
Second, set up facilities for manufacturing of specialty materials, nanotechnology, precision mechanical devices, integrated circuits, etc. This would require investments in existing and new R&D institutions headed by professionals of proven capability. Korea is an interesting example of how a developing country can transition into a high-tech manufacturing country largely through government driven interventions, subsidising R&D investments.

Third, facilitate manufacturing of computer, TV, mobile phone and other electronic and telecom equipment. This sector made China the world’s industrial giant. Starting in the mid-1990s, China focused on electronics and telecom sectors where final products contained a large number of components and parts that could be imported from other countries. In less than 15 years China emerged as the leading exporter of electrical machinery, electronic and telecom equipment. India already spends large amounts of foreign exchange importing such items.
Fourth, create large-scale manufacturing facilities for producing skill- and labour-intensive products like auto components, toys, furniture, footwear, mattresses and low-end engineering products. This would require creating the largest possible scale of organised production, ensuring economies of scale.

India should move quickly as the factories are easy to develop and can employ millions of people who can move from agriculture or the informal sector to formal jobs. Labour law reforms are a critical factor in facilitating large-scale employment. GST will raise India’s productivity and reduce prices. Combining GST with a clearly articulated manufacturing strategy would attract global investments, create jobs and make India a large manufacturing nation within a few years.