Photo: Reuters
Photo: Reuters

Coronavirus supply chain disruptions: Is there a silver lining for India?

India’s rising tariff walls may thwart India’s ambitions of replacing China in global value chains, research suggests

Coming on the back of a protracted trade war directed at China, the outbreak of the Coronavirus pandemic (Covid-19) has led many firms to reconsider their investments across Asian supply chains. For India, this raises the possibility of a silver lining amid the turmoil: that firms diversify their supply bases and invest in India.

However, trade experts fear that India’s growing protectionist tendencies could get in the way. The past three Union budgets have seen India raise import barriers in a bid to protect domestic industries. The most recent union budget, announced on February 1, increased customs duty across a broad range of products accounting for over US$8 billion of India’s imports. While this is a small share (about 2%) of India’s overall imports, the protectionist barriers mark a clear embrace of import substitution. This hurts India’s objective of expanding exports through greater integration with cross-border production chains, which involve goods and services crossing borders several times while assembling a product.

Already, India lags way behind its Asian peers in Global Value Chain (GVC) participation.

Not only has India’s participation in global production dropped, its gains from integration have also declined. An analysis of data from the UNCTAD-EORA GVC database shows that India is using more high value inputs from abroad to produce its exports and adding less value to the exports of other countries.

India is importing high-technology and high quality imports from abroad and mostly just assembling products here before exporting them to the rest of the world, said Anjali Tandon, professor at the Institute for Studies in Industrial Development (ISID).

Expanding the share of the domestic value-added in a value chain require efforts to reduce trade barriers, enhance infrastructure, and improve access to finance, said Saon Ray of the Indian Council for Research on International Economic Relations (ICRIER)

India’s level of integration is especially low in the services industry. Data from OECD shows that Indian exporters have become more reliant on domestic service providers over time. At the same time, the foreign market for Indian service inputs has become smaller compared to the domestic market.

According to a new study by Ray, the main reason for India’s low GVC participation lie in logistical inefficiencies (including high power costs) and limited access to finance. According to the latest World Development report, India’s logistics costs are double that of Bangladesh and triple that of China.

While it is important to address these domestic distortions, it is also important to liberalise imports and exports as tariffs on intermediate goods can be equally damaging to GVC integration.

According to Mint calculations, of the tariff hikes effected on February 1, about 28% were on processed industrial supplies and 53% on capital goods.

Seemingly small tariffs can disrupt regional and global value chains substantially. By restraining competition from imports or making imports of intermediate goods more expensive, India is raising the costs of inputs for many Indian exporters.

According to an IMF working paper authored by Kevin Cheng and others, tariffs are especially detrimental to GVC-related trade. This is because fragmentation of production across the global value chain requires multiple border crossings and so GVCs have an amplified increase in rate of protection even with a small tariff increase.

With successive tariff hikes since 2018, India has become much more protectionist than most other large economies. According to a WTO report, trade-restrictive measures implemented during mid-Oct 2018 to mid-Oct 2019 affected about US$746.9 billion or 3.84% of world merchandise imports. Protectionist tariff barriers raised by India, alone accounted for 22% of the total impact. It was the second biggest contributor to these restrictions, behind only Donald Trump-led United States.

Data from Global Trade Alert database also shows that among G-20 economies, India has been among the worst perpetrators of protectionist policies since the global financial crisis of 2008. Even when compared to countries with similar GDP per capita incomes, India’s protectionism stands out.

India’s rising tariff walls and lack of integration into global production chains is probably the reason why India’s share in world merchandise exports has largely remained stagnant in a 1.6-1.7% range since 2011. This stagnation has occurred at a time when China’s share in merchandise exports has dropped significantly over the past few years, with the gap being filled by other Asian countries.

A number of companies are looking to diversify away from China, suggesting that the shift could be more structural and long-term in nature, a UBS report dated February 26 said. UBS’ survey findings suggested over 63% per cent of global executives are looking to move at least 40% of their current production in China outside the country.

Will India miss the bus once again?

This is the sixth of a ten-part series on Budget 2020.

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