MOOWR 2019 hurts indigenous manufacturing, especially capital goods —here’s the math
If you have not heard of MOOWR, and think the term probably refers to a cow’s moo turning into a growl in protest against the abuse she is being subjected to in the Indian political discourse, you can be excused. The MOOWR in question, however, is not anything remotely bovine or pastoral. It is a policy initiative by the government meant to help the noble cause of Make-in-India, which ends up ignobly harming the project of indigenous manufacture.
Import advantage
The finance ministry is reportedly grappling with conflicting demands from renewable energy companies that, in one case, import equipment, particularly batteries, in the normal course, and, in another case, import inputs under the Manufacture and Other Operations in Warehouse Regulations (MOOWR), 2019 scheme. Those who make use of the scheme, says the India Energy Storage Alliance, have a cashflow advantage that helps them bid lower for renewable energy contracts, in comparison with folks who import their inputs in the regular fashion.
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While the heartburn of those suffering a competitive disadvantage as a result of policy-induced tilting of the playing field is perfectly understandable, and it is fair to ask what particular antacid is their appropriate remedy, the more pertinent question is whether the government should, at all, create policy that tilts the playing field against one section of Indian manufacturers vis-à-vis another section of Indian manufacturers, that, too, in the name of promoting Indian manufacture.
MOOWR scheme
The MOOWR scheme allows any enterprise to treat its domestic premises as a bonded warehouse, the customs duty on imports into which has to be paid only when the finished product is shipped out. If the output is shipped abroad, the import duty can be waived altogether, as exports should not be burdened by import duties on their inputs.
Input duties higher than on the output make for negative protection, and input duties lower than duties on the output make for high effective rates of protection
The scheme creates two classes of domestic producers: a class of chumps and another class of wisenheimers. The chumps pay import duties and Integrated Goods and Services Tax (IGST) on their imported inputs upfront, carry the cost on their books, and recover it only through final sales. The wisenheimers do not pay import duty and IGST upfront on their imported inputs, and avoid the interest cost on these payments that chumps bear till these costs are recovered from the sale of output.
Impact on capital goods sector
The scheme is particularly harmful for India’s capital goods industry: MOOWR offers Indian producers imported capital goods at zero import duty, and zero IGST on the import. This is because capital goods mostly stay put in the factory premises, which are classified as a bonded warehouse, and attract no duty if they do not stray outside the premises. The same equipment, when procured from a domestic producer, would be more expensive, at least by the extent of GST payable on it. In other words, MOOWR offers Indian producers negative protection vis-à-vis imports.
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Hitherto, Indian producers have had only to complain against inverted duty structures. An inverted duty structure arises when an input faces a higher level of protection, as compared to the final output. To illustrate, consider aluminium and a window frame made out of aluminium. The import duty on aluminium is 7.5 per cent, and that on the window frame is 10 per cent. The window frame maker is happy. But suppose the import duty on the window frame is zero, because it comes in from a country with which India has a free trade agreement. The domestic maker of aluminium window frames will start howling about the industry being killed by an inverted duty structure: the duty on the raw material, aluminium, is 7.5 per cent, but the finished product faces nil import duty.
People often make the mistake of seeing the import duties of 7.5 per cent on aluminium and 10 per cent on a product made out of aluminium, and conclude that aluminium products get a protection of 2.5 per cent. This is a common mistake, but a mistake, nevertheless.
Effective rate of protection
Protection, strictly speaking, is not for goods but for the value added in the making of the good in question. The effective rate of protection is the difference in value addition introduced by tariffs on the input and the output, as a proportion of the value added in the absence of tariffs.
Suppose the cost of aluminium used in the manufacture of a window frame is 80 per cent of the price of the window frame. If the price of the window frame is P, the value added in the window frame production is P – P x 80/100 or P-0.8P, as 80/100 is 0.8. The value added is 0.2P.
If we represent the share of input cost in the final price of a good by ‘a’, instead of fixing it at 80 per cent, we have the price of the final product as P and the cost of input as aP. Value added = P – aP or, using elementary algebra, P(1-a).
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Now we introduce tariffs, t on the final good and ti,. on the input, both t and ti expressed as percentages. The absolute value of the tariff on the final good would be Pt, and the price of the final good would be P+Pt or P(1+t). The tariff element of the cost of the input would be aPti, and the cost of the input would be aP+aPti or aP(1+ti). The value added with tariffs would be P(1+t) - aP(1+ti).
The difference between the value added with tariffs and the value added without tariffs would be {P(1+t) - aP(1+ti)} – P(1-a), which works out to P{(1+t) – a(1+ti)} – P(1-a), which is the same as
P{1+t-a-ati-1+a}, or P(t-ati), +a cancelling out -a, and +1 cancelling out -1. This difference in value added with tariffs as a proportion of value added without tariffs is the effective rate of protection.
ERP= P(t-ati)/P(1-a). Cancelling out the common factor P,
ERP = t-ati/1-a
Understanding protection dynamics
Suppose the import duty on the final good were equal to the import duty on the input, would it mean no protection for the final good? Not at all. In our equation, t and ti both become t, so that the numerator would be (t-at) or t(1-a). In the equation for ERP, (1-a) would be a common factor for both the numerator and the denominator, rendering ERP=t (1-a)/(1-a) or ERP=t. When the duty on the output is the same as the duty on the input, the effective rate of protection for converting the input into the output is at the same identical rate as the duty on input or output.
Protection, strictly speaking, is not for goods but for the value added in the making of the good in question.
In our aluminium example, where raw aluminium gets a duty of 7.5 per cent and window frame gets a duty of 10 per cent, ERP would be (0.1 - 0.8 x 0.075)/(1-.8) = (.1-.06)/.2 or 20 per cent, significantly higher than the nominal protection of 10 per cent or the difference in duties on input and output. If the duty on window frames were to be below that on aluminium, say 5 per cent, or 0.05, ERP would be (0.05-.8x0.075)/0.2 or (0.05-0.06)/0.2 or negative 5 per cent.
Negative protection
Input duties higher than on the output make for negative protection, and input duties lower than duties on the output make for high effective rates of protection. This is why industry routinely protests against inverted duty structures.
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When whole built-up capital goods are allowed to enter production entirely duty-free, and domestic producers of the same goods face duties on their inputs, they face unfair competition, with negative protection on the customs duty front, and the additional disadvantage of their customers of having to pay IGST while the import under MOOWR scheme faces no IGST either.
The government should scrap the MOOWR scheme, and stop sorting importers into chumps and wisenheimers.