Export-led economic growth has a proven track record of success. From the Asian Tigers in the 1960s to China more recently, growth through exports has lifted millions out of poverty by creating quality jobs. Consider the case of Vietnam. Over the past 30 years, the country has witnessed a remarkable increase in living standards, with the average annual income for a Vietnamese citizen rising from less than USD 100 in 1990 to over USD 4,000 today. What is behind this rapid growth? While in 1990 Vietnam exported only USD 2 billion worth of goods, this number today is over USD 370 billion.
India has also witnessed success in exports over the past few decades with goods exports rising from USD 18 billion in 1990 to USD 225 billion in 2010. Crucially, India’s tariff rate on manufactured imports from World Trade Organization partners in the same period dropped from 71% to 5.4%. From 2011 to 2019 however, India’s goods exports stagnated at around USD 300 billion and in the same period tariffs have also gone up from 5.9% to 8.5%. Economists have long pointed out the detrimental effect of import tariffs on a country’s exports. As tariffs drive up costs of key imported inputs, exporters become less competitive in the global market. Instead of reducing tariffs, Indian policymakers have offered duty drawbacks as a “trusted and time-tested scheme…to promote exports.”[1] But what are duty drawbacks and are they a solution for exporters?
Put simply, a duty drawback is a type of adjustment in which the duties or taxes levied on imported goods are refunded, in whole or in part, when the goods are exported. The idea of duty drawbacks, introduced in India by the Customs Act of 1962, is to reduce the burden of input costs for exporters while still maintaining a tariff at a country level. The most important category of duty drawbacks in India is the export of manufactured goods that have used imported inputs on which duty has been paid.[2] Think, for example, of a mobile phone manufacturer who imports key components and assembles them in India for export. Here the manufacturer would get a percentage of the final value of their export as the duty drawback. The following discussion will focus on this category as, historically, close to 90% of duty drawbacks are paid for this type of export.[3] There are three key issues with duty drawbacks: the amount of duty drawback recovered, the time it takes for the duty drawback to be credited and the opaque nature of the entire process.
The first important issue with duty drawbacks is the limited amount of duty actually recovered by the exporter. To understand this, it is important to understand how the drawback rate is determined. One option exporters have is to use the so-called All Industry Rate (AIR). The AIR is calculated based on a weighted average of the duty paid on the material that ordinarily makes up the exported good and is represented as a percentage of the value of the exported good. These rates are supposed to be reviewed annually by the “Drawback Committee” in the Department of Revenue of the Ministry of Finance. For example, in 2020, the Committee set the drawback rate for mobile phones at 4%, along with a cap of INR 350 per unit. On a phone with an export value of INR 30,000 this cap results in an actual drawback rate of just over 1%. Given that import duties on mobile phone components are often in the range of 15-20%[4], the AIR is clearly insufficient to recover all the duty paid.
For exporters not satisfied with the AIR, there is the “Brand Rate”. A Brand Rate is a special rate that an exporter can apply for to recover the actual duty paid in case their product is not available in the AIR or the AIR returns less than 80% of the duty paid. The very existence of the Brand Rate implies that the AIR often insufficiently reimburses the exporter for the duty they have paid. While the law specifies that the Brand Rate should be verified and fixed within a month, the reality is different. A Comptroller and Auditor General (CAG) report from 2011 noted a delay in 96% of Brand Rate cases at the Central Excise Commissionerate, Mangaluru. The report found that the average time taken to fix a Brand Rate was almost a year. While theoretically useful, in practice the Brand Rate makes the duty drawback process unnecessarily complex.
Another significant issue is the delay in settling a drawback claim. Section 75A of the Customs Act, 1962 specifies that any drawback must be paid within one month (before interest is applied). The law also requires that a “deficiency memo” be issued within fifteen days to the exporter if the drawback claim does not have the appropriate documents. The same CAG report from 2011 scrutinised the processing of drawback claims from Andhra Pradesh and Gujarat and found significant delays. In Andhra Pradesh, more than half of the over 10,000 cases were processed after more than three months, with one-fifth of these claims taking longer than a year. In Gujarat, apart from processing delays, the report found that in more than 4,000 cases deficiency memos were not raised in time, with some memos taking two years to be raised. Moreover, vague memos with instructions such as “please produce documents” added to the confusion. Such delays in settling duty drawback claims tie up crucial working capital for exporters.
The final issue with the duty drawback scheme is the overall difficulty in finding information related to it. Firstly, various government and private sources have separate lists of documents needed to apply for the scheme, with some listing 17 different documents. Secondly, the latest drawback rules introduced in 2017 are not easily accessible. Finally, the all-important AIR was last updated in 2020, with no clarity on when the 2023 exercise will be completed. Notably, it is not just exporters who struggle with duty drawbacks. Sometimes government officials find it difficult too. A 2022 CAG report found that an Export Commissionerate in New Delhi applied the incorrect drawback rate to an export of garments, resulting in an excess payment of about INR 50 lakhs (which needed to be recovered from the exporters). Given the host of issues surrounding duty drawbacks, it is clear they are not the best solution for exporters.
The aim of any scheme that intends to reduce costs for exporters is to make that country’s exports competitive in the global market. Do duty drawbacks achieve this for India? The discussion so far on the limitations of duty drawbacks makes it clear that the answer is no. However, let us consider a situation in which duty drawbacks work exactly as intended, and all the import duties paid by exporters are recovered in a timely manner. Even in this scenario, tariffs (by increasing input costs) will continue to make domestic manufacturers selling in India uncompetitive by global standards. So, for exporters looking to source some of their inputs locally, which is one of the main reasons to setup their business in a country, India will remain uncompetitive. It is no surprise then that countries like Vietnam, which have no or much lower tariffs on mobile phone components such as battery packs, cables etc. are exporting electronics at much higher levels than India.[5]
How then to promote exports? The solution is hiding in plain sight. Reduce tariffs on imports of equipment and parts needed to manufacture and assemble goods in India to increase the competitiveness of Indian exports. Increasing exports will develop domestic ecosystems that can steadily move up the value chain. This is what Vietnam has achieved. From 2001 to 2010, their weighted average tariff rate on manufactured imports from World Trade Organization partners more than halved from 16.6% to 6.6%. From 2010 to 2020, their high-technology exports (aircraft, computers, pharmaceuticals etc.) as a share of total manufactured exports went from 13% to a staggering 42%. There is no reason why India cannot emulate this.
[1] Ministry of Finance – Duty Drawback
[2] The other less significant category is the re-export of goods clearly identifiable as imports at the time of exports. In this category, up to 98% of the duty paid can be recovered.
[3]Comptroller and Auditor General of India Report No. 15 of 2011-12 (Indirect Taxes – Service Tax and Customs)
[4] A Comparative Study of Import Tariffs in Electronics 2023 by MEDEPC and ICEA
[5] A Comparative Study of Import Tariffs in Electronics 2023 by MEDEPC and ICEA
References
Comptroller and Auditor General of India Report No. 30 of 2022 (Department of Revenue – Customs)
Duty Drawback Scheme: Eligibility, Procedure and Drawback Rates
GDP per capita (current US$) – Vietnam
High-technology exports (% of manufactured exports) – Vietnam
Merchandise exports (current US$) – Vietnam
Ministry of Finance – Constitution of Drawback Committee for the year 2023
Ministry of Finance – Notification on Duty Drawback All Industry Rates 2020
Tariff rate, most favoured nation, weighted mean, manufactured products (%) – Vietnam
What is Duty Drawback in export: Meaning, types and process