Inverted Duty Structures and the Paradox of Negative Effective Protection in India, 2000–2014

DOI10.1177/0972266119894131
Published date01 May 2020
AuthorAditya Bhattacharjea,Kanika Pathania
Date01 May 2020
Subject MatterArticles
Inverted Duty
Structures and the
Paradox of Negative
Effective Protection
in India, 2000–2014
Kanika Pathania1 and Aditya Bhattacharjea1
Abstract
In recent years, sections of Indian industry have complained that they are being
harmed by an inverted duty structure (IDS). That is, tariffs on their imported
inputs are higher than that on their outputs. In this article, we argue that the con-
cept of effective rate of protection (ERP), despite its limitations in the context of
general equilibrium theory, provides an appropriate tool for analysing this issue.
We outline the theory underlying the calculation of ERP and its relationship
with IDS. We then offer new estimates of ERP for the period 2000–2014 using
a data source that, unlike those used by earlier authors, enables us to construct
a time series on ERP for each sector, using different tariff rates applied by India
on imports from different countries. We find many instances of IDS but none of
them results in negative ERP. Cases of negative ERP are found in a few sectors
and years for which the counterfactual value added under free trade is negative.
We discuss some possible explanations for this phenomenon. Finally, we show
statistically and econometrically that, in line with theoretical expectations, ERPs
are positively related to the degree of tariff escalation.
JEL Codes: F13, F14, O24
Keywords
Effective rate of protection, inverted duty structure, preferential trade agreements,
tariff escalation, tariff inversion, trade policy
Article
1 Department of Economics, Delhi School of Economics, University of Delhi, Delhi, India.
Corresponding author:
Aditya Bhattacharjea, Department of Economics, Delhi School of Economics, University of Delhi,
Delhi 110007, India.
E-mail: aditya@econdse.org
Foreign Trade Review
55(2) 139–167, 2020
© 2020 Indian Institute of
Foreign Trade
Reprints and permissions:
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DOI: 10.1177/0972266119894131
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140 Foreign Trade Review 55(2)
Introduction
In recent years, sections of Indian industry have been expressing concerns about
the impact of an ‘inverted duty structure’ (hereafter IDS) resulting from changes
in trade policy. Their complaint is that customs duties on the import of some prod-
ucts, especially from countries with which India has signed preferential trade
agreements (PTAs), have fallen below the duties on the intermediate inputs
required for their production. This has squeezed the profitability of the down-
stream producers by keeping their input costs high while exposing them to more
intense foreign competition for their outputs. The issue of IDS has also been rec-
ognised by Indian policymakers. In an interaction with the journalists of The
Economic Times, the then Finance Minister Arun Jaitley said, ‘I propose to reduce
the rates of basic customs duty on certain inputs, raw materials, intermediates and
components (in all 22 items) so as to minimise the impact of duty inversion and
reduce the manufacturing cost in several sectors’ (quoted in Seth, 2015). Even
Steel Ministry officials made a case against IDS, pointing out that ‘customs duties
levied on key raw materials such as coking coal, iron ore and metal scrap are
higher than those on the end product’. The ministry urged the Finance Ministry to
raise the peak tariff on steel from 15 per cent to 20 per cent in the 2016 Budget in
order to protect the domestic industry (PTI, 2016a).
Spokespersons of different industries have continued to complain about IDS,
for example, copper alloy fabricators (Iyenger, 2015), Federation of Indian
Export Organisations (FIEO) (PTI, 2016b) and toy manufacturers (BS Bureau,
2016). A survey by the Federation of Indian Chambers of Commerce and
Industry showed that industries such as machinery, electronics, cement, rubber,
minerals and textiles suffer from duty inversion (FICCI, 2016). On the eve of
the 2019–2020 Union Budget, such complaints were voiced by the Engineering
Exports Promotion Council (EEPC; PTI, 2019) and FIEO again (FIEO, 2019).
Many of these complaints specifically mentioned duty-free imports from PTA
partner countries. A very specific case of IDS was pointed out by secondary
metal producers who produce finished metal products from scrap. Non-ferrous
finished metals are imported duty-free from ASEAN under a PTA, while a tariff
of 2.5 per cent is imposed on imports of non-ferrous metallic scrap. Consequently,
according to an industry spokesman, ‘The inverted duty structure has prompted
many Indian players to shut down their shops for scrap recycling and import
finished products for production of valves, tubes, panels, engines parts etc. If
this continues, the survival of Indian metal recycling units would be difficult.’
But at the same time, primary metal manufacturers called for increasing the
duty rates on imported scrap (Jha, 2019). This case illustrates the difficulties
involved in balancing the interests of different sections of industry, as well as
their sensitivity to apparently minor divergences in the tariff rates imposed on
inputs and outputs.
Taking some of these issues into account, Finance Minister Ms Nirmala
Sitharaman, in her 2019 Budget speech, stated that ‘On the Customs side, my
proposals are driven with the objectives of securing our borders, achieving higher
domestic value addition through the Make in India initiative, reducing import

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