COMPETING ON A GLOBAL STAGE: How Tariffs Shape India’s Electronics Industry
By Dr. Harsha Vardhana Singh & Kapil Gupta
Electronics, and within that the smartphone, are among the top traded items in international trade. International trade in these products is impacted by several overlapping factors. One, the huge significance of the sector due to the extensive and rapidly increasing impact of digital technologies across nations shows the major significance of electronics for a country’s competitiveness, growth, widespread implementation of social programmes and efficient governance. Two, the major significance of global value chains (GVCs) for international trade, which potentially creates a possibility for multiple nations to participate in electronics production and trade, thus creating strong competitive pressures in international trade.
This results in a very strong focus among multiple competing nations on improving cost-competitiveness, attracting foreign direct investment through policies that reduce investment and operational costs, and facilitating operations and reducing the time taken for imported inputs to be processed for exports as part of the GVC trade. In this context, policy measures that facilitate GVC participation, attract investment, and enhance the cost-competitiveness of the electronics sector are paramount for a nation aspiring for a significant role in the international trade of electronics.
India Cellular and Electronics Association (ICEA) has conducted detailed studies that help clarify the relevant policies to improve competitiveness and achieve the high growth potential of the Indian electronics sector. These studies show that in general, especially after the Production Linked Incentive (PLI) scheme and an emphasis on facilitation policies to reduce operational costs, India and its competing nations have a similar approach to most policies, except for one major difference. That is the tariff (customs duty) policy adopted for the electronics sector, which directly raises the cost of manufacturing and sales, thereby impacting India’s global competitiveness. This is shown for instance by a detailed recent study conducted by ICEA titled “A Comparative Study of Import Tariffs in Electronics 2023.”
This study explores how India’s tariff policies affect the competitiveness of its electronics sector in comparison to the competing nations, such as China, Malaysia, Mexico, Thailand and Vietnam. The most significant learning comes from an assessment of the tariff regime of Vietnam, a nation which has rapidly become a major exporter of electronics, including being the second-largest global exporter of mobile phones. For the comparison, the study has considered 120 HS tariff lines of India which include the supply chain for mobile phones, as well as tariffs for some finished products such as laptops and tablets.
First, let us consider the facts. India’s average MFN tariff (the Most Favoured Nation tariff) stands at 9.7%, whereas China’s is 3.2%, and Vietnam’s is 5.6%. Higher tariffs, especially on inputs raise the cost of production, thus reducing cost competitiveness as domestic prices increase due to tariffs.
An important point is that with respect to Vietnam, a comparison with MFN tariffs is not correct because about 80% of Vietnam’s imports come at lower tariffs from countries with which it has Free Trade Agreements (FTAs). A valid comparison would be the weighted averages of FTA and MFN tariffs, based on a detailed exercise which has been performed in the ICEA study. The FTA weighted average tariffs come down to 7% for India and just over 1% for Vietnam, thus showing a large gap between the actual tariffs paid by imports into India and Vietnam.
Another important factor, especially for a product for which GVCs are a major part of international trade, is the number of tariff lines with zero tariffs because zero tariff not only reduces the cost of production but also the turn-around time for processing the imported inputs for further exports. The ICEA study shows that the competing economies have kept this aspect in mind, with a significant number of their tariff lines at zero duty. For instance, while India has zero duty on 32 of the 120 lines, the competing economies have many more duty-free lines: 56 (Thailand), 66 (Vietnam), 71 (China) and 77 (Mexico). This shows that the competing economies have strategically implemented their tariff regime to improve the ability of their exporters to be quicker and more cost- effective when competing in GVC trade.
The comparison of tariffs is an eye- opener. For India’s tariff lines with non- zero tariffs, the competing economies have lower tariffs than India for at least 90 per cent of these lines, ranging from 90% for Thailand) to 93% for China. A similar comparison of the FTA weighted averages of India and Vietnam shows that Indian tariffs are higher than those for Vietnam in the case of about 98% of these tariff lines.
India’s higher tariffs for electronics are a result of a specific policy focus. Tariffs in 2021 are higher for a very large number of lines compare to 2015 to 2021. In contrast, tariffs of competing economies have generally decreased during this period.
In 2023, the import duty on lens glass for cameras was reduced from 2.75% to zero, but its impact on costs is effectively inconsequential. Much more needs to be done to increase competitiveness because tariffs, particularly tariffs on inputs, raise costs and they are not a particularly good instrument for achieving the objectives for which they are put in place. Two such ostensible objectives are to encourage domestic production and to limit the large trade deficit of India. Regarding trade deficit, it is noteworthy that the economies with much lower tariffs have performed much better than India. Three of them (China, Vietnam, and Thailand) have registered trade surpluses for electronics, and Mexico has a much smaller trade deficit than India.
Thus, higher tariffs do not appear to reduce the trade deficit. In fact, the trade deficit will be reduced with an increase in exports, which requires improved competitiveness, and as we saw above, higher tariffs lead to lower competitiveness.
Further, the adverse impact of tariffs is more complex and a number of aspects are often overlooked. For instance, to some extent higher tariffs do lead to an increase in domestic production, but in actual fact the increase in domestic production is much less than usually anticipated. While tariffs make imports more expensive and producers may look for domestic substitutes, the domestic producers do not often have the technological capability to produce the item. As a result, the product either needs to be imported at a higher cost or is not of a quality level that meets the requirements of the global market. The result is a loss of competitiveness and a reduction in potential exports.
Even for the items that can be produced domestically, the domestic producers normally seek a higher margin by raising their price close to the import price plus tariff. This reduces demand for domestic inputs and in several instances, the reliance on imports continues. The net result is again an overall increase in domestic costs and lower exports potential. This makes it harder for programs like the Phased Manufacturing Programme (PMP) to develop important parts like mechanics and display assembly. High tariffs can thus create a cycle where a country relies on imports because it is too expensive for the local industry to compete. This is especially important for industries like electronics, which are trying to grow through exports.
There is a need to review tariffs both because of the negative impact on competitiveness as well as to support the export increase that has begun with support from the PLI scheme for mobile phones. With the increase in investment and production based on the PLI criteria, as India’s production of mobile phones has begun to exceed domestic demand for mobile phones in recent years, India’s exports have begun to take off. In 2022-23, India’s exports of mobile phones increased almost 100% to $11.1 billion, and electronics exports went up by about 56% to $23.6 billion. The other impact of this development is that while imports met about 78% of the domestic demand of mobile phones in 2014-15, they were equivalent of only 4% of domestic demand in 2022-23; in volume terms, 99.2% of the number of phones sold in India are produced in India.
In effect, India has grown from a phase of import substitution into a period of export promotion. In this phase, policies which reduce competitiveness, such as tariffs, need to be reviewed and amended. For instance, the ICEA report shows that the cost increase due to tariffs on inputs significantly erodes the benefits provided by the PLI scheme; and also that if the tariffs of Vietnam were implemented in India, the costs of production would have been about 4% lower in India.
The study recommends enhancing competitiveness by lowering tariffs on parts (components) used in mobile phone manufacturing, arguing that the existing tariffs no longer offer benefits. Another proposal is to gradually reduce tariffs on parts to align with the rates offered by Vietnam and China over the next two years. This approach would also help the local industry prepare for any impact of the adverse decision in the WTO case on the ITA-1 matter.
The industry also seeks to simplify the tariff system. Currently, India has six different tariff levels – 0%, 2.5%, 5%, 10%, 15%, and 20%, plus surcharges. This system is overly complex and leads to misunderstandings and disputes between importers and customs authorities. A reduction in the number of levels from six to three—0%, 5%, and 10%—is suggested to circumvent such issues.
Finally, there’s an important recommendation for the formation of a joint team from the Ministries of Finance (MoF) and Electronics and Information Technology (MeitY) departments to manage tariff classification and solve interpretation-related issues. In case of a disagreement about interpretation, this team, consisting of Customs and MeitY, could review the case. This process would ensure proper classification under the correct codes, reducing conflicts and streamlining operations.
In conclusion, although India’s high tariffs were initially designed to protect domestic industries, particularly the electronics sector, it is time to reconsider this approach in light of global economic shifts and increased local manufacturing capabilities. As India strives to strike a balance between protecting its electronics industry and enhancing its global competitiveness, a nuanced and informed approach to tariff policies will undeniably play a critical role.
Whether India chooses to adopt Vietnam’s low tariff model or retain its current system will define the future of its electronics industry and economy. One thing is clear: the decisions made now will significantly impact India’s economic future.
About the Author-
Dr. Harsha Vardhana Singh is the Chairman of Ikdhvaj Advisers LLP
Mr. Kapil Gupta is Deputy Director – Public Policy, ICEA
