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Jaitley’s budget a mix of expected measures for poor and a high level of trade protectionism

Prime Minister Modi’s powerful pro-globalization sentiment in Davos on January 23 was strongly contradicted in practice with this budget.

By Richard M. Rossow

Finance Minister Arun Jaitley of India presented the country’s Union Budget for Fiscal 2018–2019 to Parliament on February 1, 2018. This is the last full budget of the Narendra Modi government ahead of the spring 2019 parliamentary election. There were expected measures related to farmers, rural workers, and employment generation. There was also a surprisingly high level of trade protectionism—especially coming on the heels of Prime Minister Modi’s speech against protectionism at the World Economic Forum (WEF) meeting in Davos, Switzerland. U.S.-India trade policy discussions in 2018 are likely to be even more antagonistic.

The budget’s role as an economic policymaking tool has been on a steady decline for two decades. The accompanying budget speech, laying out reform priorities beyond items specifically in the budget, is also less crucial as the government issues reform test balloons throughout the year. Excitement around this year’s budget seemed particularly muted, likely a recognition that with India’s spring 2019 election on the horizon, the government would not have an appetite for major policy reforms.

The budget did meet analysts’ expectations in terms of having specific programs to appeal to farmers and rural voters. Included among these are a new health care insurance program for the poor, expanded programs to deliver subsidized cooking gas and electric power connections, and escalated programs to build homes and toilets. Barriers to the export of agriculture items will be relaxed, and the “Minimum Support Price,” a floor price the government pays to farmers for staple crops, will see a hefty increase.

The government also included a range of programs meant to boost employment. This includes expanding a pool of funds to help small and medium-sized businesses grow, augmenting jobs-related tax credits given to employers, and increasing the ceiling for companies qualifying for a reduction in corporate income tax to 25 percent down from 30 percent.

Despite an overtly election-focused budget, the Indian government believes it will still be able to further reduce the fiscal deficit. The year before the Modi government came to office, India’s fiscal deficit was 4.4 percent of its gross domestic product (GDP). This has dropped steadily to an estimated 3.5 percent of GDP in the current fiscal year. The government pegs the deficit for the coming fiscal year at 3.3 percent of GDP. Finance Minister Jaitley outlined a range of other positive initiatives, such as expanding an “e-assessment” tax program that will increase fairness and transparency, building credit ratings of cities, expanding the unique identification (Aadhar) program to include corporations, strengthening rankings of states’ business environments by including user feedback, and creating a new mechanism to fast-track the settlement of customs disputes.

In one area, however, there is bound to be widespread international criticism. India has taken a dramatic protectionist turn with this budget. In Finance Minister Jaitley’s own words,

In this budget, I am making a calibrated departure from the underlying policy in the last two decades, wherein the trend largely was to reduce the customs duty. There is substantial potential for domestic value addition in certain sectors, like food processing, electronics, auto components, footwear and furniture. To further incentivize the domestic value addition and Make in India in some such sectors, I propose to increase customs duty on certain items.

What this means in practice is that customs duties will be increased across 49 product groups. Several sectors that had not attracted customs duties, such as flat panel television components, silica for fiber optic cables, and materials for phone chargers, now face customs duties of 5 percent to 15 percent. A wide range of other product groups will face much higher customs duty rates, including candles (10 percent up to 25 percent); perfumes and makeup (10 percent to 20 percent); teeth, shaving, and hair care products (10 percent to 20 percent); footwear (10 percent to 20 percent); cellular phones (15 percent to 20 percent); built motor vehicles (20 percent to 25 percent); unassembled motor vehicles (10 percent to 15 percent); and more.

In addition to these sector-focused increases in customs duties, the government has removed a 3 percent education tax on the aggregate customs duties, replacing it with a 10 percent “Social Welfare Surcharge” that will be applied to the aggregate customs duties of nearly all import categories.

India’s reasons to increase trade protectionism are well known. India’s annual goods trade deficit has been in the range of $108 billion to $190 billion in recent years. In the current fiscal year, India’s goods trade deficit is likely to be around $140 billion, a 30 percent increase from the previous year. There is a widespread perception that protections are required to ensure the success of “Make in India.” To that end, the Modi government has expanded local manufacturing preferences in government contracting across multiple heavy industries.

Hardly more than a week has passed since Prime Minister Modi addressed the World Economic Forum in Davos, Switzerland. In his January 23 speech, Mr. Modi made a forceful appeal for nations to avoid protectionism, stating:

Contrary to globalization, the forces of protectionism have emerged. Their intent is to not only avoid globalization but also to turn the trend of the natural flow of globalization. As a result, new types of tariffs and non-tariff barriers are seen. Bilateral and multilateral trade agreements and negotiations have been stalled. Cross-border financial investment has decreased in many countries. And the growth of global supply chains has also stopped. The solution to this worrisome situation against globalization is not to remain in isolation.

This powerful sentiment was strongly contradicted in practice with this budget.

Several sectors attracting higher customs duties rank among the United States’ top export categories to India, including jewelry and telecommunications equipment. And the Social Welfare Surcharge will hit most U.S. exporters simultaneously.

On one hand, the United States is not in a terribly strong position to complain loudly, coming on the heels of the Trump administration’s announcement of new customs duties on solar equipment and washing machines. Still, the scale of India’s protectionist leap is surprising and likely to elicit a strong response from the United States and other major trading partners. Government-to-government trade discussions will start the year with a longer list of concerns and dim hopes for progress.

(Richard M. Rossow is a senior adviser and holds the Wadhwani Chair in U.S.-India Policy Studies at the Center for Strategic and International Studies in Washington, D.C. This piece was originally published on CSIS website.)

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