How the indirect tax put Indian competitiveness to test

Order book entries receded, scale of business reduced, jobs curtailed

While the 18th century American thinker Thomas Paine supported ‘free trade’ for its power to uproot existing traditional social and political arrangements, Edmund Burke, his Irish contemporary, believed, “Free trade is not based on utility but on justice”.

Three months after the introduction of the goods and services tax (GST) regime, ‘free trade’ is under test in India, at least for exporters. Indian exports, which were effectively free pre-GST, have turned expensive in the short term. This, industry observers say, will hit their competitiveness with a lag.

Financial hurdles post-GST — delayed refunds and upcoming reduction in duty drawback — have de-scaled exports despite unchanged international demand, tapered skilled employment in exporting firms, inflicted a forced slowdown in small and medium enterprises, and reduced the probability of new and better trade contracts in the first quarter of GST implementation.

“Indian exports rely on the economy of scale and use liquidity as a means to achieve that. In the first quarter of GST implementation, liquidity has reduced,” Ajay Sahai, Director and Chief Executive Officer at the Federation of Indian Export Organisations (FIEO), told Business Standard.

India followed the principle of “taxes are not to be exported”, and continued with ‘zero-rated’ exports under GST, too. But post-GST, exporters had to pay an effectively higher tax at a relatively earlier stage. Input-tax credit will be available at a later stage, after the sale of exports. The monthly returns filed for July have not been processed as October approaches, resulting in financial assets — in the form of GST refunds — getting stuck with the government.

Evidence from the apparel sector

“This is the first time — courtesy back-to-back implementation of demonetisation and GST — our production is facing a slowdown of a massive scale,” the production manager of a big apparel export firm with operations in Haryana said.

Daily employment (averaged over a week) in the Haryana factory reduced from 600 in the first week of May to 440 in the last week of September, touching 399 in the second week. “This is unprecedented,” he added.

The company reduced the number of machines in one production line from 45 to 36, so that the factory does not ‘look empty’. Production has reduced from 60,000 garments a month in April to 40,000 per month in September.

SMEs feel a tighter pinch

While big companies have registered under GSTN, small firms which are typically vendors to big ones have become wary of registration owing to their flimsy profit margins.

Big exporting firms outsource job work such as attaching lace, embroidery, beads to apparels to smaller companies. For instance, a small company A, with a 50-member job-worker team was prompt to register with GST network, but another firm B, with 15-20 workers found it difficult to do so, since it would wash away its profits. B is now routing contracts through A, paying it commission, and marginally reducing its own profit. B has laid off four of its 15 workers.

“About 5-6 per cent of annual turnover of exporting companies is frozen; for smaller companies, about 10 per cent,” HKL Magu, vice-chairman of the Apparel Export Promotion Council, said.

Apparels sector is facing a peculiar situation, where the input tax credit on yarn is not available. “GST on viscose yarn is 18 per cent, while that on the fabric manufactured using that yarn is 5 per cent. As a fabric manufacturer cannot claim input tax credit on yarn, the tax component gets embedded into the final fabric price,” Magu added.

This is making exports from other apparel majors like Bangladesh cheaper and preferable. As a result, Indian exporters are keeping peace with buyers with whom they have long-term ties.

Labour-intensive leather sector faces trouble

“Indian shoes are known for their quality and affordability in the international market. But, raw material used in the shoes is attracting GST of either 18 or 28 per cent, higher than what we paid earlier,’’ Puran Dawar, owner of Agra-based Dawar Footwear, told Business Standard. Pre-GST, leather product exporters would get most job work done by unregistered small-scale establishments, which were exempt from excise duties owing to their size. “Today, we must outsource from GSTN-registered enterprises, and wait for refunds,” Dawar said.

There has been a 20 per cent reduction in daily shoe production in his factory.

Small-scale domestic manufacturers, who supply job-work to big exporters, are in a precarious condition. “The cost of basic shoe raw material — sole and upper leather — has increased from ~150 to ~183 per shoe, as I had to pay GST upfront,” Bharat Singh, a household shoe factory owner, said. He is extremely upset that instead of a rise in orders during festivals, he’s witnessing a decline in business.

In fact, Agra, a leather hub, has around 7,000 small household industries manufacturing shoes and handbags, employing at least 200,000 of its residents. “A typical house becomes a factory in the day, a kitchen in the evening, and a bedroom at night. We work on utterly minuscule profit margins. Now, job-work has fallen, too,” Singh added.

Chief Economic Advisor Arvind Subramanian had once said that under an export-led strategy, demand is infinite. Estimates peg the employment creation capacity of exports at a million jobs per $10 billion of investment.

But, investment and job creation will happen only when existing exporting firms decide to expand, investing their incremental capital, point out analysts. With the opposite happening, the industry is looking for support from the government.

“We have put our demands to the finance minister with utmost clarity, and we are hoping they will be addressed very soon,” FIEO director Sahai said.