Need to rejig export incentives

Minster of State for Commerce, Nirmala Sitharaman recently announced that the review of foreign trade policy will be completed prior to July 1 when GST will be rolled out. This review is especially important since it is being done in an environment where India is under some pressure to move away from post-export incentives that are increasingly not compatible with WTO rules.

Besides incompatibility with WTO, giving incentive to a firm that is already exporting somewhat counter-intuitive as it is essentially rewarding a successful and therefore competitive exporter. Logically, investment in developing firm or sector level competitiveness requires support at the pre-export stage. Pre export production related subsidies and government support measures are more compatible with WTO rules and extensively used across the world.

However, production level support or incentives are expensive since benefits cannot be limited to just successful exporters like in the current schemes, but are potentially open to all manufacturers and service providers. Thus, the burden on the exchequer due to either tax foregone or direct financial support can be substantive.

An export development programme reliant on production-based subsidies therefore require targeting of specific sectors in a manner that helps develop competitiveness, but with some discrimination criteria that ensures that the scheme is not open to all. Designing such programmes would require institutional capacity to develop the right criteria, transparent administration of such criteria in the distribution of benefits, and close cooperation with industry associations and sectoral export promotion councils. The current administrative machinery is insufficiently prepared for such an exercise.

But radical overhaul is necessary not just to make our incentives more compatible with WTO rules, but also to address the serious challenge posed to Indian industry by industrialisation 4.0 and automation. India will not be able to replicate the low-wage-middle-skill manufacturing boom that worked for China and other SE Asian countries, given the current shifts in technology and consumer preferences. McKinsey analysis shows that over 235 million jobs in India are at risk from such changing dynamics.

Starting from this current round of foreign trade policy making cycle, policy makers need to give serious consideration to completely over-hauling the way exports are incentivised in India.

I would like to focus on three ideas for this article.

Public-private venture capital to fund innovation and productivity : New product development, financing strategic tie-ups with global partners or expansion of product line are all projects that have a certain amount of risk tied to it. Exporters, especially small and medium exporters find it difficult to find right kind of financing for such projects. Private venture capital is not interested in smaller projects. In many cases the risk is seen as too high.

One way to lower the risk and increase the appetite for the private sector is to create a public private partnership (PPP) venture capital fund with the government infusing about 25 per cent of the seed capital and private sector players the rest. Private sector would also bring in the professionalism of venture capital managers. The Irish government did this for their technology sector based exports with some success. The Indian government too can create such venture capital funds for a few critical sectors with potential for future growth and employment generation. These could include the next generation of high-end textiles, machine tools, pharmaceuticals, or data analytics or remotely delivered health services for example.

To make such a scheme even more attractive, it can be supplemented by an ‘Angel Law’ modelled on an Israeli incentive programme that allows venture capital investors putting money in such higher risk projects to deduct a portion of their investment amount out of their taxable income.

Funding performance pay based business development : Larger firms benefit from professional help of consultants. In industrialised countries, highly evolved clusters provide hand-holding services to exporters on product development, marketing, and sourcing of inputs.

Most of these services are ‘performance based’; in other words, consultants charge a very low base fee, and take a share of actual profits made by the firm due to successful product or business development execution. The Indian export eco-system (except some large firms) is largely bereft of such a focused professional business development ecosystem. The government can run a special programme, in partnership with export promotion councils, to engage such professionals. The recruitment process should be through transparent global tenders, and the contract should be designed in a way that professionals get paid a majority of their fees based on their actual performance, i.e. export growth or export volumes.

Interested exporters can approach these professionals with proposals. The exporting house would be expected to bear a percentage of the professional’s fees, which would mean they also invest in the successful implementation of the project. The access to these services with the initial state subsidy would help level the playing field for Indian exporters’ vis-à-vis competition.

Supporting recruitment and training of new skill sets : The key to adaptation to new technologies and production methods that are rapidly replacing the old ways of the factory and office would be having the right kind of human resources with skills and know-how to work with artificial intelligence, big data, robotics, and factory floor automation. Such changes would not be confined to just technology intensive sectors like auto industry or IT enabled services, but extend to textiles and food processing.

One way to handle this transition would be for the government to bear a portion of the cost of hiring such skill-sets for SMEs and start-ups. Many countries provide indirect incentives for acquisition of skills that allow the firms to adopt new technologies and increase productivity. A simple scheme is to give a certain percentage of salaries hired by MSME for such advanced talent as an incentive. Allowing a certain portion of such salaries paid as a deductible from net income would be another way, using the tax foregone method.

The key is for government to start considering the range of possibilities available and develop the institutional framework within the bureaucracy and industry. The country has no options but to incentivise competitiveness and productivity in line with the new industrial future. Hopefully, the foreign trade policy announced in June would provide the first step in that direction.

The writer is Senior Director, Corporate Public Policy (South Asia), Deutsche Post DHL. The views are personal

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