Free Trade Agreements (FTAs) signed by India with any country or group of countries entitle exports from such countries to India to a preferential customs duty rate, often nil rate. Budget 2020-21 has proposed a change in the Customs Act that places the onus on the importer to verify the origin of goods being imported into India using the FTA route.

Some experts have argued that this is a protectionist measure. Arvind Panagariya, professor of economics at the Columbia University, has equated the proposal with provisions during the licence-permit era. The proposal, however, is a much needed trade defence measure to protect domestic industry against unfair trade practices and origin fraud.

Goods from an FTA partner are eligible for benefits only if it is the country of origin (COO) of such goods. A COO is one in which at least 35 per cent value addition of the good has happened. But it is difficult for India to find out how much of a good coming to Indian shores has been developed in the FTA partner country. This constraint is often exploited to commit origin frauds.

Origin frauds are of two types — transshipment and general assembly. Under transshipment, goods originating from a third country are routed through an FTA partner into India, to take advantage of low duty rates. Under general assembly, parts are separately exported from the third country to the FTA partner, where assembling happens before despatch of the goods to India. In both cases, fraudsters manage to get COO certificates from the FTA partner country.

For instance, the import of stainless steel from Indonesia grew from about 8,000 tonnes in year ending March 2018 to 67,000 tonnes in year ending March 2019: a spike of over 700 per cent in a single year. Indonesia cannot add this much additional production capacity in a single year. The Indian Stainless Steel Development Association (ISSDA) claimed that these goods are of Chinese origin. They were routed through Indonesia because China has an FTA with ASEAN (which includes Indonesia), and ASEAN has an FTA with India. India imposes customs and countervailing duty on direct import of stainless steel from China.

Artificially low prices

Prices of Chinese goods are artificially low, as pointed out by Parliamentary Standing Committee on Commerce of the Rajya Sabha in a report tabled in 2018. The report has pointed out that China has been found guilty of unfair trade practices like export incentives and deep subsidies in contravention of WTO regulations. China has also been long accused of manipulating its currency to maintain export competitiveness. The report mentions that maximum anti-dumping measures world over have been imposed on China.

When cheap goods from China do not face duties, they can flood the Indian market. Dumping of artificially priced goods has a disastrous impact on domestic industry. It leads to under-utilisation of existing capacity and unforeseen crisis for domestic entrepreneurs. Origin frauds circumvent the country’s trade defence measures by routing Chinese goods through India’s FTA partners.

The problem has become especially acute in recent times due to two events: the US-China trade war and the Belt and Road Initiative (BRI) of China.

The US-China trade war started in March 2018 with US imposing tariffs of 25 per cent on import of steel products. Since then, the US has been levying specific tariffs on Chinese exports. This initially led to a surge of transshipment of Chinese goods through Vietnam to the US (in some cases, ‘Made in China’ tags on Chinese goods were replaced by ‘Made in Vietnam’ tags in Vietnam and re-exported, while in some cases assembling of parts happened in Vietnam). But the US and Vietnam together clamped down on the fraud.

The US could influence other countries to go after origin frauds because of its economic might. Now there are exporters in China who are in search of markets to dump the excess production in China. They may try to utilise FTAs to reach out to new markets and dump their goods. The problem assumes alarming proportion for large markets in the vicinity of China.

Secondly, the Belt and Road Initiative gives China logistics access to many countries along the old Silk Route and the so-called maritime Silk Route. Chinese exporters can use the logistics and port infrastructure in any of these countries to export Chinese goods to India. It will be extremely difficult for India to verify the country of origin.

In June 2019, US customs authorities found that Chinese goods were re-routed into the US through the Sihanoukville Special Economic Zone (SEZ) in Cambodia to escape the tariffs imposed on Chinese goods. Sihanoukville SEZ is jointly owned by the government of China and government of Cambodia, and was started as part of BRI. Many countries in the extended neighbourhood of India are part of BRI and house joint venture infrastructure projects — that could be used to re-route artificially priced Chinese goods into India.

Preventing abuse

There is zero deterrence on origin frauds, because India cannot go after foreign suppliers. As per Section 9A of Customs Tariff Act 1975, India can impose anti-circumvention duties on conduit countries. However, investigations by following due process have proved to be quite lengthy. Impact of origin fraud on domestic industry can be dramatic in the short-term. Hence, there is a need to implement anti-abuse checks at the point of entry.

Placing the onus of proof of ‘country of origin’ on the importer is normally not a sensible approach. Buyers and sellers in an open market interact on a contingent basis, and cannot be expected to know each other’s affairs. But this is not an ideal situation, and this is perhaps the best action that can be taken by a destination nation to prevent abuse of free trade agreements.

Further, in contemporary times, production process is highly technology driven. Goods differ widely on technical specifications. Volume importers generally inspect the factories of their suppliers, and appoint sourcing agents for quality control. They would normally be aware of the value addition to their goods in various territories. Placing an onus on importers will deter them from purchasing transshipped goods.

The writer works in the Foreign Tax & Tax Research Division of GoI. The views are personal.