Why interest sops for exports can’t work

Parthapratim Pal / Atulan Guha | Updated on June 03, 2019 Published on June 03, 2019

Mending needed Policymakers must redesign the Interest Equalisation Scheme to make it more effective S.SIVA SARAVANAN

Interest subvention for exporters, besides not picking up, goes against WTO norms. A solution is to extend it to all MSMEs

Recently, the government changed the Interest Equalisation Scheme (IES) which is available to some exporters. The broad objective of the IES is to provide exporters with a cheap source of rupee credit both for pre-shipment and post-shipment activities. In India, nominal and real rates of interest are relatively on the higher side compared to some of the other countries. This makes cost of capital expensive and it may affect competitiveness of exporters.

The government uses the IES as an export incentive, whereby eligible exporters get interest subvention on their export credit. It is expected that cheaper working capital will enable these exporters to become more competitive. The original IES, which was launched in 2015, provided incentive to all manufacturer-exporters who were MSMEs and all manufacturer-exporters under 416 specific tariff lines at 4-digit HS code. These 416 products were largely labour intensive manufactured goods and chosen with a broader goal to promote export-led job growth in manufacturing.

However, the IES-2015 did not become very popular among exporters in India. While launching the scheme, the government estimated the financial implication of the scheme to be ₹2,500-2,700 crore per year. However, from a Rajya Sabha question dated July 18, 2018, it appears that only ₹4,829 crore was spent in the first three-and-a-half years of its implementation (2015-16 to July 2018).

This implies only about 55 per cent utilisation of the scheme by the exporters.

There can be several reasons why the IES was underutilised even when funds were available. Generally, low export growth and slowdown in global demand may have led to low demand for export credit during this period. Also, the implementation of the IES, to a large extent, coincided with the imposition of demonetisation and GST.

As highlighted in a paper by the RBI, these twin shocks may have disrupted the MSME supply chain and had a negative impact on exports from MSMEs. Apart from these, lack of awareness among exporters and banks about this facility may have resulted in low utilisation. Also, high interest rate in India could have discouraged the exporters.

It is possible that, even with an interest subvention of 3 per cent, the rate of interest plus the assortment of processing fees charged by banks for export credit may still have been high, discouraging Indian exporters from borrowing from the domestic banking sector.

Major changes

To make the scheme more popular, the government introduced some major changes in the IES. In November 2018, a change in policy increased interest subvention from 3 per cent to 5 per cent for exporters from the MSME sector. However, non-MSME large exporters, who export the 416 eligible products, will continue to receive interest subvention at 3 per cent. Subsequently, in January 2019, another change in policy was introduced.

This amendment now allows merchant exporters of these 416 products to take advantage of the interest equalisation scheme at 3 per cent. It is notable that previously only producer-exporters were eligible for the IES.

It is argued by the government that MSMEs export a significant amount of products through merchant exporters; they play an important role in finding overseas markets and getting export orders. Extending these benefits to the merchant exporters should facilitate higher exports from the MSME sector.

While it is perfectly fine for a government to create an exporter-friendly interest rate structure, the recent changes in the IES have not been able to address a major shortcoming of the scheme. In its present form, the IES will be categorised as an export subsidy in the WTO. According to the WTO Subsidies and Countervailing Measures (SCM) agreement, any measure by a national government, which is either a financial contribution or revenue foregone and is contingent upon export performance, is considered an export subsidy.

Export subsidies are prohibited by the WTO and if a country is found to be providing them, it must remove them at the earliest. The IES is contingent upon exports and hence would be treated as prohibited subsidy in the WTO. The WTO has a rapid (three-month) dispute settlement mechanism for complaints regarding prohibited subsidies.

This problem was not there in 2015 when the IES was introduced. Till 2017, India was under a special status for poor countries in the WTO which allowed exemption from the prohibition on export subsidies. However, India graduated from that exemption in 2017. Therefore, according to the WTO rules, IES will be treated as a prohibited subsidy. In the present global trade scenario where countries are combative and protectionist, it is expected that they will challenge these measures and Indian exporters are unlikely to get away with these. Therefore, export contingent incentive measures may not be a prudent policy.

Extend the reach

A possible solution can be to make interest subvention available to the entire MSME sector. The government can make it contingent on non-trade measures like production, value addition and job creation. There are two advantages of this. First, this way the interest subvention scheme will not be an export-contingent subsidy; hence it will not be treated as a prohibited subsidy in the WTO.

And, second, this will extend lower cost of capital for the firms in the MSME sector who are producing for the domestic market. Given the sluggish global demand and tensions related to potential trade-wars, facilitating the entire MSME sector may make more sense than focussing only on exporters from the MSME sector. Non-MSME labour-intensive firms may also be given some incentives for job creation.

The policymakers must redesign the IES to make it more effective under the present global trade regime. A more horizontal and cross cutting interest subvention scheme may take care of the relatively high rate of interest prevailing in the Indian economy now and help in employment generation.

The writers are faculty at IIM Calcutta and IIM Kashipur, respectively

Published on June 03, 2019
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