The GST was introduced in 2017 as a landmark reform to India’s indirect tax structure. The GST will subsume several central and state-level taxes within one single tax, thus eliminating the cascading effect caused when each uses up to eight intermediary stages before transmitting its burdens on as many targets further downstream, reducing compliance costs, promoting exports and encouraging the creation of such a common national market. At the same time, India has accepted free trade agreements (FTAs) with its major trading partners to expand and integrate into global markets.
In 2022, India signed FTAs that cover trade in goods and services with ASEAN, South Korea, Japan, and Malaysia. Bhutan, Nepal, Chile, MERCOSUR (Argentina, Uruguay), And Afghanistan. Yet opinions differ over whether FTAs collectively weigh domestic industry interests against India’s trade prospects. This article examines how GST could affect India’s FTAs, specifically regarding tariffs, rules of origin (ROOs), trade facilitation and revenue collection, and any broader effects on Indian trading.
GST and FTAs: Overview
The Goods and Services Tax is an indirect, destination-based tax levied on the supply of goods and services. It subsumes over a dozen Central and State-level indirect taxes into a unified rate structure consisting of four main rate slabs – 5%, 12%, 18%, and 28%. Registered businesses can claim input tax credits for the GST they pay on business purchases, thereby avoiding the cascading effects of tax-on-tax. Key features include centralized registration, online tax filings, and seamless interstate trade, as IGST allows for cross-utilization of input tax credits across state lines.
On FTAs, India has agreements with ASEAN, South Korea, Japan, Malaysia, Bhutan, Nepal, Chile, MERCOSUR and Afghanistan. These provide preferential access to Indian exports by reducing tariffs on goods traded with significant partners. For example, the India-ASEAN FTA inked in 2009 aims to promote trade by eliminating duties on 80% of tariff lines for ASEAN nations and India. Similarly, the India-Japan CEPA signed in 2011 created duty-free import quotas for Japanese goods into India.
On rules of origin, most Indian FTAs adopt a general value-addition threshold of around 35% -40 % for conferring originating status to ensure third-country products do not inordinately gain. Related aspects include self-certification procedures, verification protocols, and panels for settling origin disputes. Beyond goods, India’s comprehensive FTAs with Singapore, South Korea, and Japan also liberalize service trade, protect investments, open government procurement markets, and outline digital trade rules.
GST Impact on India’s FTAs
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Tariffs and Rules of Origin
A critical impact of GST on India’s FTAs relates to tariff preferences and rules of origin. Export costs have been reduced by unifying numerous domestic indirect taxes into a single GST. This enhances the margin of tariff preference that imported goods from FTA partners enjoy in Indian markets. Estimates from NITI Aayog show that effective export prices could decline by 3-4 percentage points for labor-intensive sectors like textiles, making these products more competitive internationally. At the same time, lower export pricing improves margins over the value addition thresholds stipulated under rules of origin. This facilitates easier compliance with regional value content requirements for claiming originating status and margin of preference over third-country imports. However, the intricate system of product classifications and tariff differential across goods is a challenge. For instance, while tariffs vary between 0-5% for IT products, they remain at 15-20% for automobiles under the ASEAN agreement.
Similarly, value addition norms range between 30% in chemicals to 45% in cars. Hence, aligning the four-tier GST rate slab structure with many FTA tariff lines remains an administrative obstacle. Further, aspects like refunds of accumulated input taxes for exporters also need to be synchronized to leverage FTAs effectively.
Trade Facilitation
GST also bears on trade facilitation mechanisms instituted under India’s FTAs:
- The IT infrastructure set up for nationwide GST compliance, like the GSTN portal, signifies an important step in easing cargo clearance at customs ports and borders. The standardized, online tax documentation cuts red tape by reducing paperwork and data submissions.
- By amalgamating a number of border levies like countervailing duties (CVD) and special additional duties (SAD) into GST, border tax adjustments stipulated under FTAs become more administrable.
- Initiatives like e-sealing shipments, RFID-enabled logistics tracking, and electronic advanced ruling using the single window ICEGATE e-portal build synergy with FTA provisions calling for simplified customs procedures, transparency, and paperless trading.
However, the total gains remain contingent on how the teething IT challenges facing GST rollout get effectively resolved in the short to medium term.
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Revenue Collection
An issue requiring close attention is the loss of fiscal revenues from tariff reductions under FTAs in light of the GST introduction. With customs duties slashed to zero for 80% of traded goods with ASEAN, Japan, and South Korea, India risks further loss of import duties as a higher margin preference potentially expands imports from FTA partners. This could widen deficits where it already exists, like with ASEAN and Malaysia.
According to experts, this tariff revenue loss may have to be compensated through higher GST mop-up, including by rationalizing the merit rate structure or raising standard rates. Further, customs efficiencies brought about by the modernization of GST systems could also offset some revenue leakages from valuation fraud, misclassifications, and outright smuggling from third countries. The capacity to adjust revenue losses also differs based on partner country – for example, while the FTA Utilization rate remains low for Japan (around 5%), it exceeds 25% for ASEAN sources. Hence, tariff cuts under FTAs must align with the fiscal flexibility afforded by GST and the competitiveness gains for domestic exporters in partner country markets.
Broader Impacts on Indian Trade
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Export Competitiveness
By consolidating India’s complex indirect tax system, the GST reform enhances the competitiveness of the Indian industry in global markets, thereby improving the utilization of existing FTAs. First, input tax credits under GST enhance cost efficiency, as taxes paid on business purchases can be offset with GST collected on sales. Second, eliminating border check posts reduces transportation time and the cost of exporting. Third, for services sectors where GST is applied on a uniform basis, price competitiveness increases. Finally, significant investments in infrastructure, including highways and rail freight corridors, augment connectivity to gateway ports like Jawaharlal Nehru Port Trust (JNPT) and raise competitiveness. This cost advantage feeds positively into leveraging market access created under FTAs and the conclusion of proposed deals like the India-EU FTA.
However, an emerging challenge with the four-tier GST structure is the widening gap between merit rates and bound tariffs under FTAs, which permit 0-5% imports into India. With the top slab at 28%, domestic sectors like auto components, textiles, and plastics could become vulnerable to substances as the preference margin keeps rising. Hence, vigilante on unfair trade from FTA partners is considered necessary – an avenue being antidumping duties, safeguards, and countervailing measures permitted even under FTAs like the ASEAN agreement.
Also Read: GST and the Export Sector
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Export Diversification
GST benefits India’s export diversification into the services, investments, and government procurement modes liberalized under its comprehensive FTAs signed with Singapore, Japan, and South Korea. One, services receive equal tax treatment as goods regarding ITC benefits, easing their export. Two, GST provides credit for procurement by exporters, thereby aiding participation in overseas government tenders accessed under FTAs. Third, by bringing numerous border levies into its gamut, GST mitigates the disadvantaged position of Indian service providers who earlier paid higher domestic taxes than goods exporters. Finally, measures like online Visa issuance, trade facilitation, and customs cooperation add momentum generated by GST systems modernization and enable services sectors to harness FTAs.
However, an under-utilized area still needs global supply chain network integration. Poor infrastructure like cold storage chains thwarts India’s agricultural export integration with processing centers in ASEAN as envisaged under the FTA. Similarly, the need for mutual recognition agreements on standards and technical requirements continues to constrain integration with advanced industrial value chains between India and South Korea. Realizing these gaps through trade-enabling policies holds the key to optimally harnessing FTAs.
Trade Balance and Current Account
By improving export competitiveness, GST helps mitigate India’s merchandise trade imbalance with key FTA partners like ASEAN, South Korea, and Japan. As export price advantages translate into higher shipments of outward-bound trade, they countervail the dominant trends of the last decade, where FTAs reciprocally boosted imports from partner regions without matching gains in India’s export orders. Similarly, growth impulses created by GST to services trade surpluses also bear on correcting India’s current account deficit, which is projected to widen to 2.5% of GDP in 2022. In particular, openings in overseas project exports and IT enable services to hold substantial promise to raise the economic gains extracted from India’s comprehensive FTAs that feature services, investments, and digital trade. Thus, sound implementation of GST and FTA commitments remains integral to lifting India’s trade and current account balances over the long run.
Conclusion
This article assessed the interactions between GST and India’s FTAs across aspects like tariffs, rules of origin, trade facilitation, fiscal changes, and broader consequences for India’s trade. While GST holds substantial efficiency gains and positively affects FTA utilization by enhancing export competitiveness, challenges impede extracting their full combined potential. Key administrative hurdles like aligning domestic GST slabs with FTA tariff schedules and minimizing revenue losses from duty cuts should be priorities from an institutional standpoint.
At the enterprise level, challenges of export diversification, supply chain integration, and trade imbalance vis-à-vis major Asian partners highlight enduring competitiveness issues facing Indian industry. Nevertheless, credible strides are being witnessed in export performance to FTA partners like ASEAN on the back of such domestic tax rationalization. This underscores the value of continuing regulatory reforms to position India as a formidable global merchandise and services trade player in the 21st-century digital age.
Also Read: GST: Everything You Need To Know
FAQ’s
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What is GST, and what are its key features?
GST, or Goods and Services Tax, is an indirect tax system introduced in India in 2017. It has subsumed multiple cascading central and state taxes into a single tax system on the supply of goods and services. Key features are 5%, 12%, 18%, and 28% tax slabs, input tax credits, unified national market, and centralized registration.
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What do free trade agreements (FTAs) aim to achieve?
FTAs are reciprocal agreements between two or more partners that seek to promote trade by reducing or eliminating customs tariffs and other trade barriers in substantially all sectors. India has signed 13 FTAs with ASEAN, South Korea, Japan, Malaysia, Bhutan, Nepal, Chile, MERCOSUR, etc.
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How does GST impact the utilization of FTAs?
GST reduces export costs by 3-4%, providing Indian goods a competitive edge. This, coupled with reduced paperwork, transport time, and unified procedures, improves the margin of preference to avail duty-free access under FTAs.
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What effect does GST have on rules of origin under FTAs?
GST lowers production costs, facilitating easier compliance with 35-45% regional value addition thresholds for claiming originating status under ROOs. However, aligning multi-tier GST rates with many FTA product-specific rules remains challenging.
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How does GST address trade facilitation under FTAs?
The centralized compliance framework of GST improves transparency, cuts red tape by reducing data submissions, and builds synergy for paperless trading envisioned under FTAs. Entire gains will, however, depend on resolving early GST procedural challenges.
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Can revenue losses arise on account of tariff cuts under GST?
Yes, with 80% of import duties eliminated under key FTAs, loss of customs revenue may arise, which will require compensating through higher domestic GST mop-up. However, reducing tax evasion through GST IT systems helps partially offset this.
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How does GST augmentation support Indian exports under FTAs?
GST enhances the competitiveness of Indian exports by streamlining domestic taxes. This, coupled with trade-enabling policies, raises leverage to access overseas markets opened up by FTAs. Lower export pricing also improves the utilization rates of existing FTAs.
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Can GST enable services export diversification under FTAs?
Yes, GST provides equal treatment to services vis-à-vis goods, thereby creating opportunities in overseas services procurement tenders, Mode 4 supply, etc., that India’s comprehensive FTAs have unlocked.
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How does GST impact India’s trade balance concerns under FTAs?
GST efficiencies make Indian export prices competitive, which helps increase outward shipments. This counters dominant trends of disproportionate import surges from FTA partners, mitigating trade imbalance over the long term.
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What are some lingering issues in effectively harnessing FTAs under GST?
Challenges include managing inverted customs duty structures under FTAs, lack of mutual recognition agreements affecting standards compliance of exports, and poor cold chain infrastructure, constraining FTAs from realizing their full potential.
