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Importer Beware: FOB Prices Out of India Spike 5 Percent

It seems the Indian government is stuck between a rock–complying with global trade rules and its overall tax structure –and a hard place–supporting its apparel and textile industry.

India’s move to slash duty drawback rates on Oct. 1 created an uproar among exporters that had relied on the funding to keep prices at bay and maintain competitiveness with its Asian manufacturing neighbors.

Deepika Rana, president of strategic initiatives at Li & Fung with responsibility for the Indian Subcontinent, said in an interview with Sourcing Journal that exporters see the drawback as rebate and figure their costing with that in mind, which, she said, is “probably not the most effective thing to do.”

A drawback officially is the refund of certain duties, internal revenue taxes and certain fees collected upon the importation of goods when goods are then used for export. When the duty drawback move was announced, Indian manufacturers were in somewhat of a panic, claiming the cut would lead exporters to raise prices to balance the loss of revenue from the refund.

Industry reacts

Ashok G. Rajani, chairman of the Apparel Export Promotion Council (AEPC), said at the time, “The apparel industry needs to book orders in advance for the next season. I think the present new rates are unacceptable and the ministry of textiles should immediately consider AEPC’s recommendation for extending the current transition rates until March 31, 2018, to instill confidence in the sector and…for sustaining employment in the sector. In the absence of an encouraging drawback rates, the exports will further witness a sharp decline just ahead of the peak festival season when the industry was expecting recovery.”

The lower rate comes at a time when the industry is facing a decline in exports due to global conditions and currency overvaluation. The duty drawback was one of the key policy support measures designed to make the industry more competitive.

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AEPC said the steep drop in the drawback support will negatively impact about 7,000 small and medium enterprises in the apparel export sector, creating an adverse effect on the employment being provided to more than 12 million people.

[Read more about Indian policies: Indian Spinners Advised to Reduce Yarn Production for Market Stability]

The Tiruppur Exporters Association (TEA) also termed the reduction in duty drawback rate a death knell for the region’s garment export sector. TEA president Raja M Shanmugham said once buyers go out of the country to places like Bangladesh, Sri Lanka, Cambodia and Vietnam, it will be difficult to bring them back.

The new rates for cotton garments was dropped to 2 percent from 7.7%, while the duty drawback rate on garments containing cotton and man-made fiber blends is now 2.5% compared to the existing 9.5%, and the rate on garments made of man-made fibers is also 2.5% compared to 9.8% previously.

Clothing items made of silk are subject to a rate of 4.8% compared to the earlier 7.6%, while the rate on wool apparel came down to 3.5% from 8.7%, all representing major cuts in subsidies.

The rates were lowered in 2016 as a boost to the apparel and textile industry, but the government decided to end the incentive program.

Li & Fung’s Rana said from the government perspective, the drawback program was essentially a refund of a group of taxes levied on the industry.

“Now with all the taxes rolled into [the new regime of Goods & Services Tax], the government has withdrawn the refund because they had already given the exporters a provision that the GST could be claimed back,” Rana said. “So, the government is saying that if we are allowing you to claim back the GST under Make in India, then why should we give you the additional refund under the drawback program begun last year?”

Make in India is a government initiative launched in 2014 to encourage national and multi-national companies to manufacture their products in India.

But there still is a gap between the rescinded drawback and the rollback of the goods and services tax of about 5 percent, which is what is causing the consternation among manufacturers and could lead to a comparable increase in FOB prices, she noted.

Issues at play

While the government is trying to work with the industry on remedies that fit into its overall budgets and polices, it is also “very aware of the fact that garment manufacturing is the second largest employer in India and they’ve really streamlined their salaries and how they’re functioning in many ways,” Rana said, adding that the government also realizes other Asian nations that compete with India on apparel exports have some competitive advantages, like more duty-free agreements and lower costs, “so there’s a lot of imbalance” in the region.

Some experts said another contributing factor for the government slashing the drawbacks is that they might not comply with World Trade Organization rules.

“Global trade rules require India to phase out its once allowable export subsidies within the coming year,” Stephen Lamar, executive vice president of the American Apparel & Footwear Association, told Sourcing Journal. “At a time when there is increased focus on countries adhering to their trade obligations, it’s important for India to show leadership in this area. This looming deadline, and the uncertainty around it, creates confusion and undermines business predictability. The sooner these practices are phased out to bring India in line with global trade practices, the sooner India’s textile and apparel sector can become sustainably competitive.”

While that might be a contributing reason for the policy change, it’s no solace to the industry, for which things were exacerbated when neighbor and rival Pakistan raised incentives to promote exports late last month.

Pakistan’s Economic Coordination Committee approved a proposal that 50 percent of the export package incentive for eligible textile and non-textile sectors be provided on the same terms as for the period January to June, according to Pakistani news reports. A meeting of ECC cabinet also gave approval for a stipulation that the remaining 50 percent of the rate of incentive would be provided if the exporter achieves an increase of 10 percent or more in exports compared to the corresponding period of the last year.

All this left Indian experts and foreign importers with even more anxiety over the potential for swiftly rising prices on apparel.

For the year ended Sept. 30–the most recent data available–U.S. apparel and textile imports from India increased 8.22% to 5.09 billion square meter equivalents from a year earlier, so it’s too early to tell whether the situation will impact exports.

Seeking remedy

The apparel industry in India has continued to lobby the government for relief and has been able to obtain some help from the Goods & Service Tax Council, since GST is an indirect tax levied on the supply of goods and services within the country, allowing the government more flexibility in policy.

These measures include a reduction in the rate of GST on man-made items such as synthetic filament yarn, nylon, polyester and acrylic to 12 percent from 18 percent.

The GST council also made a provision for an immediate refund of GST for the month of July and August to ease working capital stress. In addition, exporters have been exempted from furnishing bond and bank guarantees when they clear goods for export, and GST on bunker fuel is being reduced to 5 percent for both coastal vessels and foreign-going vessels. The council said this will boost coastal shipping and improve India’s competitiveness.

“The council is confident that these measures would provide immediate relief to the export sector and enhance export competitiveness of India,” the Ministry of Finance said earlier this month. “The council also decided to continue to monitor the situation closely so that going forward all required support continues to be extended to this important sector.”

AEPC said it views that these measures as offering immediate relief to apparel exports sector that has been going through a difficult stressful phase due to various global and domestic factors.

Commenting on the move, AEPC chairman Rajani said, “The changes which have been announced by GST Council…will give a great relief to the apparel industry for the immediate term, as the sector has been facing severe liquidity crunch after the introduction of GST.”

AEPC has been raising the issue of embedded taxes on exports at various forums and has stressed that “this key issue needs to be taken up in a considerate manner to address the genuine concerns of the exporters and export sentiments.”

“[The] appreciating rupee and the instance of new levies like GST on intra company stock transfers, job work, freight and samples imposed in the GST regime have led to cost escalation for exporters, further narrowing their low margins in highly competitive global apparel markets,” the council said in response to the Finance Ministry’s latest policy announcement. “AEPC has been in constant consultation with Commerce and Textile ministries…on the issue of restoration of old duty drawback rates until the new rates, reflective of the total tax incidences, is worked out.”

Rana said, “It’s a work in progress. I don’t see it as so dire, I see it as a correction. The first light at the end of the tunnel is that there is an ongoing conversation with the government. So, these numbers are not set in stone. What is worrying the exporters and why they are making noise is that the fabric prices in India haven’t come down, whereas the fabric prices in other countries have been rationalized in keeping with the demand and other factors of production.”

She added that another maybe more important problem for regional competitiveness is that the Indian industry hasn’t modernized and become more automated and efficient in its factories, even in comparison to competitors like Bangladesh. That, however, is beginning to occur, Rana said, and is necessary for them to be more competitive, noting that the government is providing incentives to buy machinery and offer lower interest rates.