Indian Tariffs on Non-Essentials

The finance ministry of India increased customs duties on “non-essential” items, including washing machines, air conditioners, footwear, gemstones and jet fuel. The objective of the increase is to limit the weakening of the Indian currency and reduce the country’s current account deficit. However, the approach and items are chosen means that this might not be as effective as intended.

Background

India’s economy can be described as a developing economy. It is the world's seventh-largest economy by nominal Gross Domestic Product. It is also the third largest economy in terms of Purchasing Power Parity (PPP). However, it ranks at 141 in per capita GDP (nominal). The recent rupee weakness has largely to do with the risk-off sentiment associated with emerging markets (EM). However, India’s fiscal and current account deficits make it more vulnerable. If left unchecked, it presents a dangerous spiral. In the worst-case scenario, a further depreciation leading will lead to a higher inflation expectation. So far, growing fears about rising inflation and consistent outflow of foreign funds from the domestic equity market has also impacted the domestic currency trading. 

Read more of our India coverage here and here.

Analysis

India increased its import tariffs on goods deemed as ‘non-essential’, in an effort to increase confidence in the weak Indian currency, which has fallen almost 13% against the US dollar.  Finance minister, Arun Jaitley, announced the increase in customs duties earlier this month and the increase came into effect today. Industry associations affected by the tariff lobbied hard to change this decision as the prices of their inputs would dramatically rise. However, the finance ministry still imposed the duties, claiming the 19 selected items were originally part of a much longer list. It has also indicated it will take measures to boost exports, though no specific measures have been shared regarding this. 

The airline industry, which is already financially struggling, is likely to be hit particularly hard by the tariffs since fuel was previously not taxed for importing. The other items that will be taxed are considered as being typical purchases of the wealthy and affluent, thereby nudging these purchases to be made locally, aligning with Prime Minister Modi’s “Make in India” initiative. The push towards greater protectionism is following a global trend as the U.S.-China trade war continues to escalate with rising tariff impositions. As trading partners continue to emphasize domestic production and consumption, the trend towards protectionism is likely to be prolonged. 

Read more of our coverage on the U.S.-China trade war here and here. 

The key items affected by the tariff are air conditioners, refrigerators, washing machines, footwear, furniture fittings, gemstones and aircraft fuel. The 19 items contributed to an import bill of over $11 billion in the last year. The government has stated that the tariffs are intended to decrease the country’s current account deficit, which is currently 2.8% of the national GDP – thereby improving the Indian economy. The additional duties are expected to generate Rs. 4000 crores in revenue. 

While the tariffs will generate more revenue, it also raises the risk of imported inflation and could impact investment decisions. Import duties are a short-term solution but could have long-term impacts if implemented effectively. Using the tariff revenue generated to diversify India’s manufacturing base could help the country reduce its reliance on imports.

Assessment

Our assessment is that the recent increase in import duties are unlikely to have a sufficient impact on the current account deficit - to offset the detrimental impact the tariff will have on the aviation and gemstone industries. The depreciation of the Indian rupee and India’s high level of imports for energy-related products will be further hampered by import duties. We feel that increasing interest rates or choosing foreign bonds could have been a more effective way of addressing the weak Indian rupee. We feel that these non-essential goods are more likely to have greater price elasticity due to their high-end nature, which would result in a limited effect on reducing imports or improving the current account deficit.