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For healthy SME exports, India urgently needs tax neutralisation, logistics infra for clusters, SEZs

By Kabir Bogra and Ayush A Mehrotra

The Small and Medium Enterprises (SME) segment, which constitutes more than 40 per cent of India’s exports, is the second-largest employer after the agriculture sector and accounts for 30 per cent of India’s gross domestic product. Despite its huge significance to industrial production, the SME segment faces continuing headwinds. These include a variety of indirect non-creditable taxes, high logistics and transportation costs, unavailability of credit on reasonable terms, unpredictability in certification and testing procedures for international acceptance, etc. 

Export Push

To offset some of these difficulties for the industry, the government provides export incentives through the Foreign Trade Policy (FTP), which is regulated by the Directorate General of Foreign Trade (DGFT). In the current FTP 2015-20, direct incentive schemes for exports, such as the Merchandise Export from India Scheme (MEIS), has rewarded exporters, to the extent of Rs 40,000 crores in 5 years, through duty credits used for importing duty-free goods into India.

As India’s economic indicators have improved in recent decades, MEIS has come under challenge at the World Trade Organization (WTO) for being non-compliant with India’s status as a developing economy. As India prepares to transition to a WTO-compliant framework, it will have to eliminate export subsidies through direct fiscal incentives. Accordingly, the new export incentive schemes would be required to meet the twin objectives of enhancing competitiveness in global markets while introducing efficiencies through the ease of doing business. 

Neutralising Taxes

The DGFT is evaluating several options for achieving these objectives and a recent scheme introduced by the government for the textile sector offers a blueprint for what may be in store.  The Rebate of Central Taxes and State Levies Scheme (RCTSL) seeks to neutralise incidences of central and state taxes, through reimbursements, which is aligned with the WTO framework. A scheme like RCTSL can offer tax-neutralisation to up to 4 per cent to 5 per cent of the value of exports -- a marked improvement in efficiency in relation to the highly competitive global market. The expansion of the RCTSL scheme to other categories of products, as envisaged by the government for the upcoming FTP, would be a significant boost to the export-focused SME segment. 

What’s Needed Next

In addition to fiscal reforms, the SMEs require significant infrastructural support to enhance competitiveness. While not all kinds of support can be implemented through the FTP, which is a policy framework, necessary measures would be critical for the long-term health of the SME export segment. Some other measures that can be implemented effectively are as follow:

  • Creation of integrated logistics infrastructure near SME clusters to aggregate exports: India has several geographical clusters where SMEs are present in large numbers, such as Coimbatore, Kanpur, Jalandhar, Ahmedabad, Rajkot and Anantpur. The Ministry of Micro, Small & Medium Enterprises lists 150 such clusters across the country with high export potential. Establishment of end-to-end logistics for such clusters would introduce significant economies of scale and cost competitiveness for businesses in these regions.
  •  Special Economic Zones (SEZ) for the SME sector: SEZs are designated locations where industries and service providers focus exclusively on exports to other countries. In the current SEZ framework, these locations are primarily organised as per the nature of the industry, irrespective of size. The government can consider promoting SME-focused SEZs to address specific issues common to the SME segment. Some obstacles that can be comprehensively addressed in this manner include lack of infrastructural facilities such as certification and testing for international standards, best practices in packaging, services for industrial design, etc. 
  • Access to trade credit and working capital facilities: SMEs have high working capital and finance requirements due to cash flow mismatch in receivables and payables. The government can, therefore, consider instituting a fund or a guarantee scheme governed by the DGFT or the Ministry of Commerce to provide access to cheap and relatively long-term working capital for SMEs.

  • A combination of the above steps in conjunction with the new tax-neutralisation schemes is likely to provide the impetus which the sector needs. Considering the extent of employment and economic value generated by the SMEs, there is a pressing need to ensure that they receive all the assistance they need.

    (Kabir Bogra and Ayush A Mehrotra are partners at Khaitan & Co. Views expressed are the authors’ own.)