The Union Budget for 2020 reversed liberalisation of the customs tariff regime by increasing customs duties across the board. The most significant change, however, was not a mere rejig of rates, but a potential challenge to India’s standing in the global supply chain.

Global trade relies on a simple but vital document — the ‘Certificate of Origin’ (COO). A COO is akin to a birth certificate for exported goods. Free Trade Agreements (FTAs) grant the benefit of reduced rates of customs duties to the importing country — provided the value addition in the country of origin/exporting country is reasonable (around 35-40 per cent generally). These benefits are extended in trade and diplomatic policy by identifying goods based on COOs. A popular example is the ‘Generalised System of Preferences’ provided by developed countries to least developed countries.

This system relies on trust, as verification is performed by an external agency in another country. Unfortunately, the system is also vulnerable to manipulation. ‘Origin fraud’ involves the outsourcing of certain minor processes, such as assembly, or even mere transshipment, to obtain a certificate of origin and claim duty benefits.

According to publicly available information, India has witnessed a few prominent cases of origin fraud recently:

Import of stainless steel from Indonesia grew from 8,000 tonnes in March 2018 to 67,000 tonnes in March 2019, coinciding with the imposition of anti-dumping duty on Chinese steel products

Import of ready-made garments from Bangladesh grew from $672 million in 2016-17 to $1.04 billion in 2018-19. Indian producers allege that such imports at preferential rates do not adhere to the value addition norms in the South Asian FTA.

India imported 1,90,000 tonnes of palm oil duty free from Nepal. It is alleged that no manufacturing capacity for palm oil exists in Nepal, but this was merely a transshipment from Malaysia. Such imports would otherwise have incurred 44.5 per cent customs duty.

Consequently, the Finance Minister has proposed a verification mechanism in the Union Budget for ascertaining origin of goods “to ensure FTAs are aligned to the conscious direction of our policy”. However, resolving the issue may not be as simple as it seems.

Previously, the government would tackle origin fraud through data exchange and enforcement with the exporting countries’ government authorities. In contrast, under the verification system, the importer will have the onus to prove the origin of preferentially imported products and provide detailed information for such imports. Verification is premised on the low threshold of ‘reasonable belief’ of the assessing officer, creating a risk of undue use.

Commercially, the importer will have to verify the origin of imported goods in the exporting country on his own account. This involves sourcing production data and bill of material from the exporter. The exporter may be unwilling or not be at liberty to provide such sensitive data. Would small-scale importers particularly have the capacity or leverage to undertake such verification?

Owing to the degree of effort involved, importers may decide to forego preferential benefits in the FTAs entirely. Import would be made on payment of duty; this will add to the cost, since customs duties are not creditable.

If importers decide to forego procurement, FTAs become non-operational for Indian importers. The verification mechanism may act as a non-tariff barrier operationally.

India cannot obtain benefits for exports through FTAs while curbing market access to other countries. Other countries may retaliate with their own verification scheme for Indian exports or litigate before the WTO. Considering India’s export schemes are already under scrutiny, this could heighten trade tensions.

Importers are likely to experience a lot of questioning and scrutiny when imports are made from FTA countries, reducing the ease of doing business.

Publicly available trade data shows that imports into India under the FTAs are small in comparison to total imports, comprising only $32.22 billion out of $617 billion for FY20 (i.e. around 5.2 per cent). Customs duty collections have risen an impressive 20 per cent to a total of ₹1,55,904 crore in FY20, irrespective of the above trends. Whether drastic measures at this stage are needed, demands introspection.

India’s foreign reserves have risen on account of access to global markets by Indian exporters. As the centre of global trade in the world shifts from the US, deeper trade ties are particularly promising for Asian economies. A holistic alternative to protectionism lies in greater inter-governmental cooperation to counter cases of fraud.

Co-authored with inputs from chartered accountants Sandip Jain and Aditya Venkataraman

(A version of this article appeared in The Hindu Business Line, on March 31. 2020)