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Has protectionism done India more bad than good?

By Finserv MARKETS - Dec 5,2019
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Protectionism in India

It was sometime in 1991 that India embraced globalization and privatization, opening up the country to trading opportunities with partners across the globe. In recent years, however, many moves point toward a growing state of protectionism in India, indicating that the country is increasingly turning inward and erecting virtual walls to curb the inflow of goods from the other side of its border.

India’s recent moves embracing protectionism

At first glance, India’s stance appears to be anti-protectionism. In 2018, Indian Prime Minister, Narendra Modi, sent out a strong message against protectionism, equating it to being as dangerous as terrorism. In his keynote speech at the World Economic Forum (WEF) Annual Summit, Modi stated that many countries were becoming inward-focused, that globalization wash shrinking, and that such tendencies couldn’t be considered a lesser risk than terrorism or climate change. Even at the BRICS Summit, 2019, India appeared to align with the rest of the BRICS countries on their views against protectionism.

  1. Budget 2018: Increase in customs duty

However, despite these apparent anti-protectionism standpoints, India’s policies have slowly, yet steadily, been migrating toward an inward-focused economy. Mere days after the WEF Annual Summit, India’s budget 2018 saw a steep hike in customs duties in more than 10 sectors. The motive, it appeared, was to discourage imports from other countries, particularly China and other Asian players, in order to create more jobs within the country.

Protectionism in India

Source: moneycontrol.com

  1. June 2019: Another hike in customs duty

In June 2019, India announced another hike in customs duty, this time on 28 products imported from the US. The move was, perhaps, in retaliation to the USA’s decision to hike tariffs on Indian goods like steel and aluminum.

  1. November 2019: Opting out of the RCEP Agreement

In addition to these tariff hikes, India recently decided to opt out of signing the Regional Comprehensive Economic Partnership (RCEP) agreement. While the reasons for not joining in with the other 15 countries include valid causes like reducing trade deficit and giving a boost to the Indian economy, it certainly hints at a protectionist attitude.

Impact of protectionism in India

Protectionism, like all economic practices, comes with its own set of advantages and disadvantages. The impact of protectionism on the Indian economy can be broken down as follows.

  1. The good side of protectionism

In the long run, protectionism in India has the potential to impact the Indian economy favorably in three ways.

  • Firstly, it can reduce the country’s trade deficit. In the past six years alone, India’s trade deficit with the countries that signed the RCEP free trade agreement went from $54 billion in 2013-14 to $105 billion in 2018-19. Currently, the RCEP countries make up 35% of the country’s imports and only. Protectionism can help bridge this gap by reducing imports.
  • Secondly, by discouraging imports and encouraging domestic industries to scale up, protectionism can boost the country’s GDP. The government’s Make in India campaign can get the boost it needs to bring about the positive changes it was intended for.
  • Finally, with local industries flourishing, the employment rates in the country may start to look up. Domestic businesses will need more workforce to scale up and meet rising demand levels, thereby creating jobs.

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  1. The adverse side of protectionism

While there are many benefits to this economic practice, the downsides to it may be more far-reaching. Protectionism has four main pitfalls, as explained here.

  • Firstly, with imports restricted or cut off, there are limited choices for consumers. Without access to foreign goods, consumers will have to make do with what’s produced or offered in the country’s home ground.
  • Secondly, consumers will also eventually end up paying higher prices for goods and services that show no significant improvement. Since the supply is limited to the domestic market, prices can rise steeply and unchecked.
  • Thirdly, with little to no competition from foreign markets, domestic manufacturers and services providers will have no incentive to innovate and improve the quality of their offerings. Research and development may slow down or come to a stop altogether.
  • Lastly, by erecting trade barriers, India risks retribution from other countries. At its most extreme, this could lead to economic isolation. Even if doesn’t get to that point, Indian economy could suffer due to trade barriers that other countries might erect in response to our protectionist strategies.

So, how has protectionism impacted India?

On the upside, rising protectionism in India has made trade deficit narrower, even if only marginally. In September 2019, the trade deficit stood at a seven-month low, coming in at $10.86 billion. However, a deeper look at this deficit reveals a slowdown in both exports as well as imports, which is not necessarily a favorable situation for the Indian economy.

Additionally, the expected success for domestic businesses has also not seen the light of day, mainly because other factors have contributed to low levels of consumption in the country. With purchasing power getting weaker, even established businesses are failing to do as well as they did in the era of globalization.

Curtailing globalization has also negatively impacted India’s participation in Global Value Chain (GVC). GVCs are essentially networks spread across various countries, along which the many stages of production of goods or rendering of services are distributed. It’s achieved by outsourcing parts of the trade process. According to a World Bank Report, GVC integration for most countries declined between 2007 and 2017. For India, however, the decline has been steeper, especially since 2013.

All in all, it appears that protectionism does not fit in well with the current economic climate in the country.

A silver lining

Despite the dismal outlook in most sectors, some industries in the Indian economy are flourishing. Smart MSMEs are tapping into the power of digital solutions to help meet the cash crunch in the country. For entrepreneurs with ideas that can ease the burden of consumers, the situation is ripe for turning these ideas into a concrete business plan.

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