**Policy, Research, and External Affai(s**

# **V IA**

## **Industry and Finance Operations**

## WPS 433

This paper --- a product of **thc** Industry and Finance Operations Division, A .ia Regional Office, Country Department IV (India) --- is part of a larger effort to undcrtakc a comprehensive review of intlia's trade regimc and( oxlicics and to man kerecomnmncndations for liieral /.ait011 of tradc policics. Copics are available free froni thc World Bank, 8 18 I11 Strect NW, Washington DC 2()33. Please contact Francois Eltori, room DI-049 , cxtension 80324 (39 pages with graphs and tables).

Some 60 industrial projects (chiefly in tihc chemical and cnginecring subsectors) finainced by thc Developmnent Finance Institutions in India in 1988 and 1989 were analyzed. The major finding is that levying the heaviest dutics on imported capital goods has deeply distorted industrial incentives anid harmed industrial competitiveness and exports.

With taniffs on capital goods averaginig 80 percent (except for clcctronic industries equipmnerit which pays about 4() percent), Indian projects are generally 40 to 50 percent more ;spensivc than thyc \ould bc under f'ree tradc, and( Up tO 80 perCet ntore expensive in capitaliniitesive projects.

'I _hc_ high iu esint cosLs require a comnillsator) ef'fc cti\ c roictlionl aB erlging 3() percent to allow industrial pIrojX ds to carn rcturns at least equal to lihose available undter _trc_ trade. I Ic locvc r, about haiil the' projects igenral lv those producinig final goods) rccix\e cf'L,ctive p)rotectionl significatlilk lo'.cr than111 thle com,)pensator\ elf'cliVye protect ion, and gcncrai loAer profits than tiose of foreign comi petitors Nomllinal proicction \'arics Awidel\ belt cen lh,ectciors - frl'01om 25 pericent for 'itn.:l goods idi(ustries to **610** to oS perceni lor indu trics producingi intermcdiates and inputs for downstream subsectcrs -- and witiin cach subsector.

Nominal protection rates (as reflected by domestic to world price ratios) averaging 40-50 percent, are substantially lower than average tarif'f collection rates (c()-70 percent) and much lower than ol'ficial tarif'f;s (120-140 percent). The wide variations in protection rcflect a complex system comprising many exemptions and ad hoc tariffs.

Tariff'reform is urgently necded. T'ariffs should primarily providce protection arid incenV \ives, ith only' **a** seconidaryv unction of gcnerating pub!ic revcrnuC. First, tariffs should be slashed, and imports liberalizied, on capital goods, tO\; ard a un;lornim tariif of 15 percent and f-ull **cxcmiption** for projects exponing at Icast halt ol output. [or intncniediates and **othcr** inputs. most tari lf exempt ions should be eliminated. import regirreCS unifiLd, anll(d larilfs aligned on :ollcction rates tom,ard rc(luced levels averaTgingt .40 percent.

Public rccnuC should he generated increasinolv throughl trade-nCuiral instrunitnts (profit ta;Xs aInd itiirCet taxes suchi as O(M \A'' and colnsumliption **VAT ).**

**Thle** PRE **Workirng PaIer Series di,wsen,n:n~ ihe** nndinc **nf ork U1dL r vay** in **Lhc** Bank's Policy. Rescarch, and **Liternat** AffEir,s Con(ipcx. An **ohI-** t(" **1Ie** scr:ez is **is** _to,-t_ thcse fil-tling', **ot iii** iki.,. e%en **if prekenlttion-s are l.ss** than futlly polishd.F **The fintings:** in[Crp)retalini vid **Lnol(u';ons** in thes. **papers** **_do_ noi nek.es.;ri!r represent ofiOcial Rank Tolihc**

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