Tuesday, December 28, 2010

Indian Textile Sector: Fiscal Structure and Changes in Commodity-mix

Generally, it is expected that changes in fiscal structure have a direct impact on prices of commodities, which gets translated into changes in demand and hence a change in the commodity-mix. A close look at fiscal structure and consumption behaviour of textiles in India helps us understand the complexities involved in this economic phenomenon and the policy lessons arising from them. Textile sector may broadly be classified as natural/conventional fibres (NF) and man-made/unconventional fibres (MMF). Decades ago, the excise and customs duties relevant for the MMF were set much higher than NF and this trend has been continuing till today, supposedly to protect the declining conventional sectors. However, the recent Indian budgets have been reducing the gap gradually. Excise duties for MMF are still quite high: 8-16%. This analysis will point out what more is needed in this direction and why.
Textile consumption contributing to about 6-7% of an average Indian’s consumption basket (calculations based on NSS 60th Round, 2005-06), by itself is vital for enhancing the economy, in addition to the fact that textile sector accounts for a major part of employment, GDP and exports of India. Of late, textile sector is becoming demand-constrained domestically, though the external constraint is far less than the MFA quota regime. Given these factors, enhancing domestic textile consumption, as a whole, is an important policy outcome.
The basic premise behind high excise duties for MMF is that without them, low prices of MMF products might destruct the NF market, owing to substitution. However, an empirical analysis using a huge reliable household-level survey data on Indian textile purchases from 1994 to 2003, proves that demand for MMF is more elastic to its own price and also that MMFs and NFs do not any more substitute each other, as seen from their negligible cross-price elasticities, which reflect the extent to which the demand of NF falls with a fall in price of MMF. So, a fiscal-measure-induced fall in MMF prices will lead to a greater expansion in MMF demand than the one in NF prices. What this means to a policy-maker is: If you decrease the excise/customs duties for MMFs, you are not harming NFs because they are not substituted and in fact, you are facilitating an expansion of the textile consumption, which is in the interest of the entire textile industry and economy as a whole. This has been one step that is almost never missed by any Finance Minister of India in the Annual Budget. Perhaps this is a testimony to sound research-backed policy-making in India?

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