Hindu mythology could provide some useful metaphors for the lexicon of central planning. In a planned economic system, the state was the trimurti. Only the roles got altered a bit from the version in the myth.
Instead of being a creator, preserver and destroyer, the government became a producer, regulator and risk manager. It produced all sorts of things from bread to nuclear missiles and set in place price controls that ensured that producers did not earn more than a 'fair' rate of profits. Finally it ensured that all industries were always in the black irrespective of the dictates of demand and supply.
This kind of economic wonderland was possible only with the help of huge subsidies, controlled interest rates and crippling tax rates. To cut a long story short, this was found unsustainable and by the early nineties, almost all economies found it imperative to liberalise.
Successful liberalisation meant that the government shed all the three roles it had played under a planned system. However in the Indian case, while the government has relinquished its role as producer to a degree, it seems reluctant to cast off the other two mantles.
The recent cut in steel duties, for instance, saw a clear reincarnation of the regulator-risk manager avatars. While this cut (from 20 to 15 per cent for prime steel; 10 to 15 per cent for pig and sponge iron) was ostensibly in response to the sharp rise in global steel prices and the consequent erosion of user industry profits, the government seems to be working with two implicit assumptions.
First, steel companies are earning supernormal profits because of the international steel price up-tick and these profits need to be capped.
Analytically, this is similar to a utility regulator setting a price cap for a service like telecom or power. Only steel companies operate in a globally competitive environment unlike utilities that operate as local monopolies.
The second assumption is that the government's duty is to iron out the volatility of steel users' profits that are hurting because of higher steel prices. (This could be altogether fallacious. It is not even certain that major user industries will actually be hurt too badly, given the share of steel in product costs. I do not go into this issue here) Thus as the de-facto risk manager of the user sectors, North Block needs to 'smooth' their profit stream by ensuring a reduction in steel duties and prices.
Should the government be doing this? Clearly not in this manner if it believes in the fundamental principles of liberalisation. Don't get me wrong.
This is not an argument against import duty cuts in general. Steel tariffs and indeed tariff levels for most sectors in India continue to be high, given Asian and other emerging economy standards. There is a clear case for a drastic reduction across the board.
What rankles in the recent steel case is its ad-hoc and discriminatory nature and the factors that drove the decision. Lobbying and counter-lobbying by user industries and steel producers had reached a crescendo and the government, in its wisdom, found it imperative to appease the users. Quite simply because the user's claims conform to the regulator/risk manager role the government simply sees for itself.
If this principle is carried forward, the natural corollary is that when international steel prices dip, the government is likely to reverse roles.
This time it would play risk manager to the steel sector, raise steel duties to protect steel industry margins and regulate user industry profits. Thus, import tariffs become a short- term policy instrument to be used for regulation and managing risk; not a long-term signal of trade policy stance.
A contrast with the peak tariff cut in early January from 25 to 20 per cent should help clarify my point. The cut did have an impact on steel prices since some steel products were at the peak rate.
But the critical difference was that it was a non-discriminatory cut, reducing duties on all products at the highest level of import duty. It did not single out a specific industry for the chop. There was no explicit concession to any interest group.
Though the media tried hard to sniff out a whiff of future electoral gain in the move, the policy measure clearly conveyed the government's commitment to bringing average tariff levels down. It was, for once, a case of good economics getting the upper hand over politics.
So, what's wrong with a little tinkering with duty rates? Isn't that what generations of Indian finance ministers excelled at? The problem is that such tinkering goes against the spirit of liberalisation. Liberalisation is all about the government laying its hands off industry.
However, if it continues to keep fiddling with excise and import duty rates, it remains, de facto, a key participant in the functioning of industry. It pits its fiscal arsenal against the laws of demand and supply depending on which interest group it wants to please at that moment.
Relative profitability becomes a matter of whose clout at North Block is greater. This leads to misallocation of resources in the long-term and compromises the efficiency of Indian industry.
Doesn't this mean throwing the user industries to the mercy of the ruthless barons that rule commodity markets like steel? Not quite. Here's where the laws of demand and supply take over. Higher prices mean lower demand.
So steel producers are unlikely to squeeze the market to the point where their volumes suffer significantly. There could be instances where domestic prices fall below landed cost to ensure that demand does not dry up completely.
Besides, the fundamental principle of commodity price cycle is that 'what goes up, must come down'. Steel producers will earn high profits in a cyclical upswing. But this is bound to get mitigated when prices turn down, as they invariably will.
If Indian manufacturers are to really survive in the global marketplace, they have to get used to periodic cyclicality in their bottomline.
The price regulatory role of the government should be confined only to sectors where domestic and international competition are inadequate. That pretty much means only public utilities like power and telecom that operate as domestic monopolies.
What is the way forward then? I think it is imperative that the current cut in steel duties is portrayed as an element of a long-term strategy of duty reduction, not a reversible concession to steel users that will be withdrawn if international prices soften.
A sensible move would be to bring the overall peak duty rates down to 15 per cent where steel tariffs have been placed. This would also take care, at least partially, of the problem of plenty in the money markets that a large forex hoard has created.
Finally, to rid the problem of interest group pressures on rate setting, India should move to a uniform tariff regime. There is no economic case for maintaining a differential between final products and intermediates. All that this differential tariff structure fosters is something a liberalised economy could well do without -- industrial lobbies.
(The writer is senior economist at the Crisil Centre for Economic Research.)
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