Logic doesn’t have buyers, not always

Logic doesn’t have buyers, not always - EPCG

Since the day the Ministry of Commerce floated the post-export variant of the immensely popular, yet extremely complicated, Export Promotion Capital Goods (EPCG) scheme in 2012, a debate has been on among stakeholders regarding the motivation(s) behind floating it. While the majority has downrightly rejected it and claimed that it will never find takers, a few have tried to justify it with all kinds of explanations and arguments. Although the jury is still out, an impartial and objective analysis reveals that it probably is not as illogical as was initially perceived to be. Shakti Shankar Patra | @TheDollarBiz

Ever since the EPCG Scheme was launched in the early 90s to promote the exports of Captial Goods from the country, it has seen several rounds of tinkering

Before one starts criticising or praising the post-export EPCG scheme, one needs to first understand the main motivation behind the pre-export variant – promoting exports. That the government is ready to wave off duties when a manufacturer imports Capital Goods, as is the case with the pre-export variant, is only because it wants the manufacturer to export more. The motivation behind the scheme is not to give cheaper access to superior technology, though that might be a by-product. For, the scheme is not available to a manufacturer, who is selling only in the domestic market, no matter how much the domestic economy is benefitting from its products. As the name suggests, EPCG is just about export promotion. Period. A free ride As per the scheme, for every rupee saved in terms of import duty, the manufacturer has to export Rs.6 worth of goods/products over the following six years – technically called Export Obligation (EO). And in the event it fails to honour the EO, it has to pay the money saved by not paying the duty and an 18% per annum interest and penalty (on a case to case basis). But there are several catches. The government has been very lenient when it comes to the EO. Not only has it reduced the EO on several occasions for reasons like a slowdown in demand for a specific product or difficulty in procuring raw materials or on the basis of the geographical base of the manufacturer, but also offered an amnesty scheme to escape the EO. Speaking to The Dollar Business, Sandeep Chilana, Principal Associate, Amarchand & Mangaldas and Suresh A. Shroff & Co., says, “Last year, the government offered an amnesty scheme for all those who have not met or are not in a position to meet the EO. The scheme was very successful, with several EPCG licence holders using it to get rid of the EO burden.” But despite several instances of such leniency, the pre-export EPCG scheme has several issues. Firstly, exports are not just a function of one’s competency, but also overseas demand. What would an EPCG licence holder do if, for some reason, demand for what he/she produces collapses in the international market? Not only he/she has to convince the government to bring down the EO, but in the situation of the government not relenting, he/she has to a pay a hefty penalty in terms of interest.

Royalty payments received in freely convertible currency and foreign exchange received for R&D services are also counted for discharge under EPCG

Secondly, under the pre-export EPCG scheme, the government, no longer, accepts the practice of the EO being met with an alternate product. For example, if a two-wheeler manufacturing company, which also manufactures three-wheeler, has opted for the EPCG scheme to import a machinery to manufacture bike handles, it has to meet the EO solely on the basis of bike exports. It can’t meet the EO by exporting more three-wheelers if the export of bikes fall! According to Kamal Jain, Director, Cargomen Logistics, “The practice of not considering alternate products while figuring out if the EO has been met or not, defies logic. As long as a company is meeting its EO and ensuring the inflow of foreign exchange, we shouldn’t really care if it’s happening because of a specific product or a slight variant of it.” Not considering exports of a group company is also a practice that irks Jain. “Let’s say a company that has an EPCG licence is going through a bad patch. Should it really matter to the government if it meets its EO via a subsidiary? It’s about time the government addressed these issues,” he adds. The new kid As discussed earlier, the only reason the government is willing to waive off duties while importing Capital Goods under the pre-export EPCG scheme is because it wants to promote exports. But then, shouldn’t a manufacturer who doesn’t want to burden itself with a pre-defined EO but actually ends up exporting as much, if not more, as compared to its EPCG licence-holding peers, be incentivised to a similar extent? Let’s take a hypothetical example of two car manufacturers and assume both of them import a certain Capital Good at the same time. Let’s also assume that Company A opts for a (pre-export) EPCG licence and saves Rs.100 crore on import duties, while Company B pays the due import duty of Rs.100 crore. Now, because company A has opted for an EPCG licence, it has an EO to export Rs.600 crore worth of cars in the next six years, while company B doesn’t have any such obligation. Let’s also assume that both companies A and B export exactly Rs.600 crore worth of cars in the next years. This means that company A, having honoured its EO, ends up saving Rs.100 crore but company B, despite having exported cars worth the same value, doesn’t get anything! This, despite having had a cash outflow of Rs.100 crore at the time of importing the Capital Good. Isn’t this injustice? Shouldn’t company B feel cheated? It is this anomaly that the new post-exports EPCG scheme addresses. Under the scheme, a manufacturer that exports goods worth 85% of the amount that it would have taken up as EO, had it opted for an EPCG licence, is paid back the amount it had paid for import duties via duty credit scrip(s). This is why, in the strictest sense, the post-export EPCG scheme is actually called the ‘Post Export EPCG Duty Credit Scrip(s)’ scheme. And as per the scheme, one need not fully wait till one exports 85% of the EO to reap the benefits in terms of duty credit scrip(s). One keeps getting paid in terms of scrip(s) throughout the six years as the 85% of the EO is calculated on a pro rata basis. For example, if one meets half of 85% of the EO in the first three years, one is paid scrip(s) worth half the import duty that had been paid. No albatross One of the basic concepts of finance is the time value of money (TVM), which basically means that a rupee today is more valuable than a rupee tomorrow. And having established the fact that the post-export EPCG scheme is actually more logical than its older pre-export variant, if not for an exporter but for the economy, the really question is whether the post-export variant will find enough takers. For, the obvious question is why would an exporter part with money in the present and get it back later in terms of scrip(s), if it has the luxury of not parting with it at all? “When a client seeks our advice on whether to go for the pre-export or the post-export EPCG scheme, our suggestion always is to opt for the former if one is confident about being able to meet the EO. There’s no point in parting with cash and getting it back later, if one can avoid it altogether,” Chilana tells The Dollar Business. But then what is more important for a manufacturer – avoiding cash outflow or flexibility? The answer to this difficult question is actually very simple. The post-export EPCG scheme gives a manufacturer the luxury to pick and choose its market. Let’s say due to some reason, the pricing power of a manufacturer falls in the international market but the demand for its products surge in the domestic market. Doesn’t not having the albatross of an EO around its neck a great freedom? Of course it is, at least for those manufacturers that are not facing a cash crunch. Change we should The only reason for the post-export EPCG scheme not finding many takers despite being around for more than two years is, probably, the fact that the duty credit scrip(s) don’t entirely compensate for the duty paid at the time of importing – in terms of interest on the cash outflow. “The government can popularise the post-export EPCG scheme by adding interest to the value of the scrip(s). If not at a rate at which a pre-export licence holder pays penalty in the event of not meeting the EO, but a rate close to that. This should make it fair for all,” says Chilana. Going by the logic that post-export schemes do have significant appeal, one cannot agree more.

Logic doesn’t have buyers, not always - EPCG

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