Cash Incentives for Export Promotion in Nepal

Chandan Sapkota
South Asia Watch on Trade, Economics and Environment (SAWTEE)
November 11, 2011

Presented at Policy Study on Cash Incentives for Export Promotion in Nepal workshop, November 11, 2011, Hotel Annapurna, Kathmandu, Nepal
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Presentation outline
Export promotion and national policies Current trade performance Cash incentives scheme

Value addition and employment

Critical issues in cash incentives Conclusion

Comments/Discussion
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1. Export promotion and national policies

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Export promotion
Governments use export promotion measures to support export-oriented sectors so that they have an added incentive to produce goods with high value addition and sell them abroad. Objectives:
Increase exports, reduce trade deficit, maintain balance of payments Increase foreign exchange reserves Support structural transformation, employment generation, and industrialization Increase competitiveness of exported items by covering a portion of cost Assist in export diversification

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Trade Policies
Trade Policy 1983
Considered as first trade policy; aimed to promote investment in export-oriented sectors and promote indigenous products in the international market. Tax concessions, duty drawback, cash incentives,

Trade Policy 1992

A follow up of the SAP launched in 1985 Supply of infrastructure & SEZs, tax exemption, full convertibility of Nepalese currency, duty refund

Trade Policy 2009

Export credit guarantee, duty refund, SEZs, Export Guarantee Scheme, Product Development Fund, Export Promotion Fund, subsidized loans, cash incentives based on value addition Focus on exporting products with high value added, strengthening backward and forward linkages, and increasing income and employment Address supply-side constraints
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Industrial Policy and Three Year Interim Plans

Industrial Policy 2010
Emphasizes on high value addition, employment generation, promotion of domestic industries, and encouraging backward and forward linkages Additional facilities to export-oriented industries such as customs and excise duty refund, duty flexibility

Three Year Interim Plan 2010/11-2012/13

Aims to increase income and employment opportunities by promoting trade, enhance price and quality competitiveness of exports, encourage use of domestic raw materials Targets to limit trade deficit to 20% of GDP and increase annual average export of goods by 10 percent
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2. Current trade performance

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Decreasing exports and increasing trade deficit

In 1997 exports of goods and services were around 26 percent of GDP, which dropped to almost 12 percent of GDP in 2008. Imports are as high as 37 percent of GDP.

Trade deficit is ever-widening. It reached 22 percent of GDP in 2009.

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3. Cash incentives scheme

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Three value addition criteria

Cash incentives scheme is aimed at increasing exports and reducing trade deficit. Budget 2010/11 included cash incentives (% of total export revenue earned in convertible currency) based on value addition (VA):
30-50 percent VA gets 2 percent cash incentive 50-80 percent VA gets 3 percent cash incentive 80 plus percent VA gets 4 percent cash incentive

Initial amount Rs 240 million (increased by Rs 60 million later on). Budget 2011/12 allocated Rs 300 million. It makes a total of Rs 600 million.

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Demand for cash incentives

The MoCS asked cash incentives on exports to India as well, but MoF denied it The MoCS asked 5% cash incentive on export of NTIS 2010 products Garment exporters asked a flat 2% cash incentive (complication in VA calculation & procedural hurdles) FNSCI asked for 25% cash incentive for export promotion of small and cottage indusry.
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4. Value addition and employment

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Computing value addition

MoI (cash incentives):
Value addition= [(Exports, FOB price Total value of foreign and undeterministic component of inputs) / Exports, FOB price]*100

CBS (CME 2006/07):

Value addition=Value of output less value of input

Industrial promotion board:

Value addition= [(Sales revenue - (Raw material cost + utilities + depreciation))/Sales revenue]*100

Department of Customs:
Value addition= [(FOB price - Raw material cost, CIF) / Raw material cost, CIF]*100

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Four VA computation methods

Different ways of calculating value addition are adopted by the various government agencies for specific purpose to suit their needs and due to data limitation. CBS's VA calculation method is the most comprehensive. MoI does not take into account other input (direct and indirect) costs considered by the CBS in CME 2006/07.
Possibility that cost of imported inputs may be underreported. Provision of undeterministic component (raw materials and packaging materials purchased in the domestic market ) in input cost to be verified by local authorities leaves a wide open door for undervaluation of cost of inputs. Might inflate VA by underreporting input costs. With VA consideration only to boost exports, the other objective related to increasing employment is not addressed.

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Cash incentive in Bangladesh and India

Cash incentives to pre-defined export products that employ large number of people Bangladesh
Cash incentives between 10% and 30% Cash incentives of 10 percent on export of frozen shrimp and fish; cash incentive of between 15 and 20 percent (provided that use of local raw materials is more than 50 percent and 80 percent respectively) on export of products made out of Hoogla, straw, and coir of sugarcane; cash incentive of between 20 and 30 percent on export of agriculture and agro-products (vegetable/fruit) and agro-processing; and cash incentive of varying rates on export of jute and leather products, potato, poultry and garment

India
Cash incentive between 2%and 5% Cash incentives on exports of agriculture goods (oleoresins, forest products, flowers, fruits and vegetables); cash incentives on import of technology for upgrading in leather, textile and jute, handicrafts and engineering sectors

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Using CME 2006/07 for analysis

Use CBSs CME 2006/07, which provides firm-wise value addition as well as employment data A set of 21 products are chosen based on their relevance to the agricultural and industrial products listed in NTIS 2010, TP 2009 and top products exported outside of India in fiscal year 2010/11 Our sample constitutes 38 percent of all the firms included in the CME 2006/07. Noted that not all goods manufactured domestically are exported. Some of them are consumed domestically. If we assume that all products satisfying value addition criterion are exported, then the CME 2006/07 provides a good benchmark for clubbing value addition criterion with employment and other relevant variables such as wages earned.

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Considering value addition only

VA 30-50 percent:
228 firms, producing 18 manufacturing products, qualify for two percent cash incentive Almost 32.46 percent of all manufacturing firms in the 30-50 percent value addition category produce carpet and rugs, followed by grain mill products (14.91 percent), textile fibres and woven textiles (14.04 percent), and knitted and crochet`ed fabrics (7.89 percent), among other products

VA 50-80 percent:
209 firms, producing seventeen manufacturing products, qualify for three percent cash incentive 45.93 percent of all manufacturing firms produce carpet and rugs, followed by fibres and woven textiles (20.57 percent), pulp, paper and paper board (10.05 percent), knitted and crocheted fabrics and articles (4.31 percent) and wearing apparel except fur apparel (3.83 percent), among other products.

VA 80 plus percent:
137 firms, producing five manufacturing products, qualify for four percent cash incentive 86.86 percent of all manufacturing firms produce carpet and rugs, followed by textile fibres and woven textiles (8.03 percent), wearing apparel except fur apparel (2.92 percent), pulp, paper and paper board (1.46 percent) and grain mill products (0.73 percent).

If the sole criterion is value addition then overall the carpet and rugs exporters will claim the highest amount of cash reward, followed by textiles, apparel and pulp, paper and paper board exporters. Very few agro manufactured goods and those giving high employment dont feature here. Promotion of NTIS 2010 products??
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Considering employment as well

(product-wise value added per worker in thousand rupees)
VA 30-50 percent:
Manufacture of pesticides and other agro-chemicals, followed by non ferrous metals, knitted fabrics, apparel, sugar and basic iron and steel have value addition above 40 percent if we look at value added per worker, then tanning and dressing of leather has the highest value. Its value added per worker is 1275 but value addition is only 35.5 percent. the product with relatively high value addition and also high value added per worker is casting of non ferrous metals (46 percent value addition and 289 value added per worker)

VA 50-80 percent:
Manufacture of pulp, paper and paper board has the highest value addition (76.7 percent), followed by knitted fabrics, vegetable and animal oils and fats, casting of non ferrous metals, and paper and paperboard, among others. In terms of value added per worker, manufacture of basic iron and steel (7927) followed by manufacture of vegetable and animal oils and fats (1456), and manufacture of pulp, paper and paper board (1219) has the highest values. The value addition per worker of carpet and rugs is 95 only, but value addition is 61 percent. It means that if we consider then value addition criterion only, then carpet and rugs will take away more cash incentives in 50-80 percent value addition category than manufacture of precious and nonferrous metals, which has value addition of 59 percent but value added per worker of 601. The products not listed in NTIS 2010 would take away more cash incentive than the ones listed in priority products if we distribute cash just on the basis of value addition. Carpet and rugs is not one of the 19 products in NTIS 2010, but jewelry is.
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Considering employment as well

(product-wise value added per worker in thousand rupees)
VA 80 plus percent:
Manufacture of wearing apparel (91 percent), followed by carpet and rugs (90 percent), grain mill products (86 percent), spinning of textile fibers (82.3 percent), and pulp, paper and paper board manufacturing (81 percent) has the highest value addition, respectively. In terms of value addition per worker, manufacture of grain mill products has the highest value (1091) followed by pulp, paper and paper board (400), preparation and spinning of textile fibers (183), carpet and rugs (113) and wearing apparel except fur apparel (69).

In terms of exporting goods with high value addition and touching upon development goals, the above analysis indicates that looking at value added per worker as well would make cash incentives scheme more attuned to the objectives of both TYIP II and TP 2009.

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Two percent cash incentive

Sector wise value addition for two percent cash incentive
0.5 0.45 0.4 0.35 800 0.3 0.25 0.2 0.15 0.1 400 1000

1400

Value addition per worker (Rs '000) for products that qualify for two percent cash incentive

1200

600

200

0.05
0 1531 1542 1711 1721 1722 1724 1730 1810 1911 1912 1920 2101 2102 2109 2421 2710 2720 2732 0 1531 1542 1711 1721 1722 1724 1730 1810 1911 1912 1920 2101 2102 2109 2421 2710 2720 2732

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Three percent cash incentive

0.8

Sector wise value addition for three percent cash incentive

8000

Value addition per worker (Rs '000) for products that qualify for three percent cash incentive

0.7

7000

0.6

6000

0.5

5000

0.4

4000

0.3

3000

0.2

2000

0.1

1000

0 1514 1531 1542 1711 1721 1722 1730 1810 1920 2101 2102 2109 2421 2710 2720 2732 3691

0 1514 1531 1542 1711 1721 1722 1730 1810 1920 2101 2102 2109 2421 2710 2720 2732 3691

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Four percent cash incentive

0.92

Sector wise value addition for four percent cash incentive

Value addition per worker (Rs '000) for products that qualify for four percent cash incentive 1200

0.9 1000 0.88 800 0.86

0.84

600

0.82 400 0.8 200 0.78

0.76 1531 1711 1722 1810 2101

0 1531 1711 1722 1810 2101

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Considering both VA and employment

Though there appears to be no systematic correlation between these two, there are some products that have both high value addition and value added per worker. These are casting of iron and steel, vegetable and animal oil & fats, pulp, paper and paper board, and grain mill products. These products are also more or less similar to the ones listed in NTIS 2010 that have high export potential as well as have decent socio-economic impact.

Looking at both value addition as well as value added per worker for cash incentives would help the scheme achieve twin goals of boosting exports and touching upon development goals as envisioned in TYIP II and TP 2009. Gives credence to the argument that these schemes could be designed to aid exports of pre-defined products or sectors that have been extensively analyzed as having both export potential and socio-economic impact. This indicates that cash incentives in Nepal could better be designed more in terms of Indian and Bangladeshi model of flat cash incentive rates to key sectors.
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5. Critical issues in cash incentives

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Critical issues in cash incentives I

Focused and targeted cash incentives program might not only boost exports of key goods, but also potentially have positive impact on Nepals development challenges.

Cash incentives program aimed at addressing coordination externalities/market failures would help in better linking different sectors in the economy and buttress structural transformation.

Cash incentives directed to achieve this goal would also help in diversification of export basket with addition of new products linked to high productivity sectors.

Cash incentives program at least should be used to aid pre-defined exportable products that have high proximity with high productivity sectors and have plenty of sophisticated nearby goods.

Distributing cash just based on value addition, whose calculation and verification itself might be subject to gross manipulation, might not contribute much in terms of meeting the goal of the scheme

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Critical issues in cash incentives II

Objectives of cash incentives program : Increase exports and reduce trade deficit. If so, how about directly addressing the binding constraints to export growth? Cash incentives program has not taken into consideration the substitutability of goods in the domestic market High opportunity costs of the money, though small in amount, allocated for cash incentives Allocated sum for cash incentives could be used to enhance productive capacities of the exportoriented sector by addressing some of the structural issues that are increase cost of production. Leakage in the form of under-invoicing of imported raw materials and over-invoicing of final product in order to show high degree of value addition

Consultation with stakeholders appears to be inadequate

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6. Conclusion

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Conclusion
Cash incentives on exports based on value addition criterion is the sole consideration right now. However, if employment generation by the firms meeting value addition criterion is also considered, then it will touch upon the development aspects (increasing employment) of export promotion, the intended goals of the latest TYIP II and TP 2009.

CME 2006/07 analysis shows that sectors that have high value addition do not necessarily have high value added per worker.

If value addition is the sole criterion then the products that are not listed in NTIS 2010 might claim more cash than those listed there and also have medium to high export potential and socio-economic impact.

However, if value added per worker is also considered, then some of the products listed in NTIS 2010 would claim more cash than those not listed. It implies that this added consideration will help align the cash incentives with development goals envisioned in TYIPs and TP 2009.

It gives credence to the argument that cash incentives might be better put to use if it is given to pre-defined sectors with high employment generation and decent value addition like India and Bangladesh are doing.

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Discussion
Comment on paper Views on cash incentives Will it achieve the goals of boosting exports and reducing trade deficit? Following Indian and Bangladeshi model (predefined sectors)? Pros and cons? Any issues on export promotion

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NSIC code Sample products from CME 2006/07 1514 1531 1542 1711 1721 1722 MANUF. OF VEGETABLE & ANIMAL OILS & FATS MANU. OF GRAIN MILL PRODUCTS MANU. OF SUGAR PREPARATION & SPINNING OF TEXTILE FIBRES; WEAVING OF TEXTILES MANUF.OF MADE-UP TEXTILE ARTICLES EXCEPT APPAREL MANUF. OF CARPET & RUGS

1724
1730 1810 1911 1912 1920 2101 2102 2109 2421 2710

MANUF. OF JUTE AND JUTE GOODS

MANUF. OF KNITTED & CROCHETED FABRICS & ARTICLES MANUF. OF WEARING APPAREL EXCEPT FUR APPAREL TANNING & DRESSING OF LEATHER MANUF. OF LUGGAGE,HANDBAGS & THE LIKE MANUF. OF FOOTWEAR MANUF. OF PULP, PAPER & PAPER BOARD MANUF. OF CORRUGATED PAPER & PAPERBOARD MANUF. OF OTHER ARTICLES OF PAPER & PAPERBOARD MANU. OF PESTICIDES & OTHER AGRO-CHEMICALS MANUF. OF BASIC IRON & STEEL

2720
2731 2732 3691

MANUF. OF BASIC PRECIOUS & NON-FERROUS METALS

CASTING OF IRON & STEEL CASTING OF NON FERROUS METALS MANUF. OF JEWELLERY & RELATED ARTICLES

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