Service sector incentives - Policy challenges

Services has emerged as an important part of our exports. More about facts and figures on service sector here  ;-)

Anyway, this blog is about the challenges when  it comes to grooming (?) services sector through incentives. There is a line of thinking which says that services sector grew as the Govt. was caught napping and didn't know how to deal with it. So all that the Govt has to do now, for services to keep growing, is to just let it be and don't spoil the party by interfering. However, from a trade policy-making point of view, services has emerged as a strong sector with a comparative advantage that is here to stay for some time to come. The policy-makers could not ignore this sector, and in good faith, decided to introduce incentives for this sector too, alongside other sectors. The current foreign trade policy incentivises services exports through schemes such as Served From India Scheme (SFIS). To know more about the scheme refer chapter 3 under this FTP link. 

SFIS provides incentives to service exports in the form of duty credit scrips, to the tune of 10% of total exports done in the financial year, which can be used to import capital goods. One can use the scrips to pay the customs duty on capital goods imported and used by the service provider. 

Under the scheme, the definition of service sector is very broad. See here. It covers everything from private real estate consulting to hospital and hotel services, except exports from SEZs, STPIs and such special zones. So anyone doing anything that can be put under services exports, is eligible to be incentivized. I won't get into hair-splitting over specifics, as the focus is broader here. 

What's wrong with such schemes. 

Firstly, there is no fool-proof way of establishing the 'value' of services provided. Whatever the exporter declares on the invoice, cannot be disputed easily. The organization which implements the FTP scheme (DGFT) is hardly competent to check if the declared value is correct or not. It goes by whatever foreign remittance was realized through banking channels. The realized money can be anything, including round routing of black money, as long as it says that it came as a payment for 'some' services provided. I must add here, that goods/merchandise trade cannot be easily mis-invoiced, especially if they are being incentivised. There is a specific group in customs which looks after incentivised exports, and checks the value of such exports strictly, using national level standardized database. There is no such known database for valuation guidelines in services.

Secondly, there is no link between services sector performance and incentive that is being provided. It is 'hoped' that it helps, but there is absolutely no data to back up the 'hope'. I am unaware of any study being conducted to check the efficacy of this incentive scheme. 

Thirdly, the Govt might be incentivising something that falls in grey area, viz capital control avoidance through trade mis-invoicing. An eloquent blog on the topic of capital control avoidance through mis-invoicing is here. The  blog accepts that services trade offers substantial opportunity for misinvoicing as valuation guidelines are not easy to come by. So services trade can easily be used to avoid capital controls. And this scheme (SFIS) seems to incentivise such efforts! 

If someone thinks that it is not easy to get benefits under this scheme, one just needs to see the procedures and details. It's cakewalk. And if it still feels difficult, you have consultants advertising on Google, promising to do exactly that for you. One can even float a company, get some money under the services head, take this incentive, and send the money back, all in the name of some service being exported and imported. You keep the capital good for free, without paying any duty. 

This blog is a strong advocate of measured incentivising. Incentives must come with a calculated goal in mind. They should be implemented on field with proper care, and the feedback must be continuous to ensure that the effect is as desired. The logic is simple. Given scarce funds, we need to look at the margins. Services sector, is not yet ready for such incentives. It is still a grey area for the Government, given that we do not have reliable way of capturing the data for this sector.