India is in the midst of an aggressive free trade agreement (FTA) drive, seeking greater global market access at a time when many economies are turning inward. But this liberalising impulse comes with a fiscal cost. Customs duties—long a reliable source of government revenue—are under pressure. In 2023–24, the Centre collected ₹2.3 lakh crore in customs revenue. Yet, by FY25, India had already foregone ₹94,000 crore in customs duties under existing FTAs with Japan, South Korea, and ASEAN.
As more agreements loom on the horizon, the question is no longer whether FTAs boost trade—they often do—but whether the government is adequately prepared to absorb the fiscal hit and compensate through alternative means.
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Customs duties and the FTA dilemma
FTAs are designed to lower or eliminate tariffs and other barriers to trade, making imported goods cheaper and more competitive in the domestic market. While this is good news for consumers and importing industries, it dilutes one of the government’s key revenue streams. India’s relatively high tariff structure means that trade deals often involve steep customs duty concessions in exchange for reciprocal market access.
This not only reduces tax collections but complicates enforcement. The problem of circumvention—where exporters exploit relaxed Rules of Origin norms to reroute goods—adds another layer of risk.
The India-UK FTA illustrates the challenge. India has committed to reduce the weighted average tariff from 15% to 3% over a decade. About 90% of UK goods will see tariff reductions, with 64% becoming entirely duty-free. According to estimates by the Global Trade Research Initiative, revenue forgone in the first year could be ₹4,060 crore, rising to ₹6,345 crore by the tenth year. The Centre’s own budget estimates customs revenue growth at a modest 2.1% in FY26.
Is revenue loss justified
While the revenue erosion is evident, economists argue that customs duties should not be treated as a long-term revenue instrument. Instead, the focus should shift to the broader economic gains that FTAs enable—greater exports, employment, and tax compliance.
Lower tariffs can stimulate domestic production and competitiveness by integrating Indian firms into global value chains. Over time, this generates more value-added activity, boosting collections from indirect taxes like GST and direct taxes such as corporate income tax.
In fact, high customs duties often penalised Indian consumers, who ended up paying inflated prices for imported goods of questionable quality. A rationalised tariff regime, economists argue, could improve consumer welfare while boosting competitiveness in export markets.
From protectionism to targeted intervention
That said, tariff cuts should not be indiscriminate. Strategic sectors—especially vulnerable ones like agriculture—require calibrated protection. Selective duties must remain to check dumping and preserve the viability of small producers. The government should evolve a policy that distinguishes between essential revenue protection and structural competitiveness.
The government must now plan for a post-customs world. First, it must harness the growth potential of FTAs by pushing high-value exports in sectors like pharmaceuticals, textiles, electronics, and IT services. Initiatives such as the Production-Linked Incentive (PLI) scheme can support this transition by boosting scale and competitiveness in these industries.
Second, FTAs should be leveraged to attract greater foreign direct investment (FDI), particularly in emerging sectors like semiconductors, clean energy, and electric vehicles. FDI not only brings capital and technology but also expands the tax base through job creation and formalisation of economic activity.
Third, enhancing domestic manufacturing aligns with India’s Atmanirbhar Bharat goals. Reduced import dependence, especially in high-value segments like electronics and APIs (active pharmaceutical ingredients), can preserve fiscal space while bolstering industrial capacity.
Lastly, trade negotiators must adopt a more strategic approach. Tariff reductions should focus on low-revenue or non-sensitive goods while retaining higher duties on segments that contribute significantly to customs collections or require nurturing.
With prudent planning and a deliberate shift in revenue strategy, India can afford to forgo customs duties—provided the gains from trade are effectively channelled into new engines of growth. The FTAs of the future must serve not only trade diplomacy but also fiscal resilience.