Free trade pacts: Why India must be wary of signing more

free-trade agreements
Safeguard measures against import surges must be considered in all industries of strategic and livelihood significance.

By Smitha Francis

Months into the economic collapse triggered by the COVID-19 pandemic and the lockdown announced to contain it, India has begun considering some of the preferential trade deals that were earlier put off. There are renewed calls for India to even consider re-joining the Regional Comprehensive Economic Partnership (RCEP) negotiations involving China. This, when the country is in the middle of the humongous challenges related to re-orienting the economy and supply chains away from overdependence on China. India had exited from the RCEP negotiations in November 2019 after considerable domestic pressure had built up on the government. The latter was on the basis of clear logical inference that granting increased duty-free access to China and to the agricultural/dairy exporters of Australia and New Zealand would not be beneficial for our economy and the already precarious livelihoods of millions. There is nothing in India’s recent trade performance and economic conditions that supports a changed stance towards new free trade deals. If anything, both point the other way.

Except for those who refuse to renounce their theoretically and empirically untenable ideological positions on free trade, there has been widespread acknowledgement among analysts and domestic industry players that India’s pre-pandemic domestic industrial slowdown and the heavily increased import dependence have been related to the shift in India’s trade policy focus away from multilateralism towards preferential trade agreements (PTAs). Owing to the deadlock in WTO negotiations, India was among the countries that had come to perceive PTAs as important tools for improving export competitiveness and accelerating industrial growth since the early- to mid-2000s.

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Three channels have been believed to be at work through PTAs: MFN-plus access to export markets, increased access to more “competitive” intermediate imports from PTA partners, and increased FDI-led integration into global value chains (GVCs). More than a decade has passed since the entry into force of both the India-ASEAN Free Trade Agreement (FTA) and the India-South Korea Comprehensive Economic Partnership Agreement (CEPA) in 2010 (followed by the CEPA with Japan in 2011).

Detailed analysis of India’s and her trade partners’ tariff liberalisation schedules under these trade deals and their impact on India’s manufacturing sector trade performance clearly establishes that India’s WTO-plus tariff liberalisation lacked any strategic intent in the absence of a coherent industrial policy in which trade policy is one of the tools to meet industrial development objectives. Rather, tariff liberalisation became a policy objective in itself. First of all, India undertook greater tariff liberalisation than many of her PTA partners in ASEAN and granted significantly higher margins of preference to them across the majority of industries.

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Secondly, not only did India’s tariff liberalisation in most consumer goods, capital goods and intermediate goods in the manufacturing sector under these PTAs go far beyond the country’s MFN commitments under the WTO, they were also undertaken without taking cognisance of the need to sustain existing domestic backward and forward linkages between these three segments of the manufacturing sector. In particular, in the case of the strategically critical electronics industry, India’s tariff liberalisation went significantly beyond that under the Information Technology Agreement (ITA-1), which had already led to significant import dependence by the mid-2000s.

Thirdly, in the case of some sectors such as textiles and clothing (HS 54, 55, 59 and 60); plastic and plastic products; rubber and rubber products; cotton; silk; copper and copper products; etc., there seemed to be no coherent policy given that these product lines were kept in the negative lists of the PTAs with Korea and Japan, while most of them had already been liberalised under the ASEAN FTA. Given that ASEAN economies are deeply integrated with Japan and Korea through production sharing arrangements and value chains such that firms from these countries can utilise the ASEAN-India FTA for gaining market access in India, keeping such sectors in the negative lists of the India-Korea and India-Japan CEPAs has been rather meaningless. So where does India’s export story stand?

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India’s global export performance — slacking since 2011

Despite unquestioned belief in the ability of such trade deals to work through the mentioned three channels, India has not witnessed any sustained export growth. In fact, India’s share in global merchandise exports has been stagnant around 1.6%-1.7% since 2011 (after the PTAs with ASEAN, South Korea and Japan came into force). Note that this is way before global merchandise exports were weighed down by the US-China trade tensions and slowing global economic growth and declined by 3% in 2019. On the other side, India’s share in global merchandise imports has risen much faster and stood at 2.5% in 2019.

The slowdown particularly in non-oil manufactured export growth since 2011 gives us a clear indication at the macro level that India’s export performance has suffered despite the additional opening up of markets through FTAs, and in spite of the import liberalisation that has been carried out. Although non-oil manufactured exports showed momentum during 2017-18 after four years of negative or dismal growth, their growth rate fell below 3% in 2019. As a result, at 75%, the share of non-oil manufactured exports in India’s merchandise exports was much lower in 2019 than the peak in 2003. With the continuous rise in the share of non-oil manufactured imports in India’s total imports from 2002 on the other side, non-oil manufacturing sector trade balance, which had turned negative from 2004, has increased massively.

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Another telling indicator of India’s weak global export competitiveness is reflected in the fact that even as India’s non-oil manufactured exports seemingly increased in capital and technology-intensive sectors (like vehicles and parts, non-electrical machinery, organic chemicals, pharmaceuticals, electrical machinery, iron and steel, articles of iron and steel, etc.), the share of India’s manufactured exports going to the technologically more mature developed country markets has declined. It is in the case of developing country markets that India’s exports have been relatively strong.

Furthermore, as many as six out of the top ten manufactured exports were also among the top ten non-oil manufactured imports, namely, gems and jewellery, electrical machinery and parts, non-electrical machinery and parts, organic chemicals, iron and steel, and vehicles and parts. The other significant manufactured imports have been: optical, medical and other professional equipment and their parts; fertilisers; inorganic chemicals; and miscellaneous chemicals. Among these, the electrical machinery sector, comprising largely of electronics products, has seen the largest increase in import share since the early 2000s.

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Abysmal export competitiveness vis-à-vis major PTA partners

Subsequent to the mutual MFN-plus tariff liberalisation, India’s total trade with all the major PTA partners indeed witnessed significant growth as anticipated. However, performance of India’s bilateral trade balance to total trade ratios gives an indication of India’s overall export competitiveness via-vis the PTA partners. Except for three least developed countries (Cambodia, Laos, Myanmar) and the Philippines, the ratio of India’s trade balance to total trade has deteriorated drastically between the pre- and post-PTA phases for every major ASEAN member country (including for Vietnam, from 2018), for ASEAN-10 as a group, as well as for South Korea and Japan. Clearly, India’s capacity to compete against these FTA partners in her domestic market had declined over the last decade after these PTAs came into force.

It is critical to note that despite some improvement observed in the trade balance to total trade ratios for all these PTA partners for 2019, India’s trade with them has continued to remain highly adverse. Further, the ratio actually worsened between 2018 and 2019 in the case of Vietnam.
In fact, it must be noted that since 2017, there has been a noticeable increase in the market shares of Vietnam and Singapore. Among ASEAN, Vietnam has thus registered the largest increase in share as a source of India’s global imports, with Indonesia and Thailand registering the second largest increase. Overall, ASEAN-5’s aggregate share in India’s global imports went up from less than 8% in the pre-FTA phase (2008) to 10% in 2016 and further to about 12% in 2019 over a period of just 3 years due to the jump in the shares of Vietnam and Singapore. Between the pre- and post-CEPA phases, South Korea’s share in India’s global imports too increased steadily. Although Japan’s share in India’s imports (and exports) declined after the CEPA came into force, this too has seen an increase from 2018.

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As highlighted last year in an article by the author with Murali Kallummal, there is evidence in the case of electronics products, that since 2017 Chinese imports have been diverted to enter India through Vietnam and Singapore. This is in addition to the significant re-routing through Hong Kong, China. This has followed the increased focus on India’s rising bilateral trade deficit with China, after China’s emergence as India’s single largest import supplier in many non-oil manufactured sectors for several years now. This re-routing of Chinese products via ASEAN FTA partners is not limited to electronics products; it has also become evident in iron and steel (HS 72, with Indonesia’s market share also showing a sudden surge in 2019) and vehicles and parts (HS 87) through Singapore, in inorganic chemicals (HS 28) through Vietnam, etc.

Meanwhile, there has been a very significant increase in India’s imports of intermediate products from all the major ASEAN partners, as well as from South Korea and Japan. Despite such increase in intermediate imports through the preferential route, which was expected by several economist colleagues to have improved India’s export competitiveness, India has failed to make significant and consistent market access gains in these PTA partner countries (or globally, as we saw). India’s market share did increase in the less developed countries of Myanmar, Brunei, Lao PDR, and also in the Philippines. India’s market share increased gradually in Malaysia also, followed by Thailand and Indonesia. But even among these markets with preferential access, Myanmar was the only ASEAN country in which India attained a share of even 5% of their global imports during 2017-18. This also dropped to 3.8% in 2019. In 2019, India’s market share increased marginally only in Brunei and Thailand.

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Further, wherever India’s market share in these five major AIFTA partners increased in some manufacturing sector product groups (such as textiles or clothing, petroleum, leather and footwear, followed by chemicals, non-electrical machinery, transport equipment, minerals and metals, etc.), India’s average shares remained below 5% of their respective global imports even during 2017-18 and 2019 – a decade into the ASEAN FTA. The large majority of the increase in market share that India gained in the major ASEAN partners was in agricultural products. Two major exceptions were transport equipment exports to Indonesia and electrical machinery exports to Vietnam.

In the case of South Korea, even as South Korea’s global imports nearly doubled between the pre-CEPA phase (2002-08) and 2019, India’s share in these imports has stagnated around one per cent. As a share of Japan’s global imports too, India’s market share has remained stagnant throughout the post-CEPA phases—below one per cent. There are industry-wise differentials in India’s market shares in South Korea and Japan; however, India’s market shares remained abysmally low—below 2% or 1% of these countries’ global imports even in 2019.

That is, while India’s PTAs with these East and Southeast Asian economies did lead to a very significant increase in intermediate goods imports from them, the latter did not lead to a sustained or substantial increase in India’s manufactured export market share in these countries.

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Industrial development through FDI-led integration into GVCs

Uniquely, all the preferential trade liberalisation which India undertook since the mid-2000s has involved East and South East Asian economies, which are deeply integrated with regional/global value chains in several industries. By granting duty-free market access to foreign producers through such production centres having ‘first mover advantages within GVCs’, India’s MFN-plus non-strategic trade liberalisation under these FTAs created perverse incentives for investments in local manufacturing in India (as opposed to assembly)—for both domestic and foreign producers. As this author has argued for several years now, deep trade liberalisation under overlapping FTAs removed the need for tariff-hopping FDI, in the absence of ‘other policies and factors that incentivise local manufacturing’.

In the absence of strategic industrial policy support for building up the dynamic competitiveness of local value chain segments and indigenous producers, domestic producers of both final products as well as parts and components were put in disadvantageous domestic market access position against imports. The heightened imports enabled by the PTAs therefore led to the displacement of even existing domestic production. As established in a recent book, this was most starkly reflected in the erosion of India’s domestic electronics manufacturing ecosystem. Apart from disregarding the varying levels of indigenous technological capabilities that had been built up over decades in different industries, India’s preferential tariff liberalisation strategy was also not calibrated to incorporate the presence of non-tariff barriers in the PTA partners.

These PTAs therefore had led to the disintegration of domestic backward and forward linkages in the Indian economy with adverse outcomes, as reflected in the across-the-board increased import dependence (including in top exporting industries). These inferences are also supported by the trends available in the literature on the decline in India’s domestic manufacturing output, value added and employment. Rather than contributing to increased export competitiveness, the significant increase in the availability of imported intermediate and other products from ASEAN, South Korea and Japan enabled through the PTAs thus played a major role in India’s pre-pandemic manufacturing sector slowdown.

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Policy lessons for trade and industrial policy

The evidence of significant adverse impact of these existing major PTAs do not give any basis to the renewed calls for India to join RCEP negotiations, before coherent policy support leads to an increase in manufacturing value addition in the country, in particular by indigenous firms. It has been amply evident that the shift in India’s trade policy towards preferential trade agreements to obtain faster export growth did not automatically deliver the build-up in domestic capabilities and capacities required to make our production base dynamically competitive.

In the context of the economic crisis due to the adverse impact of the COVID-19 pandemic and the heavily accelerated digital transformations happening across several sectors, any new bilateral/regional trade negotiations must be put off until the government sorts out domestic policies for indigenous manufacturers (whether in the name of Make in India or Atmanirbharata). The latter range from industrial policy support, particularly for SMEs, in the context of access to finance, technological upgradation needed to meet climate change challenges, digital transformation, etc. as well as those related to FDI, government procurement, data protection, public digital infrastructure, etc. All these policies have to be in sync to support indigenous companies and to signal preference for innovation-led domestic manufacturing that also address our employment challenges.

In the short-term, India must urgently carry out a review of the existing PTAs even if a handful of indigenous firms have benefited from increased market access in a few product groups under a PTA. Product-level variations in India’s market access gains in ASEAN partners must be analysed in-depth to identify the impact of specific industrial policy measures that have helped improve the dynamic competitiveness of our successful exporting product segments.

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Safeguard measures against import surges must be considered in all industries of strategic and livelihood significance. Given the significant level of state-subsidised Chinese investments in some of the ASEAN economies, the Department of Commerce should also analyse the firm-level customs data available with them to monitor the extent to which non-ASEAN firms use the PTA route.

In the case of the strategically critical telecom sector which is the backbone of digital infrastructure, and against the backdrop of the growing use of the ASEAN FTA by state-linked and state-subsidised Chinese firms, Article 13 b(iii) under the ASEAN FTA may be potentially used to protect against threat of cyberattacks. This article allows policy measures “to protect critical communications infrastructure from deliberate attempts intended to disable or degrade such infrastructure”.

It must also be noted that ASEAN has an FTA and an investment agreement with Hong Kong, China, which came into force in June 2019. Singapore, Thailand, Vietnam, Lao PDR and Myanmar have already ratified this FTA. While not re-joining RCEP is of criticality for India, it will be equally critical for India to re-work the Rules of Origin (ROO) of the India-ASEAN FTA to reflect these new realities involving China.

(This article is based on a detailed study titled ‘Impact of Preferential Trade Liberalisation on India’s Manufacturing Sector Trade Performance: An analysis of India’s major trade agreements’ carried out by the author at the Institute for Studies in Industrial Development (ISID). This study was sponsored as part of the ICSSR-funded ISID Research Programme ‘Industrial, Trade and Investment Policies: Pathways to Industrialization’. The author is a Consultant at ISID.)

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