India’s Trade Policy Options

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India’s Trade Policy Options

As the US pushes the TPP and TTIP, India needs to do a better job choosing its trade deals.

India’s Trade Policy Options
Credit: REUTERS/B Mathur

The United States is presently attempting to bypass the World Trade Organization by pushing two highly ambitious trans-regional trade pacts: the Trans-Pacific Partnership and the Transatlantic Trade & Investment Partnership. Together, these two accords would encompass two thirds of world GDP and one third of world imports, and thus would nudge global trade further into preferential routes.

The U.S. and EU account for 30 percent of India’s merchandise exports. So where does that leave India? Should India follow the trend and aggressively pursue bilateralism to push its exports, or should it stick to multilateralism, especially after the (albeit modest) success of the recent WTO Bali Ministerial?

Studies show that complying with the complex rules of origin to get preferential tariff treatment under preferential trade agreements (PTAs) or free trade agreements (FTAs) add to trade transaction cost. That leads to low net realization from trade – and explains why trade routed through PTAs is so low. The Asian Development Bank estimates that trade through India’s PTAs ranges between 5 percent to 25 percent. A consensus-based multilateral trade regime under the WTO framework would thus work better for India.

Unfortunately, multilateral trade liberalization moves slowly – getting 159 WTO members to agree to a proposal is not easy. Besides, the growing indifference of large economies like China and the U.S. to the WTO leaves India with little option but to explore the bilateralism permitted by Article XXIV of GATT 1994 and Article V of GATS.

Moreover, WTO member countries (India being no exception) are often forced to sign specific PTAs/FTAs to protect their existing markets. For instance, the conclusion of the ASEAN-China FTA prompted the India-ASEAN FTA. Sometimes, geopolitical considerations may induce a country to join a particular trade agreement, such as the South Asian Free Trade Area (SAFTA).

India has joined the talks for a Regional Comprehensive Economic Partnership (RCEP) that would cover the Asia-Pacific, despite the nervousness India Inc. has about a free trade arrangement with China. In this context, it is pertinent to look at India’s experience in pushing exports through bilateral routes.

Of India’s FTAs, the most ambitious are those with the South Asian Association for Regional Cooperation (SAARC), ASEAN, Japan and Korea. There are PTAs such as those with Chile and Latin American trade bloc Mercosur. Experts argue that India’s existing trade pacts are shallow and suffer from limited coverage (the PTAs with Mercosur or Chile, for instance) or cover only trade in goods (e.g., SAFTA and the India-ASEAN accord). India’s trade with SAARC has been stymied by hostility between India and Pakistan.

Indeed, the trade pacts with ASEAN, Japan and Korea have done little to boost Indian exports. The country’s combined trade deficit with ASEAN, Japan and Korea has risen by 70 percent, from $16 billion in fiscal 2010 to $68 billion in fiscal 2013. It is obvious that concluding an agreement covering trade in goods while continually postponing the trade in services part (where India has a comparative advantage) under the India-ASEAN trade pact has not served India well.

Even when trade in services is included – as in India’s comprehensive economic partnership agreements (CEPAs) with Japan and Korea – there is greater emphasis on areas that are adversely affected by growing sentiment against outsourcing. Further, slow progress on the conclusion of mutual recognition agreements has limited the benefits from India’s deals with Japan and Korea.

The Way Forward

Rushing into FTAs without creating a level playing field for domestic businesses will not help India’s exports. Here, one must consider the negative impact of the plurilateral Information Technology Agreement that India signed in 1997. Post accession, duties on final goods were removed (and this did help the growth of software sector), but those on components and parts were retained, which killed the growth of the indigenous electronics and computer hardware industry.

India’s manufacturing sector is troubled by cheap imports from China that are often subsidized covertly or overtly in the form of cheap loans, raw materials, land and power, as highlighted in successive U.S. Trade Representative compliance reports. Many of these trade distorting measures are the subject of WTO disputes. On the other hand, China uses non-tariff barriers to restrict access to its domestic markets. Thus, an FTA with China as envisaged under RCEP needs serious reconsideration.

This is not to argue that India cannot benefit from integrating with the Asian production network. However, unless the concerns of infrastructural bottlenecks are addressed, further trade opening with China under the RCEP, especially in manufactured goods, will lead to more imports (than exports) with implications for India’s current account balance. Of late, there is talk about rising wages in China, but it is important to consider India’s productivity differential with China, which depends on multiple factors, the extent of automation and skills upgrading being just two.

Even without an FTA, China accounted for more than 50 percent of India’s current account deficit in 2012-13. India has a narrow export basket with respect to China, with commodities such as iron ore, copper and cotton accounting for more than two thirds of its exports. Free trade with China will only exacerbate this.

However, this doesn’t mean India has nothing to gain from bilateral pacts. There are clear winners, such as the expansion of an India-Mercosur PTA into a full-fledged CEPA, or the deepening of trade relations with South Asia, especially Pakistan, Africa and CIS. A transit trade agreement (as part of the WTO Trade Facilitation Agreement) will boost intra-SAARC trade and help exports. Africa and the Commonwealth of Independent States (CIS) are the two fastest growing import markets. In 2012, imports grew by 11.3 percent in Africa and rose by 6.8 percent in the CIS; compare this to Asia (3.7 percent), North America (3.1 percent) and Europe (-1.9 percent). Going forward, these are the markets to explore.

A desirable trade strategy for India must therefore have a good mix of bilateralism and multilateralism. Given its comparative advantage in services and ever growing need for capital, India needs to target comprehensive trade pacts only, covering goods, services, and investment, among other areas. Whether we like it or not, foreign direct investment and multinational corporations remain the key source of export. So reversing policies in retail or any other sector that creates regulatory uncertainty would not be wise.

Further, with the U.S. trying to rewrite the future rules of trade through its giant trade pacts, India will have to upgrade its regulatory regime sooner rather than later, particularly with respect to intellectual property, labor and environmental standards, to safeguard its long-term commercial interests.

Ritesh Kumar Singh is Group Economist of a corporate house. The views here are his own.