EXPLAINED| What is MFN status, why the West wants to strip Russia of it?

Zelensky portrayed as Harry Potter and Putin painted as Lord Voldemort by artist Kawu. (Image credit: @kawuart/Instagram)

Almost three weeks into Russia's invasion of Ukraine, a lengthening list of Western nations, led by the United States, have decided to revoke the country’s Most Favoured Nation (MFN) status. The move will expose Russia to attacks in the form of higher tariffs on its exports or even an outright ban on its goods.

Russian banks have already been cut off from global interbank facilities, its businesses sanctioned and the overseas assets of the Moscow elite frozen in reprisal for its invasion of neighboring Ukraine. Losing the MFN status may prove to be the last nail in the coffin of the Russian economy.

The symbolism of the move will also underscore the unprecedented nature of the ongoing Ukraine crisis, in more ways than one. Moneycontrol explains what is at stake.

What is MFN?

MFN is governed by the General Agreement on Tariffs and Trade (GATT) of the World Trade Organisation (WTO)). All 164 WTO members are signatories to an agreement that commits them to not discriminate against one another.

This implies that every time a country lowers a trade barrier or opens up a market, it has to do so for the same goods and services from all its trading partners. If it grants special status to one trade partner, the country is required to extend it to all members of the WTO. Thus all nations accorded the MFN status is ‘most favored’ and have an equal chance of boosting trade with a country as its competitors.

This equal treatment also ensures that they can all benefit from each other's highest import quotas, and the fewest trade barriers for goods and services. The mandatory focus on non-discriminatory trade is considered a bedrock of WTO's global trade rules, created so that larger economies may not arm-twist smaller ones into capitulation on trade.

It is also the reason why all bilateral trade negotiations are almost always notoriously slow; both nations not only have to think about the impact of a bilateral pact on each other but on all other trading partners.

While GATT covers 96 percent of global trade, a few major economies such as Iran, Libya, Algeria, and Kazakhstan remain outside the ambit of the WTO and are not subject to the agreement GATT or provisions like MFN.

What happens if a country's MFN status is revoked by another?

Providing MFN status to all other WTO members is an obligation under the WTO's treaties of accession for all new countries joining the multilateral body. As a result, almost no nation has ever revoked the MFN status of another.

In the event of a country's MFN status being revoked by another, while trade can continue between both with little repercussions, one country is then free to impose additional tariffs on another without any restrictions and to whatever limit it sees fit.

It can also unilaterally subject another nation to a series of indirect trade barriers in the form of scrutinised processes for judging product standards, strict rules of origin norms, a freeze on investments, and ban on imports across sectors.

In the current era of global trade, the biggest hits will be to services trade and related immigration rules. One nation can also effectively cut off the logistics chains of another by taking away its MFN status.

Most importantly, the absence of an MFN tag may lead to a nation's intellectual property rights being overlooked. While there is no formal procedure for suspending MFN status, countries are usually expected to make their case before the WTO afterwards.

Why is it in the news now?

Last week, the G7 nations, consisting of Canada, France, Germany, Italy, Japan, the United Kingdom and the United States, resolved jointly to withdraw MFN status to Russia and to impose punitive tariffs on the country.

In a statement, the group declared that “Russia cannot grossly violate international law and expect to benefit from being part of the international economic order.”

Some of these nations have since then also informally asked other countries to join them. It is currently not known if the G7 nations would officially request other blocs such as the G20, which includes India, Brazil and Saudi Arabia, to revoke MFN status to Russia.

The US has also not needed to go down this route in the past. Its old enemies such as North Korea, Iran and Belarus are already outside the purview of the WTO, and trade measures can be imposed on them without flouting global rules.

Why is revoking MFN considered a measure of last resort?

Since its inception, the MFN clause has been upheld by the WTO and has worked as a bulwark against dubious, partial trade practices by countries and promoted free trade under a framework of mutual openness. MFN status has been revoked only by a handful of countries on a few occasions.

Countries tend not to revoke the MFN status unless a trade partner displays economic hostility. Also, a country to prove to the WTO that it has faced such sustained hostility by another nation once it decides to go down this path.

Despite a protracted trade war between the United States and China until 2019 which covered hundreds of billions of dollars worth of goods, both nations did not revoke each other's MFN status. Similarly, despite the heightened military tensions in Ladakh and the ensuing demand for restricting Chinese goods in India, New Delhi did not revoke China's MFN status.

Has India ever revoked MFN status of any nation?

India remains the only major country till now to have revoked MFN of another nation. In 2019, India revoked the MFN status of Pakistan following the Pulwama terrorist attack that killed 40 Central Reserve Police Force (CRPF) personnel. The attack was perpetrated by the Pakistan-based terror group Jaish-e-Mohammed. A military standoff and trade embargo also followed the attack. The embargo has not been lifted yet.

It was the only time India revoked any country's MFN status although such action against Pakistan had been contemplated earlier as well. After the Uri attack in 2016, the government considered whether to revoke the Pakistan's MFN status and Prime Minister Narendra Modi held multiple meetings on the matter with the commerce and external affairs ministries.

However, the idea was dropped because it was felt it such a move not have an impact. This was because bilateral trade between India and Pakistan was only $2.61 billion, or just 0.41 percent of India’s overall merchandise trade, in 2015-16. Also, India could not complain of harmful trade practices by Pakistan to the WTO, and felt revoking the status may make it difficult to explain India’s position to the global community.

Hardliners had also argued that while India had given the status to Pakistan back in 1996, it had not reciprocated till date. This means Indian exports to Pakistan face unfavourable odds compared to products of other countries although Pakistani exports to India face the same treatment as those of other nations.

What will be the impact on India of Russia's MFN status being revoked by the West?

​The way the US has striven to build consensus on the issue with European allies, there may be blocs forming at the WTO, in favor of or against the issue. India will be under diplomatic pressure to join both, similar to the situation it found itself in during the recent debates on sanctions on Russian businesses and closure of airspace to Russian planes.

In case of Russia’s MFN status being revoked, India can invoke Article 21 of the WTO that states that a member-country may not grant MFN to another member on the grounds of “security exceptions". The Foreign Trade (Development And Regulation) Act allows the government to impose mport restrictions on another nation.

MFNs are a bilateral policy tool and individual nations decide to revoke the status in line with their foreign policy goals. Until and unless India decides to follow the West and make the unlikely move of revoking Russia's MFN status, trade and investments between the two will continue as usual, albeit with the challenge of Western economic sanctions on Russia.