India’s FTAs have flaws. But they can be tapped smartly

FTAs are not all about driving up exports. They are also about sourcing inputs at competitive prices that can further be processed for domestic consumption and exports.

In a global economic landscape, increasingly influenced by mercantilism and trade protectionism, there are too many misconceptions about free trade agreements (FTAs). Among them is the notion that the performance of an FTA should solely be measured by its ability to increase a country's exports. This belief overlooks the multifaceted nature of FTAs and the diverse ways in which they can contribute to a nation's economic growth and consumer welfare.

FTAs are not all about driving up exports. They are also about sourcing inputs at competitive prices that can further be processed for domestic consumption and exports. Moreover, cheaper imported goods (either due to FTAs or unilateral import liberalisation) force competing domestic manufacturers and sellers to invest in research and development (R&D) to better in what they do. That, in turn, benefits domestic consumers and boosts exports.

A superficial reading of India's trade with three of its major trade partners, ASEAN, Japan and South Korea(with whom it signed free trade deals in the period 2010-2011) shows that FTAs with them have led to more imports than exports, leading to steadily rising trade deficit. Therefore, trade sceptics advise the Indian government to be extra cautious in signing new free trade deals, especially with the European Union as they may involve deeper tariff cuts and WTO plus commitments on environment, intellectual property rights (IPR), environment and investment protection among others. This logic is flawed in many respects.

No Gains From High Tariffs

First, maintaining high import tariff walls to protect its manufacturing sector have not helped if the near stagnant share of manufacturing in India’s GDP at 16-17 percent is any indication, despite a significant increase in import barriers since 2014. This share is similar to what it has been since the 1960s (yes, you heard it right). Obviously, high tariff walls aren’t leading to any significant gains in manufacturing output or jobs, and that is not without reasons.

Import barriers tend to increase the relative attractiveness of domestic markets over tougher export markets. That induces neglect of R&D. A little wonder that the top five most profitable non-financial companies in India are spending a mere two percent of their profits on R&D compared to 29 percent in China, 37 percent in the US, 43 percent in Japan and a whopping 55 percent in Germany, even though the profit-to-sales ratio is very high in India at 16 percent versus seven percent in China or nine percent in Germany and Japan.

Along with high tariff walls, a lax IPR regime dis-incentivises riskier and long gestation investments (in R&D) that is well-reflected in the number of patent applications filed with the World Intellectual Property Organisation (WIPO): 1,585,683 by China compared to 61,573 by India (2021). Innovation is the key to survival in an intensely competitive and globally connected market, and Indian companies can’t avoid it, for long. The sooner they realise the better it would be.

Second, Indian consumers have a fundamental right to cleaner air and water. That calls for tightening pollution control norms. Otherwise, the resulting increase in healthcare costs will outweigh any benefits from relaxed environment regulations that may appear to support domestic manufacturing. Moreover, reducing carbon footprint can help Indian manufacturers differentiate their products in overseas markets and command higher prices than what they are getting by exporting largely undifferentiated products with little pricing power. Anyway, developed countries can easily impose WTO plus norms on Indian exporters through border carbon measures even without FTAs as long as those norms are also applied to domestically produced goods, especially when the WTO appellate mechanism is non-functional.

Need Stable And Easy Regime

Third, a predictable and stable regulatory regime that is enforced impartially will help bring in more FDIs at a time domestic savings are declining and private investment is not picking up. Thus, India needs to adopt a more flexible approach on bilateral investment protection that it currently offers through its model investment treaty.

Fourth, there is no official data on FTA utilisation. However, it’s no secret that more than 80 percent of importers and exporters are not using preferential routes because of the increasing time and cost of complying with rules of origin. Thus, Japan's stringent sourcing rules effectively deny Indian clothing exports the benefit of duty-free market access under India-Japan Comprehensive Economic Partnership Agreement (CEPA). If FTA utilisation is so low, they can’t be responsible for a surge in imports. The problem lies somewhere else i.e. lack of manufacturing competitiveness that makes indigenous manufacturers vulnerable to imports.

Contrary to general perception, imports are not always bad. Competitively priced imports such as electronics have helped India's digital economy. Cheaper solar cells and modules have been helping the country in its green energy transition. Similarly, imports of competitively priced active pharmaceutical ingredients (APIs) from China have helped Indian pharmaceutical companies dominate global generics markets. One major benefit of India-Australia FTA will be sourcing of coal or raw wool from Australia at lower landed prices that will benefit downstream industries, power producers and textile companies respectively, and eventually end-use consumers.

Nevertheless, it’s not our case that India’s FTAs are flawless.

Need Industry-friendly Deals

The review of existing FTAs to make them more industry-friendly makes sense. The past mistakes of negotiating FTAs with “difficult to comply sourcing norms” that reduce their utilisation can, and should, be avoided. That calls for proper consultation with the industry. The focus should be on pushing India’s offensive trade interests instead of trying to protect a few industries that supply raw material and intermediates. It’s time to address the problem of inverted duties — higher import duties on raw material and intermediates and lower import duties on finished goods — to support the export of value-added products.

Moreover, it’s time to focus on giving a big push to services exports by looking at non-IT business services, for instance, other business and professional services such as accounting and bookkeeping, consultancy, research and advisory and legal services, given our comparative cost advantage in knowledge-intensive services. It’s important to realise that in the current global scenario, expecting too much on getting improved market access in Mode 4 (movement of natural persons) is a bad idea.

Instead of zealously protecting its import tariff walls, India should use this as a bargaining chip to get its trade partners to remove their NTBs (non-tariff barriers) that have been hampering India’s exports, especially those to developed countries. That will give a boost to exports. Moreover, it’s better to focus on achieving current account balances rather than obsessing about how to control imports, with or without FTAs.

Ritesh Kumar Singh is a business economist and CEO, Indonomics Consulting Private Limited, a policy research and advisory startup. He tweets @RiteshEconomist. Steven Raj Padakandla is a faculty at IMT, Hyderabad.

Views are personal and do not represent the stand of this publication.