RCEP: pros and cons of trade agreements for India

In an exclusive interview Senior business journalist Puja Mehra and Senior journalist Smita Sharma discuss the possible outcomes for India from the negotiations with ASEAN countries with regards to Regional Comprehensive Economic Partnership (RCEP) summit being held in Thailand.

Hyderabad: Prime Minister Narendra Modi is in Thailand to attend the third Summit Regional Comprehensive Economic Partnership (RCEP) scheduled to be held on Monday. In view of the ongoing negotiations for the RCEP deal there, here is a look at some of the potentially positive and negative aspects of the trade pact for India.

First, the negatives:

India’s trade balance with the trading partner usually worsens after a Free Trade Agreement (FTA) becomes operational.
Economic Survey, 2017-18 had studied the impact of free trade agreements (FTAs) signed by India. That an appraisal of India’s existing FTAs by the NITI Aayog is instructive. The survey concluded that the average effect of an FTA is to increase overall trade by about 50 percent over roughly four years. But the quality of trade balance usually worsens for India. In other words, the trade deficit increases, or the surplus reduces.

ASEAN is one of India’s largest trading partners. The CECA with ASEAN kicked off from January 1, 2010. After which, bilateral trade surged from $43 billion in 2009-10 to $97 billion in 2018-19. But India’s trade deficit with ASEAN has more than doubled from less than $ 8 billion in 2009-10 to $ 22 billion in 2018-19. This is because imports from ASEAN are increasing at a faster pace than Indian exports to ASEAN. In the case of the India - ASEAN FTA, the trade balance has worsened for 13 out of 21 sectors. The sectors that lost out include textiles, chemicals, vegetable products, base metals, gems, and jewelry. The improvement in the trade surplus sectors was so marginal it could not offset the losses.

The impact of most of the other preferential trade agreements on India’s trade balance is no different. The India-Korea CEPA also became effective operational from January 1, 2010. Bilateral trade since then between the two countries has grown from $ 12 billion to $ 21.5 billion. But again, imports grew a lot faster than exports. As a result, India’s trade deficit with Korea has nearly trebled, increasing from $5 billion in 2009-10 to $ 12 billion 2018-19.

The India-Japan CEPA became operational from August 1, 2011. After which India’s trade deficit has in fact grown at a rate even faster than India’s trade deficit with the rest of the world has.

The only exception where a preferential trade agreement has improved the quality of trade for India vis-a-via the trading partner is SAFTA (South Asian Free Trade Area) that became operational from January 1, 2006. From 2005-06 to 2018-19, India’s trade surplus with the SAFTA economies grew manifold from $4 billion to $21 billion.

Underutilisation of the existing FTAs

India’s trade balance tends to worsen with its FTA partners because Indian exporters fail to take advantage of the preferential routes as much as the trading partners’ exporters do. In fact, the percentage of India’s international trade routed through FTAs is very low. According to the Asian Development Bank, the utilisation rate of FTAs is less than 25 percent, which is among the lowest in Asia.

The primary reason for this underutilisation of the existing FTAs is that the Indian export sector is fragmented with low capacity to incur the compliance costs needed to figure out the complex rules of origin criteria. Exporters prefer using the normal route. Besides stricter rules of origin, faulty commitments and lack of awareness are also significant limiting factors.

An examination of the India-Japan Comprehensive Economic Partnership Agreement (CEPA) that kicked off on 1 August 2011 by researchers Arpita Mukherjee, Angana Parashar Sarma and Soham Sinha of the Indian Council for Research on International Economic Relations (ICRIER) and Anusree Paul of the Indian School of Business and Finance is insightful. Japan that is a major global importer of apparels shows how Indian exporters are simply unable to corner bigger market shares even when there are zero tariffs. Under the India-Japan CEPA, both countries dropped tariffs on apparels to zero. Yet Japan is still not among India’s top apparel export markets. Apparel exports to Japan have remained constant first after a brief initial blip. Although the relatively large and positive trade balance with Japan in apparels remains, India’s share in the Japanese market is barely 0.09 percent. Among India’s competitors, China has the largest share of 6.46 percent, followed by Vietnam (1.17 percent) and Bangladesh (0.34 percent).

Domestic constraints

Indian exporters face high transaction costs making them less competitive in the global market. Their price responsiveness is constrained by binding supply-side bottlenecks like energy shortages and higher logistics costs. According to the analysis by the NITI Aayog, logistics costs in India tend to be around twice that in developed countries. Average logistics costs in India are about 15 percent of GDP while such costs in developed countries are about 8 percent.

Trade deficit with China

Just weeks ago India raised import tariffs on items such as agarbatis that manufacturers in Vietnam and China are able to produce more competitively than those in India. But to join RCEP, India will have to commit to eliminating tariffs on about 90 percent of items from the ASEAN, Japan and South Korea, and over 74 percent from China, Australia, and New Zealand.

A range of industries including iron and steel, dairy, marine products, electronic products, chemicals, and pharmaceuticals and textiles have expressed concerns that proposed tariff elimination under RCEP would render them uncompetitive.

Once RCEP is concluded, Cheap Chinese imports could flood the Indian market. As it is, India’s overall trade deficit with China has risen thirteen-fold in the past decade. The neighbour now accounts for half of India’s trade deficit. The trade asymmetry is compounded by the nature of goods flow. India tends to export primary products such as ores, minerals, and cotton. Chinese exports to India are mostly a wide variety of sophisticated products higher up in the value chain that enjoys higher profit margins and creates more jobs there.

And, the positives:

For all the reasons listed above, NITI Aayog recommends that not only should India carefully safeguard its interests and comparative advantages while taking a final call on the RCEP, the unfavourable provisions of the India-ASEAN FTA and the CEPAs with Korea and Japan should also be reviewed.

However, there are compelling reasons that make it imperative for India to not stop signing FTAs altogether.
Zero tariffs versus high tariff rates

India has not entered into FTAs with the key markets for its apparel exports, such as the EU, the US, and the UAE. This puts India at a disadvantageous position vis-a-vis those of its competitors that have in fact preferential trade agreements in place with these countries. As a result, India’s apparel exports have stagnated. In the financial year 2017-18, exports of apparel from India declined 3.8 percent. India’s competitors, such as South Korea, on the other hand, have trade agreements in place with the EU or the US or both. India’s top apparel export item is t-shirts on which the US imposes a tariff rate of 32 percent. But many of India’s competitors that enjoy preferential trade treatment in the US get to export t-shirts at zero tariffs. India is highly competitive in silk shawls on which the US imposes a high tariff rate of 11.3 percent. India’s competitors that have FTAs with the US, though, face zero tariffs.

The rise of populism globally

The growing trend of protectionist measures and the threat of higher tariffs in not just the US but also Europe can further erode Indian exports’ competitive edge. Those of India’s competitors that have in place preferential trade agreements can under those arrangements claim compensations against tariff hikes or increased barriers to trade. But without FTAs, India will not be able to do so.

Labour mobility

India’s comparative advantage is its skilled labour and the potential for remittances from the diaspora overseas. The RCEP deal will be a win-win from India’s point of view if the other economies offer to substantially increase their openness to trade in services, including in the area of easing of movement of workers, which means easier and greater number of work visas. The growing trend of resistance to immigrants raises the significance of increased labour mobility for populous economies such as India.

(Puja Mehra is a Delhi-based journalist and the author of The Lost Decade (2008-18): How the India Growth Story Devolved into Growth Without a Story)