Free trade at a heavy cost for
India By Kunal Kumar Kundu
MUMBAI - The recently signed India-Thailand free
trade agreement (FTA) has stirred a hornet's nest in
India. It is being argued that India has shown
unnecessary haste in signing the agreement without fully
comprehending its economic implications for Indian
industry.
Regional or bilateral free trade
agreements (RTA/FTA) are not a new phenomenon and have
become important aspects of any country's trade policy.
The trend started with the formation of the single
European market by the European Union in 1992 and the
North American Free Trade Agreement (NAFTA) in 1994.
Over 300 FTA/RTAs are currently in different stages of
negotiation. More than half of world trade is now
conducted on preferential basis within FTAs. Therefore,
any country that ignores this route of regional
integration can do so only at its own peril.
The Indian experience India's first
brush with new-age preferential trade arrangements was
in the form of a bilateral FTA signed with Sri Lanka in
1998. This was followed by various FTAs. On the positive
side, the India-Sri Lanka FTA has led to India's exports
to Sri Lanka increasing from Rs21.63 billion (US$490.4
million) to Rs60.67 billion between 1999-2000 and
2003-04. Similarly, Sri Lanka's exports to India moved
up from Rs1.92 billion to Rs8.93 billion during the same
period.
FTAs also have a positive impact on the
members' ability to attract higher volumes of foreign
direct investment (FDI). The India-Sri Lanka FTA is a
case in point as it stimulated new FDI into Sri Lanka
for rubber-based products, ceramics, electrical and
electronic items, wood-based products, agri-commodities
and consumer durables. According to the United Nations
Conference on Trade and Development, 37 projects are now
in operation with a total investment of $145 million and
India has emerged as the third largest investor in Sri
Lanka because of the FTA.
However, India's
approach has mostly been to focus only on the import
tariff aspect, whereas rules of origin have come to play
a much greater role in today's World Trade
Organization-guided trade geography. Because of the
hurried approach, India today finds itself in a mess in
the case of the Indo-Sri Lanka FTA. Since the rules of
origin were not given the due importance in the FTA,
India has not only lost revenue but it has also been
victim of rampant dumping, causing several domestic
units to turn sick.
Using the European model of
35% value-addition and sometimes even less, all sorts of
products have been imported into the country through the
Sri Lankan route. Chinese and European goods are being
camouflaged by either re-packing or making minor
changes, and are then being pushed into the Indian
market through the Sri Lankan route. Though the country
has levied anti-dumping duties on many products, it's
clear that a number of traders have been importing such
goods to a third country and, with a minor change in
packing or stamping, importing them into India.
The directorate of Revenue Intelligence and
Customs has filed quite a few cases where Chinese-origin
goods have been taken to Singapore or Hong Kong, but
declared as made in Indonesia and Malaysia to evade
anti-dumping duties. Also, in many cases where India has
signed a FTA agreement, it has found that most items are
agricultural products that are highly subsidized by the
exporting nation and sold in India at a much cheaper
rate - a price with which Indian industry cannot
compete. In the case of Thailand, most marine products
are very cheap. In the case of Sri Lanka, export of
cloves, cassia and cinnamon hurts Indian industry
enormously.
India has now embarked on an
aggressive strategy of preferential liberalization with
its Asian neighbors. Agreements have been signed for the
creation of FTAs within South Asia and with the members
of the Association of South East Asian Nations (ASEAN).
Unlike tariff reductions announced by the finance
minister that apply to all trading partners, FTAs
eliminate tariffs against FTA members altogether. In
most case, the move toward FTAs has been necessitated by
political considerations. Unfortunately, very little
effort has been made to evaluate the economic impact of
these deals.
FTAs no win-win
solution While not many formal studies have been
undertaken to ascertain the true impact of FTAs on
respective economics, from a purely economic standpoint,
FTAs could spell potential trouble for India. Any move
toward preferential trading without further
liberalization is unlikely to work. India continues to
have high trade barriers, which make the scope for trade
diversion and the accompanying losses considerable.
Being relatively powerful in most countries in the
region, business lobbies are likely to exploit the rules
of origin and sectoral exceptions in these arrangements
in ways that will maximize trade diversion and minimize
trade creation. The rules of origin give bureaucrats
power and opportunities to share in the rents created by
tariff preferences and they too become active parties to
the diversionary tactics of business lobbies. Therefore,
member countries are better advised to proceed along
non-discriminatory lines in achieving further
liberalization.
According to economist Arvind
Panagariya, countries within the South Asian Association
for Regional Cooperation region trade "too little" with
one another compared to what one would expect on the
basis of their proximity and income levels. There could
be various reasons for this. First, the low level of
trade has been essentially the result of autarkic
policies in the region. The reason for the low level of
intra-regional trade until recently was not the absence
of trade preferences but the absence of liberal trade
policies in general. Pitigala, Pursell and Baysen (2000)
have documented this fact systematically. Among other
things, they show that once the countries in the region
began to liberalize, their intra-regional trade expanded
rapidly. The effect of trade liberalization by India,
which is by far the largest country in the region, is
especially pronounced. Second, there has been a
considerable amount of "informal" trade among member
countries of the region. This was not only to evade the
high tariffs that must be paid on official trade, but
also to carry out some trade that would not have been
permitted at all.
Given that South Asia accounts
for less than 1% of the world production and that
tariffs in the region are high, the risk of trade
diversion from preferential trade liberalization is
high. With 99% of the world production outside the
region, the likelihood that the most efficient and
competitive producers of the large majority of products
are within the region is very low. This means the scope
for trade diversion is substantial. Clearly, the country
with higher tariffs loses while the country with lower
tariff benefits from FTA.
India has now woken up
to this possibility. Recently, it rejected a proposal
from Mauritius for an FTA because of apprehensions that
it could turn into a channel for goods from other
countries to evade import duty in the Indian market. The
Indian view is that stipulations related to rules of
origin would not be good enough to prevent such trade
diversion and unintended benefits to goods from other
countries. According to government sources, the commerce
department argued that an FTA with Mauritius would
result in trade diversion and the island nation would
become a center for re-export of goods from other
countries.
Non-discriminatory
liberalization All trade diversion can be avoided
if the countries in the region were to liberalize on a
non-discriminatory basis. Since all countries within the
region are small in relation to the rest of the world,
the risk of deterioration of terms of trade from
liberalization is virtually absent. As many of the
countries in the region share borders, coordination of
trade policy would help discourage costly trade
deflection. At present, there is much incentive for
goods to be imported into Sri Lanka at low duties and
then smuggled into India. India could greatly benefit
from bringing its tariff rates down rapidly to match
those of Sri Lanka.
The Federation of Indian
Chambers of Commerce and Industry (FICCI) has urged the
government to accelerate the pace of internal reforms so
that the country can be better positioned to maximize
gains from free and preferential trade agreements. This
includes not only reduced tariff levels but also reforms
pertaining to labor laws, improved quality and
availability of infrastructure, lower transaction costs,
lower cost of finance, VAT applicable to all goods and
services, and seamless movement of goods across the
country.
Over to multilateralism India
also needs to study whether it can afford to neglect the
multilateral route and concentrate only on FTAs. Hardly,
if at all, given the numerous FTAs that already exist in
the Americas and Europe. India faces considerable
discrimination against its products in those markets.
The only way to end this discrimination is to bring
tariffs down to near-zero levels on a multilateral basis
under WTO auspices.
After all, despite the talk
of FTA, ASEAN members have undertaken virtually all
liberalization on a non-discriminatory basis. There is
even a formal provision in the ASEAN FTA (AFTA)
Agreement, encouraging member countries to extend
whatever liberalization they undertake as a part of
their AFTA obligation to the rest of the world.
Kunal Kumar Kundu is a senior
economist with a leading bilateral Chamber of Commerce
in India. He has a Masters in Economics with
specialization in econometrics from the University of
Calcutta.
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