India’s Foreign Trade Agreements (FTAs): Approach and Challenges – Explained, pointwise

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Introduction

The Government has pushed the pace of negotiations for the Free Trade Agreements (FTAs) with a new vigour in the last couple of years. Trade deals with Australia and the UAE were signed earlier this year. Similar deals with the UK, the EU and Canada are expected to signed in the coming year. The Government has altered its approach to the FTAs and seems to have shed its earlier reluctance to bilateral trade deals. Several factors like the vision of the Government to enhance exports to achieve the US$ 5 trillion economy status and the the need to diversify supply chains amidst global geopolitical uncertainties may have induced this change. Several developments have negatively impacted global trade in the last few years. In addition, many issues like Climate Change, Environment, Labour Laws etc. have become contentious issues in the context of international trade. These adds new challenges to India’s FTA negotiation process.

What are Free Trade Agreements (FTAs)?

FTAs are arrangements between two or more countries or trading blocs that agree to reduce or eliminate customs, tariff and non tariff barriers on substantial trade between them. FTAs, normally cover trade in goods (such as agricultural or industrial products) and trade in services (such as banking, construction, trading etc.). FTAs can also cover other areas such as Intellectual Property Rights (IPRs), Investment, government procurement and Competition Policy, etc.

India’s FTAs 

India had signed its first Trade Agreement in 1975. It was a Preferential Trade Agreement (PTA, tariffs are lowered but not eliminated, preferential access to goods from participating countries) known as Bangkok Agreement (renamed Asia-Pacific Trade Agreement in 2005). India signed the India-Sri Lanka FTA in 1998. This was the first time duties were eliminated on substantial tariff lines/goods. After the ‘Look East Policy’ was announced, several agreements were signed with East Asian countries. This includes Agreements with Japan, South Korea and the ASEAN.

However, the outcomes of these FTAs were not favorable. While the trade with the FTA partner countries grew, the growth rate of imports was much greater than exports leading to rise in trade deficit. FTAs benefited India’s trade partners more than Indian firms. As a result, the Government became wary of signing more FTAs. India withdrew from RCEP in 2019. The fear was that the agreement included inadequate safeguards for Indian industries and that Indian market will be flooded with Chinese goods.

Outcomes of FTAs UPSC

Source: Business Standard. India’s imports with FTA partner countries (South Korea, Japan, ASEAN) grew at a much faster rate than exports.

However, there seems to change in Government’s approach post COVID-19 pandemic. The Government is now seeking more investment, technology and potential markets for Indian goods in exchange for access to India’s domestic market to foreign goods.

What is the relationship between Multilateralism under the WTO Regime and the FTAs?

Article 1 of GATT (General Agreement on Tariffs and Trade) deals with the Most Favoured Nation (MFN) principle of the WTO. It states that “any advantage, favour, privilege, or immunity granted by any contracting party to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other contracting parties”. This means that if tariffs are lowered or eliminated on a particular good from the US, they must be lowered/eliminated for the same good from the EU or the UK or any other country.

However, derogations (exemptions) from this MFN principle are permitted for forming FTAs under specific conditions of the WTO Agreements. Article XXIV of GATT for goods and Article V of GATS (General Agreement on Trade in Services) deal with these exemptions.

The specific conditions (Article XXIV of the GATT) permitting FTAs are: (a) FTA members shall not erect higher or more restrictive tariff/non-tariff barriers on trade with non-members than existed prior to the formation of the FTA; (b) Elimination of tariffs and other trade restrictions be applied to “substantially all the trade between the constituent territories in products originating in such territories” i.e., if FTA is signed between two countries, the trade barriers should be eliminated for nearly all goods; (c) Elimination of duties and other trade restrictions on trade within the FTA to be accomplished “within a reasonable length of time” meaning a period of no longer than 10 years (i.e., if FTA has been signed, trade barriers should be removed within

The ‘Enabling Clause’ allows developing countries to form preferential trading arrangements without adhering to the conditions under Article XXIV.

Early Harvest Scheme

Early harvest scheme is a precursor to a Free Trade Agreement (FTA) between two trading partners. This is to help the two trading countries to identify certain products for tariff liberalisation pending the conclusion of FTA negotiation. It is primarily a confidence building measure. A good example of an EHS is between India and Thailand signed in October 2003, and implemented in wherein 83 products were identified to be reduced to zero in a phased manner.

What are the benefits of FTAs?

Enhanced Trade: The process of imports, exports and investments among the member countries is made much smoother after an FTA is signed. Import duties and tariffs are all reduced or eliminated, and subsidies may be introduced to facilitate trade.

Growth Opportunities: FTAs can help domestic companies enter new markets in FTA partner countries and compete in those markets. This includes bidding for/providing goods to Governments (Government procurement) of partner countries. FTA support stronger people-to-people and business-to-business links.

Cheaper Goods and Services: The reduction of duties and tariffs on imported goods will give access to a more extensive selection of imported goods and services at lower prices to domestic consumers.

Employment Opportunities: Enhanced trade and growth opportunities in new markets abroad will lead to expansion of domestic economy and create new livelihood opportunities.

Product Standards: FTAs generally involve product standards related to trade. This provides opportunities for domestic firms to upgrade their products to meet international standards.

Investments: FTAs can also help attract more foreign investments.

What are the challenges associated with FTAs?

Policy Challenges: The 2020 WTO Trade Policy Review of India noted that India makes extensive use of trade policy instruments such as tariffs, export restrictions, export taxes, anti-dumping duties, and import licensing. According to economist Arvind Panagariya, such tools create uncertainties and induce distortions in the international trading system. This is evident from Government’s restrictions on exports of wheat and rice in 2022.

Poor Utilisation of the existing FTAs: The reasons range from the cumbersome process of getting a certificate of origin and the related manual verification process to low awareness about FTAs in the domestic Indian industry.

Protectionist Fears: There are fears that FTAs will lead to influx of cheaper goods from abroad and will prove detrimental to India’s domestic industry. These protectionist fears forced the Government to withdraw from RCEP.

New Issues: Developed countries have brought new issues like the labour standards, environment, climate change within the ambit of trade and FTA negotiations. Inclusion of such issues will add additional costs and make Indian goods uncompetitive. e.g., According to a report by Global Trade Research Initiative, the US has brought up the issue of carbon emissions in the process of manufacturing melted steel as a non-tariff related issue. While India mostly produces steel generated from iron ore, which in turn comes from mining, most developed countries have resorted to methods to generate it from scrap, which results in lower carbon emissions. If conditions related to emission standards are made part of FTA, India’s steel industry will lose its competitive edge. Similarly, the EU has also proposed a Carbon Border Adjustment Mechanism (CBAM) to tax carbon-intensive products, such as iron and steel, cement, fertiliser, aluminium and electricity generation, from 2026.

India-South Korea CEPA and Zinc Trade

The India-South Korea Comprehensive Economic Partnership Agreement came to force in January 2010. At that time, India used to export considerable amount of Zinc to South Korea (Refer graph). Korea had low production and India had a weak domestic demand. As part of CEPA, the duties on zinc trade were eliminated.

Since 2010, South Korea has increased its manufacturing and smelting capabilities. It has also lowered logistical costs. In addition, it was also helped by the ‘smart free trade agreement negotiations’.
Zinc trade between two countries has completely reversed since then. South Korea now contributes 52% of India’s Zinc imports. This has adversely impacted India’s domestic zinc smelting firms, especially in the MSME sector.

South Korea does not possess zinc reserves/mines. It exports zinc from abroad, processes it and re- exports. Experts feel if India had a minimum 35% value addition clause under Rules of Origin, the zinc trade would not have distorted.
This shows that India must be very careful and consult industry at every stage while signing new FTAs. Clauses, such as related to say Rules of Origin, should be carefully negotiated.

India South Korea FTA

Source: Mint. India’s zinc trade with South Korea reversed in 2013-14 when India’s trade balance in Zinc became negative, i.e., India became a net importer of zinc.

Rules of Origin

Rules of Origin (RoO) are the criteria needed to determine the national source of a product. Their importance is derived from the fact that a number of trade policy measures are applied on the basis of source of imports.
RoOs have become vital because of globally integrated supply chains, where value addition occurs across different nations (e.g., manufacturing of a component in Vietnam and Taiwan, assembly in India etc.). Restrictions like tariffs and duties are applied on the basis of country of origin, e.g., India may want to restrict imports from China but Chinese goods may find their way into Indian markets through indirect route via another country. Hence, it becomes necessary to have clearly defined rules of origin.

What should be India’s approach regarding the FTAs?

Remove Restrictions: The Government must remove some of the restrictions on foreign direct investment and lower tariffs. Else negotiating countries may offer a lower level of liberalisation than what they offered to their other FTA partners. In that case India’s exporters will be at a disadvantage even after the agreement.

Trade Facilitation Reforms: There is also a need to improve the efficiency of Ports, Shipping, Customs Clearances etc. via automation, which can also be a big boost for participation by MSMEs.

Involve Industry: The Government must involve industry representatives in FTA negotiation process. This can help Government identify Industry’s comparative advantage and negotiate the agreement accordingly.

Hybrid Models: The existing value chains are being disrupted due various geopolitical factors. Most nations feel the need to develop alternative sources of supply in which all the components are available in the vicinity or within the country’s own economy. Therefore, India must look at a hybrid model to source from the most efficient suppliers, including domestic players.

Adjust to New Paradigms: Trade in services, e-commerce, labour, climate/environment, digital trade, public procurement will become central issues in international trade in future. Government must be prepared to adjust to this new paradigm rather than avoiding these issues.

Building Digital Capabilities: The Government must work on building its digital capabilities and infrastructure in key export sectors through a ‘Digitally Informed Foreign Trade Policy’, with a focus on enhancing India’s trade competitiveness. This can be achieved by developing digital infrastructure for trade, building digital skills in trade-able sectors, increasing the share of technology content in exports, and leveraging advanced technologies (Big Data Analytics, IoT, and Blockchain) for evidence-based and informed trade policy decisions.

WTO Plurilateral Negotiations: India could further increase its exports by participating in the major plurilateral negotiations on services, environmental goods, and government procurement now taking place at the WTO.

Conclusion

As the global economy is feared to go into a phase of slowdown, various analysts have noted India as a bright spot in the global economy. The economy is expected to reach US$ 5 trillion in the next 3-4 years. To achieve this status, all growth levers have to be engaged, including trade. FTAs can provide vital boost to foreign trade, provided they are negotiated keeping the domestic capabilities in mind. India-Australia trade agreement is being praised for careful negotiations undertaken by the Government that complements strengths of India’s industry. This approach should be adopted in other FTA negotiations as well. With the WTO losing its relevance, FTAs may be the way to go in near future.

Syllabus: GS III, Indian Economy and Issues related to Growth

Source: Business Standard, The Hindu BusinessLine, Indian Express, Economic Times, IBEF, EEPC

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