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FTAs: How useful?

While Free Trade Agreements are flavour of the season, India needs to tread cautiously, especially since a badly stitched one is likely to be inimical to our commercial interests! — KK Srivastava

 

A new report by the World Bank has ominously hinted at the faltering prospects of the global economy. The world economy is likely to plummet to a three decade low of 2.2% a year between 2023-2030, down from 2.6% in 2011-21 and 3.5% in 2001-2011. Apart from the immediate causes Covid, Ukraine war, commodity prices – from long term perspective capital accumulation, growth in labor force, or growth in labor productivity all have suffered acutely. All of these are likely to slow down further during the remainder years of the current decade. The potential growth rate could be impacted negatively further if financial crises crept in major economies and/or a global recession is triggered. 

While slowing growth rate is bad for all, it is particularly injurious to countries like India, though India may be slightly better off in its group of emerging economies. But geopolitical tensions, reduced openness to trade, policy uncertainly and such like reasons would make it tougher for India to traverse along its desired growth trajectory. For instance, demand for India’s exports, a crucial engine of domestic growth, will likely stay subdued. The government aims at boosting India’s exports to $2 trillion by 2030. This the government hopes to achieve through free trade Agreements (FTAs), import substitution, import diversification and other measures like Atmanirbhar Bharat Abhiyaan, production linked incentive scheme, National Infrastructure Pipeline, resilient financial institutions, etc. India also aims at (some would say wishfully, as of now at least) becoming an alternative to China as India is considered apt for friend shoring – being a reliable global supply chain partner by major would economies. 

But we cannot ignore the unpleasant facts. According to Global Trade Research Initiative (GTRI) India’s merchandise imports are expected to rise 15% to a record $710 billion in 2023. Indeed, India’s imports now exceed its exports for 22 of its 25 trading partners. Howsoever much against our wishes, China remains India’s largest source of imports ($102.6 billion) with an adverse trade balance against India of $87.5 billion. India has not been able to take advantage of the trend among MNCs of pursuing a ‘China plus one’ strategy which seeks to cut reliance on manufacturing production in China by exploring alternative destinations such as India. Instead smaller countries like Vietnam, Thailand, etc. have marched ahead. Despite the availability of resources and planning India has failed to relocate the MNCs moving away from China into our country. Though overall Indian economy will be moderately impacted by weak global demand due to geopolitical events, high prices, supply disruptions, etc. (in turn causing recession in large economies) nonetheless its exports are likely to be adversely instructed. 

The deepening of economic engagement between any two (individual/group of) countries is undertaken (and this is what is aimed at while forming FTAs) with a view to nurture new growth avenues beyond the realm of conventional trade. Many countries including UAE, Australia, United Kingdom, Canada, GCC, and the European Union are keen to sign economic cooperation agreements with India. India is looking benignly at this enhanced level of relationship across the bevy of countries as an outcome of our shared vision for the future, both at the multilateral and bilateral level. India is on the cusp of reaching the inflection point in its quest to become a middle income country which will be the third largest, after US and China, India’s economic clout no doubt is growing. And with external economic relations India has decided to adopt a somewhat unique approach towards free trade and multilateralism. While it does want to be a part of a more collaborative, globalized world, participating in the global business value chains, it has carved out a unique path to travel along. Production linked incentive (PLI) scheme is one such example. However, the world overall is retreating from integration globally and India is not unaware. We wish to be atmanirbhar, and want to take advantage of our vast domestic economy. Hence India has decided to tread cautiously; instead of practicing an all out opening of our markets it has decided to go in for, among others, free trade agreements. Though India is not alone.

It is somewhat benignly assumed that FTAs are win win deals for contracting parties since they increase trade and/or help a country become part of global value chains. That is why there are above 350 FTAs worldwide that are currently in force. However, a closer scrutiny (as recently one by Global Trade Research Initiate) would warn us that most beliefs that support signing of FTAs are actually myths arising out of ideology; these beliefs are contrary to what due diligence of data could point at. These myths need to be busted and exposed for the trading nations, especially for India (which is on a spree to sign economic agreements with a host of nations) so that we take a decision in a level headed manner and not fall in a trap of our own making. Let’s note certain cautionary facts.

One, countries are not rushing into signing FTAs. Certainly not USA or EUs which sign such agreements with raw material suppliers or small nations. Major industrial economies/regions are very selective in doing FTAs.

Two, FTAs will not necessarily promote investment. The quality of investment generally depends on efficiency – a relative one – of countries. A country which is more efficient is likely to become a manufacturing hub, and not merely due to signing of FTAs.

Three, just about one sixth to one seventh would trade happens through the preferential route, excluding the bilateral trade that would have otherwise taken place anyway. According to GTRI, 70% of Indian exports to ASEAN enter at zero MFN and not due to FTA. So many a time the trade taking place through FTAs is overestimated. 

Four, FTAs donot necessarily lower prices. If at all prices may be reduced only to the extent that an FTA exporter (to say India) wants to overcome competition in India from domestic firms.

Five, zero duty import of finished goods through the FTA route may actually disrupt many domestic manufacturing programs, rather than promoting them. This issue of finished goods imports thus needs to be looked at with more caution.

Six, many developed countries very conveniently ask developing countries to follow WTO norms (if they suit them) plus obligations of other issues like intellectual property, environment, etc. In short, many non-tariff barriers are put against developing country exports. Thus FTAs are certainly not building blocs of WTO.

Seven, if our partner country has low import duties anyway for the rest of the world, we are hardly likely to witness an accelerated increase in exports from India to the FTA partner countries.

Eight, FTAs may or may not lead to enhanced participation in global value chains since under FTAs comply rules of origin conditions must be satisfied. Free movement of goods is best possible under zero MFN duties. 

Are we then suggesting that FTAs should not be signed? No. Instead, that we should be more calculating. For example, we need to learn from Vietnam which focusses on trade creation and not trade diversion. Thus India should become a manufacturing destination for exporting countries that set up base here and export finished goods to developed markets as well as other countries; in other words it should aim at capturing a greater share of the value addition. Presently, individual FTAs have had a very limited effect on enhancing our export competitiveness. 

We need to tread carefully.

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