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Economy

India's trade pact dilemma

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A worker walks past a container ship at Mundra Port in the western Indian state of Gujarat.   © Reuters

Recent statements from officials show that Prime Minister Narendra Modi's government is not happy with the way India's trade agreements have performed in encouraging exports. The government thinks the country's trade pacts are generating more imports than exports, adding to the country's trade deficit.

India has been highly active in the trade arena in the last seven years, concluding agreements with South Korea, Japan and the Association of Southeast Asian Nations (ASEAN), as well as opening talks on pacts with the European Union and Canada. There is no evidence that such agreements are responsible for the country's poor export performance, but India certainly needs to improve its poor negotiating skills, which are compounded by trade-limiting regulations and the rising economic might of China.

After declining for 18 consecutive months, India's exports inched up by 1.27% in June. New Delhi is able to manage the current account problems caused by its poor export performance, mainly because of the inflow of remittances, earnings from software exports and low prices for imported commodities. But the issue has caused sufficient unease for the government to consider a detailed review of all the trade agreements the country has signed so far.

This uneasiness may also explain why India is dragging its feet on concluding newer agreements, such as one with the EU, even though India's trade with its trade pact partners is broadly in line with its overall trade growth.

With multilateral trade liberalization under the World Trade Organization framework stalled by global disagreements about how to proceed, India will need to continue pursuing bilateral trade agreements to protect its global export share. It will also need to put much more effort into addressing its infrastructure problems and improving coordination with domestic businesses to achieve better results from existing and future agreements.

Amid these noises, India's relationship with China, a major contributor to its trade deficit, should also come into focus. India's imports from China are steadily on the rise while the trend for exports to China is flat, at best. China accounted for more than 45% of India's total trade deficit, or $52.6 billion, in fiscal 2015-2016. There is no trade deal between the two countries, although negotiations for a 16-member Regional Comprehensive Economic Partnership that would include both are ongoing.

The China factor aside, India's commerce ministry has admitted that the trade agreement utilization ratio -- the proportion of eligible goods receiving preferential treatment under its various bilateral deals -- is between 5% and 25%. This is low by any standard, but it also suggests that trade agreements cannot be solely responsible for the rise in India's imports, or for its trade deficit.

Skewed

More could be done to push exports. Despite diversification efforts, India still has a narrow export basket. The top 20 product categories account for almost 80% of its total merchandise exports. Exports of services are even more skewed, with information technology and IT services accounting for almost 50% of the total. More than two-thirds of these exports go to just three countries -- Canada, the U.K. and the U.S.

India's trade agreements are ill conceived and badly negotiated in the sense that they do not seem to fully factor in its comparative advantage in the services sector, which accounts for more than 60% of gross domestic product. Services is also the sector that provides the greatest competitive advantage.

For example, the original India-ASEAN trade agreement covered only goods -- even though India competes with leading ASEAN members in key manufacturing sectors such as textiles and automobiles. The agreement was subsequently expanded to include India's stronger services industries, but this section is not yet fully operational.

India has no trade deals with many partners with which it could hope to trade successfully, including Russia and the EU, and only a limited agreement with the Latin American trade bloc Mercosur, which includes Argentina, Brazil, Paraguay, Uruguay and Venezuela.

The Mercosur agreement excludes textiles, one of India's top export items, which attract import duties of as high as 35%. Vietnam, another top textile exporter, has concluded an agreement with Russia, while India's negotiations with Moscow are progressing at a snail's pace.

In part, this lack of progress reflects a lack of preparation on the part of Indian business leaders and the country's trade negotiators in the commerce department. An agreement with the EU would help India's apparel exports immensely -- the bloc is the world's largest importer of such goods. In the absence of progress India's exports continue to suffer from tariff disadvantages compared with countries such as Bangladesh and Pakistan.

India's trade agreements so far have not have achieved much success in dealing with non-tariff barriers, including local regulations. For instance, India's clinical trials and tests are not automatically recognized in Japan, and it takes more than a year to get regulatory approvals. As a result, the India-Japan Comprehensive Economic Partnership Agreement has not helped India's pharmaceutical exports despite the huge potential of the Japanese market.

To secure real market access, the conclusion of trade agreements should be followed up with mutual recognition agreements, which are critical for pushing key exports such as pharmaceuticals and medical services. However, India's trade negotiators have often neglected this point. As a result, when global demand remains sluggish, barriers to entry rise. The shipment of pharmaceuticals from India to Japan declined steadily from $47.6 million in 2011-12 to $24.59 million in 2015-16, despite the 2011 trade agreement, according to the commerce department.

The India-Japan CEPA allows duty free imports of apparel only if all the materials are of Indian or Japanese origin. Such restrictions on sourcing limit India's potential exports. The combined value of India's exports to Japan of apparel and made-ups (goods such as carpets, curtains and furnishings) decreased from $271.38 million in 2011-12 to $234.24 million in 2015-16.

India is also damaging its own interests by imposing an import duty of 10% on inputs of man-made fiber needed by manufacturers. There is high and growing demand for exports made of such materials, but India has remained largely a cotton textiles exporter because the government maintains duty free imports of cotton fiber, artificially imposing a cost burden on man-made textiles relative to cotton. In this light, it is no surprise that India's global export share of apparel goods is just 6% compared with China's 35%.

Low-margin

In a competitive landscape, India's inability to push its exports to China remains a problem. India mostly sells low-margin commodities to China -- iron ore, cotton and copper account for half of its exports. Indian efforts to diversify away from raw materials have been thwarted by Chinese regulations, for example in the pharmaceuticals sector.

Internally, poor trade facilitation and India's failure to deal with its logistics infrastructure weaknesses adversely affect its export competitiveness, especially in a sluggish global macroeconomic environment. India is ranked 133rd by the World Bank in its league table of countries' trade facilitation effectiveness.

Despite the slow progress, India can count on a trade deal with the EU, the world's largest trading bloc, to turn its export fortunes around. But dealing with 28 EU member states (27 if the U.K. departs, probably in 2018) has its own challenges. In addition, a compromise will have to be found on a complex disagreement over intellectual property rights that is hampering the negotiations, notably in respect to the pharmaceutical sector.

India is not comfortable with making commitments beyond the WTO's Agreement on Trade-Related Aspects of Intellectual Property Rights that would undermine the capacity of Indian pharmaceutical companies to produce generic copies of drugs developed overseas. The EU has expressed optimism that a solution can be found, but Brussels needs to understand that changing Indian patent law would require parliamentary approval. Modi's government would face uproar if it tried to go down that route, and it will not do so, irrespective of pressure from the local pharmaceutical lobby.

For its part, India should agree to reduce its excessive tariff protection of the local car industry, which does not make sense because it deprives consumers of access to better quality products. New Delhi also needs to appreciate that pressure to secure freedom of movement for its software professionals into Europe at a time of rising sensitivity about immigration there may backfire.

A faster conclusion of the India-EU trade agreement would support growth in the current fragile global macroeconomic environment. New Delhi needs to acknowledge, however that even if an India-EU trade deal is concluded it will not automatically help India's exports.

To reap the full economic benefit of such pacts India will also need to fix its basic infrastructure, especially in relation to customs and ports, and make determined efforts to increase the range and proportion of goods that benefit from them. For services exports, in particular, it will be crucial to negotiate the mutual recognition agreements that have so far been neglected.

Ritesh Kumar Singh is a corporate economist in Mumbai and a former assistant director of the Finance Commission of India.

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