India has received a lot of backlash in the last few RCEP (Regional Comprehensive Economic Partnership agreement) negotiation rounds. According to reports, India got an ultimatum from the RCEP countries to either cut tariffs or leave the bloc. They were irked by its protectionist attitude towards domestic industry, and this further delayed negotiations. The commerce ministry later refuted the allegations and clarified that India very much remains a part of the trade pact. The pact has already missed its 2015 deadline and members expect to seal the deal by the end of this year. In the next round, in Auckland, between June 12-18, India may face enormous pressure to reduce tariff rates beyond the initial offer it made in Busan last year.
RCEP is a proposed free trade agreement (FTA) between 10 ASEAN countries and their six FTA partners, namely Australia, China, India, Japan, Korea and New Zealand. It accounts for 25% of global GDP, 30% of global trade, 26% of FDI flows and 45% of the total population. After submitting the initial offer on goods trade, India is now reluctant to further dismantle tariff rates unless some of its demands are met. The reason for India’s aggressive stance is largely due to its past experiences with other trade agreements, where it did not gain much.
What are India’s pain points? Based on its learnings from previous FTAs, it wants to strike a fair deal for its domestic industry. It has raised concerns related to quantum of tariff elimination, threat of cheap Chinese imports, market access for services, rules of origin requirement and a stricter IPR regime.
First, opening its domestic industry for Chinese imports is the biggest concern. India’s trade deficit with China has risen thirteen-fold in the past decade. In fact, China now accounts for over 40% of India’s trade deficit, as imports have grown at an annual rate of 30% while exports have risen only by 14%. India Inc. claims that cheap Chinese imports have hurt domestic players. This is evident from the fact that India has registered the maximum number of anti-dumping cases against China (134/545 cases). Under RCEP, India has negotiated a different tariff liberalisation schedule with China, giving concessions only on 42.5% of the tariff lines. It is not comfortable reducing tariffs, especially on textiles, metals, etc. China, of course, is not very happy.
Second, in the case of quantum of tariff elimination, India is reluctant to be aggressive. Historically, India’s trade balance with FTA partner countries has deteriorated post FTAs. For instance, trade deficit with ASEAN and Korea has almost doubled since 2010. With Japan, too, trade deficit has increased from $3.1 billion to $5.1 billion during the same period. Also, exports to RTA and non-RTA partner countries have grown at similar pace over the past decade (13% y-o-y).This points to the fact that India has not gained much in terms of exports as a result of FTAs. Due to its higher tariff regime, India has to reduce tariffs much more than other RCEP countries. Sharp reduction in tariff will mean huge revenue loss for India. The commerce ministry estimates that RCEP will lead to a revenue loss of 1.6% of GDP. The average MFN applied tariff rate for India is the highest amongst the RCEP countries (13.5%) followed by South Korea, Thailand and Cambodia. Agriculture is also highly protected with average MFN applied rate at 33.4%, next only to South Korea. While Singapore, Australia, Brunei & New Zealand are few countries that have low import duties.
Third, as India’s strength lies in services trade, negotiation on this is critical. India has been pushing for greater market access in services which has irked ASEAN members. India did not get a fair deal under the AIFTA services pact, after the goods agreement was signed. It expects greater liberalisation in Mode 4 services that facilitate movement of professionals from one country to the other. This could be critical for India’s IT sector. Apart from pushing for liberal visa regimes, India has backed greater liberalisation in Mode 3 (commercial presence) and Mode 2 (consumption abroad) services. However, member countries want tariff liberalisation for goods to precede services negotiations.
On the issue of rules of origin, India has suggested a change in HS code classification plus a 40% value addition as a criteria for “origin” in a particular country, as it is worried about surge in imports from China. However, member countries feel it to be stringent criteria which may not do justice to the regional value chain.
Lastly, the IPR regime demanded by members like Japan and Korea are stricter than the level of protection India provides under TRIPS (Trade Related Aspects of Intellectual Property Rights) agreement of the WTO. It has opposed some proposals initiated by members involving patent extensions, restrictive rules on copyright exceptions and other anti-consumer measures. This may limit access to affordable drugs and have serious implications for domestic pharma.
Initial offers for tariff reduction have been made under RCEP. India has followed a three-tiered approach to reduce tariffs from base rates. Base rates are basic customs duty as of January 1, 2014. For each tier, ‘thresholds’ are decided, based on the quantum of tariff lines and RCEP import value, on which customs duties will be eliminated.
For the 1st tier, with ASEAN countries, India’s threshold for tariff elimination is 80% which includes 65% at entry into force (EIF) and 15% over a decade. For the 2nd tier, with Japan and Korea, India has offered 65% tariff elimination threshold while the two countries have reciprocated with 80% threshold over a decade. For the 3rd tier, with Australia, China and New Zealand, India’s offer of 42.5% threshold has been reciprocated with a 42.5% threshold from China, 62.5% from New Zealand and 80% from Australia over a decade. However members, feel India should be more ambitious for their tariff liberalisation schedule.
India is negotiating an FTA with Australia. RCEP countries already constitute 27% of India’s total trade, 16% of its exports and 35% of its total imports. The trade deficit with RCEP has risen ten-fold, from $9 billion in FY05 to $93 billion in FY16, of which China accounts for 56% of the trade deficit ($53 billion).
India’s trade deficit can be attributed to two reasons. First, exports are more sensitive to income changes than price. This is because the composition of export basket has moved away from traditional exports of textiles, leather and agri products to the export of engineering goods, pharma and petro products. The latter are much more sensitive to global demand than traditional exports.
Secondly, in the case of multiple RTAs available for exporting to a particular country, exporters prefer the route where compliance is less cumbersome, even if the duty benefits are fewer. If the cost of obtaining benefits (applying for certificates of origin, waiting time and other administration cost) are higher than the benefit itself ( Margin of preference =MFN duty- preferential duty) exporter will use the MFN route instead of the preferential route. According to the Asian Development Bank, the utilisation rate of India’s FTAs varies between 5% and 25% (one of the lowest in Asia). This reflects India’s prevailing complex compliance and administration process.
In such a situation, Indian exporters may not benefit much from tariff cuts/liberalisation under an FTA. This is evident from India’s worsening trade deficit with most of its FTA partners. However, with upcoming mega trade pacts like TPP and TTIP expected to change the global trade landscape, India would not want to opt out of RCEP at this stage. Thus, India’s best bet would be to offset its loss on account of goods trade by greater benefits from market access in services and investment.
The author is a corporate economist based in Mumbai