By VK Saraswat, Prachi Priya & Aniruddha Ghosh
With a stable and full majority government back to power at the Centre, the Prime Minister has already hit the ground running by setting up two key Cabinet panels on growth & investment and employment & skill development. The focus on the manufacturing sector is critical for sustainable economic growth. Manufacturing not only creates strong positive backward and forward linkages in the economy, but, according to estimates, every job created in manufacturing has a multiplier effect of 2-3x additional jobs in other sectors. Industrial revolutions don’t happen overnight. They require careful planning, policy interventions, regular upgrades, and innovations and investments at every stage of development.
The contribution of the manufacturing sector to India’s GDP has remained stagnant at around 17% since the 1990s, and the sector needs a big push in order to drive potential GDP growth. In the current context of rising trade war tensions and slowing global growth, most countries are cushioning their domestic industry from trade diversion. According to WTO data, trade protectionism has been on the rise both in terms of the number of global trade-restrictive initiations and import coverage of these measures. In the current scenario, a two-pronged strategy of raising domestic competitiveness (via a carefully-planned and targeted Industrial Policy) and cushioning the industry from surge in imports due to trade diversion (via carefully-negotiated FTAs) is the need of the hour.
In this regard, India needs to take a cautious approach towards FTAs. A NITI Aayog note (‘A Note on Free Trade Agreements and Their Costs’, Dr Saraswat, Priya, Ghosh 2018) had earlier highlighted that India’s combined trade deficit with FTA partners like the ASEAN, Japan and South Korea has almost doubled in the last eight years. India’s trade deficit with the Regional Comprehensive Economic Partnership (RCEP) bloc of over $100 billion is almost 64% of its total trade deficit, of which China alone accounts for over 60% of the deficit. The report also highlighted that the quality of trade has deteriorated under the ASEAN-India FTA. As per UN’s Harmonised System of product classification, products can be grouped into 99 chapters and further into 21 sections like textiles, chemicals, vegetable products, base metals, gems and jewellery, etc (similar to sector classification). The analysis shows that trade balance has worsened (deficit increased or surplus reduced) for 13 out of 21 sectors. This also includes value-added sectors like chemicals and allied, plastics and rubber, minerals, leather, textiles, gems and jewellery, metals, vehicles, medical instruments, and miscellaneous manufactured items. Sectors where trade deficit has worsened account for about 75% of India’s exports to the ASEAN.
Having said that, the RCEP—the 16-country mega Asian FTA—has been viewed with caution by Indian policymakers. Commerce minister Piyush Goyal has held industry consultations over the last few days to ensure all industry issues are considered before the deal is sealed. It should be realised that reciprocity is the key to FTAs. The biggest driver for trading partner countries to sign an FTA with India is the access to a big and booming consumer market. So it’s quite logical for India also to assess what it gets in return. That’s probably the reason why India has received a lot of backlash at various rounds of RCEP negotiations from other trading partners. As per media reports, in the latest meeting in Bangkok, India’s proposal for strict rules of origin requirements was not welcomed by other FTA partner countries. Rules of origin are critical as they determine the source of a product for it to qualify for preferential treatment. India has been demanding a stricter rule of origin criteria for its domestic industry (40-60% of value-add) as it fears that China can easily misuse lax rules of origin, like the 35% value-added rule in order to dump goods into India. The fear is not unwarranted as rerouting of Chinese goods into Indian markets via India’s FTA partner countries is quite common. Previously, too, under the India-Sri Lanka FTA, Sri Lanka had started exporting copper to India by under-invoicing of imported scrap in order to show higher value-addition for its goods to qualify for preferential rates under the FTA. Thus, rules of origin norms can easily be circumvented by simple accounting manipulation.
Moreover, the domestic industry has been vocal about its discomfort with respect to opening up of the domestic market to Chinese exports. This is understandable given the massive Chinese overcapacity in key manufacturing industries, and major support programmes in the form of financial, non-financial and trade measures for the domestic industry that give an edge to Chinese producers over other trade partners. China’s manufacturing surplus and dumping of goods across the world is well known. China is the recipient of the highest number of anti-dumping duty (ADD) measures in the world, with 926 ADD measures against it (1995-2017), which amounts to almost a quarter of all ADD measures globally.
Policymakers should also be cognisant of the use of non-tariff barriers (NTBs) by China. As per reports, even though China has agreed to open almost 92% of their tariff lines, expecting India to reciprocate in the same manner, India’s concerns over China’s NTBs merit serious attention. China’s usage of NTBs like complex product certification process, labelling standards, customs clearance, pre-shipment inspection and import licensing have hindered India’s access to their markets. Dealing with NTBs is costly and, therefore, we must factor in this associated barrier before we move ahead with trade pacts, the RCEP in particular. Thus, in terms of reciprocity in an FTA, India’s exports access to Chinese markets will be limited given China’s overcapacity, use of NTBs, and significant financial and non-financial support available to its domestic industry.
Against this backdrop, India must have a plan to deal with the massive support that China offers its industries, leading to overcapacity and price undercutting post-RCEP. Therefore, we suggest that appropriate safeguard clauses must be put in place within the RCEP in case injury to domestic industry is found. A clause on provisional safeguard measures should also be introduced. Within the FTA, a provision should be made for safeguard measures to be invoked if a volume or price trigger for the concerned products is reached.
Given the current state of Indian industry, phased elimination of tariffs is necessary especially with respect to some key manufacturing industries that have long gestation periods until they start running on full capacity. An example of this kind of negotiation was the India-Japan FTA where India negotiated for most of its tariff lines under sensitive track (almost 63% under sensitive track, 14% under exclusion). This was in contrast to the ASEAN-India FTA wherein 76% of tariff lines were opened up for complete duty elimination. Therefore, at least a 15-25 years’ tariff elimination schedule should be negotiated for key sectors like chemicals, metals, automobiles, machinery, food products and textiles, which individually contribute more than 5% to India’s manufacturing GDP and employment. Thus, as suggested, phased elimination of few key manufacturing industries is absolutely essential with respect to China, and last but not the least, a rules of origin criteria that ensures a fair amount of value-addition to determine the source of a product.
While our negotiators bargain hard for an inclusive and balanced RCEP, domestically we must fiercely focus on eliminating the niggles our manufacturing sector and exports are facing. India’s transformational plans for the manufacturing sector will require support in the form of a new industrial policy that creates the necessary incentives for key sectors to be an active part of this process. These are necessary complements for ensuring maximum leverage out of our trade deals, and especially the RCEP.
Saraswat is member, NITI Aayog, Priya is a Mumbai-based economist, and Ghosh is a PhD candidate at Johns Hopkins, US