Redesigning trade policy: What is the best way ahead for India?

Redesigning trade policy: What is the best way ahead for India?

Integration with global value chains will require a rethink of our high and uncertain tariffs as well as bolder trade alliances. 

Various aspects of globalization are being rethought all over the world, and this includes rethinking trade policy. India is also going through this process. The ministry of commerce is working on a new trade policy to be unveiled in September. It would do well to give careful consideration to Professor Amita Batra’s just published book, India’s Trade Policy in the 21st century (Routledge, London, 2022), which has important messages for policy.

The book highlights the role played by global value chains (GVCs). These have not only driven the growth of trade, they have also changed its nature. A successful export strategy no longer involves producing a product made largely in one country for export to consumers abroad. Instead, the multiple components of a typical export product are produced by different companies, often based in developed countries but offshoring production to locations in developing countries based on the competitiveness of that location in producing that particular component. Components are often shipped to other locations for further value addition. The final product is ultimately assembled somewhere else for final shipment to centres of consumption. The iPhone, for example, has 178 components that are sourced from 200 different suppliers across 26 countries!.

This process of offshoring has led to a reduction in the share of developed countries in the export of manufactured goods and an increase in the share of developing countries which had the necessary human skills and physical infrastructure to enter the value chain. India has benefited from this new world, thanks to the 1991 reforms. Our share in world exports of goods had been declining before the reforms to reach 0.5% in 1990. It improved in the post-reforms period to touch 0.7% in 2000 and 1.8% in 2021.

However, while our performance improved over the past, it is China that drew the most benefit, increasing its share from 3.9% in 2000 to 15% in 2021. This star performance reflects the fact that it shaped its trade policy to take advantage of the GVC phenomenon.

The Prime Minister has now set an ambitious objective: integrating the country with global supply chains and indeed even making it a hub. Designing policies that will achieve this objective is the task before the commerce ministry as it prepares the new trade policy. It must start with the recognition that there is a divergence between what has been happening and the new goals.

Commenting on India’s backward integration with GVCs for manufactured exports—an important indicator of integration with global supply chains— Professor Batra finds it is not only lower than other regional economies, but, more disturbingly, it has declined in recent years. In fact, it is lower than it was in the early 2000s!.

One policy weakness identified by Professor Batra is the increase in import tariffs implemented over the last four years. Lowering India’s very high tariff levels was a critical element of the 1991 reforms and this process was continued by successive governments. Those who feel they were lowered too much should remember that despite the reduction, our import tariffs remained significantly higher than in East and South East Asia. Professor Batra argues that if we want better integration with global value chains, we must revert to the earlier trend of gradually reducing customs duties to levels prevailing in East Asia.

Another weakness in our policy is that our bound tariffs are much higher than applied tariffs. Our trade negotiators tend to view this as an advantage because it gives us ‘policy space’ to raise duties if we want. But as Professor Batra points out, it also adds uncertainty because investors can no longer be sure whether duties on their inputs will suddenly be raised.

Looking ahead, East and South East Asia clearly have the greatest potential for expanding trade and hosting GVCs. It makes sense for us to try and integrate as closely with this area as we can. This is also an area where geopolitical developments are likely to lead to diversification of existing GVCs to a ‘China plus one’ policy, from which we stand to benefit. In this context, Professor Batra notes that our decision to opt out of the Regional Comprehensive Economic Partnership (RCEP), after several years of negotiation, was a missed opportunity.

We cannot undo the past, but perhaps the Indo Pacific Economic Framework (IPEF) agreement which we have joined offers a new opportunity. The trade pillar in the IPEF does not, as of now, deal with market access. However, it may evolve in that direction in future, and if it does, it has the advantage of including the US, Japan and Korea, while excluding China, which is a bugbear to our producers because of a fear of unfair competition. We should work to push the IPEF towards a trade agreement.

More generally, we must recognize that trade liberalization agreements in future will require deeper ‘behind the border’ integration of standards relating to labour, the environment, intellectual property rights and even investment protection. We have traditionally opposed including these ‘extraneous issues’ in trade agreements, but we need to rethink our position. Accepting such alignment may be essential if we want to attract investments directed at greater integration with GVCs.

It is worth noting that China has applied to join the Comprehensive and Progressive Agreement for Transpacific Partnership, which is the new incarnation of the old Trans-Pacific Partnership that was trashed by former US President Donald Trump. It includes many provisions for deeper integration. If other developing countries are willing to join such agreements, there is no reason for us to hold back. We can always negotiate for longer periods for complying.

Digital trade, e-commerce and digital payments are new areas which will play a major role in global integration in the years ahead. We have substantial strengths in this area, but we seem to be ambivalent about entering negotiations on it. We should shed this hesitancy and be actively involved in the development of global rules acceptable to all.

Indian industry needs to be more closely involved in discussions of policy options. Industry groups do not speak with one voice, and often do not express their concerns transparently. But there is no substitute for fuller articulation of the pros and cons as seen by industry, while also involving civil society groups and think-tanks in the process.

Finally, trade policy needs to be supported by other policies which are outside the realm of the commerce ministry. Providing better infrastructure and easier procedures are no-brainers. The government’s production-linked incentives (PLI) scheme is a new initiative in building a competitive domestic industry. Since the scale of such assistance will inevitably be limited by the fiscal space available, it should be limited to new areas with high potential. Equally important, it should be provided on the clear understanding that the beneficiary must compete with imports subject to reasonable tariffs. The need to keep Indian access to imports open is especially important in areas where technology is changing rapidly (as in green energy). New and more efficient technologies may come up and keeping such products out by raising import barriers will only make the domestic economy more uncompetitive. PLI beneficiaries should not be allowed to lobby for an increase in import duties beyond the level initially in place.

India’s trade negotiations should not lose momentum

India has fast-tracked its trade negotiations recently, giving priorities to making India a bigger player in global value chains. A comprehensive agreement with the UAE was signed in a record time of 90 days. In our Economic Cooperation and Trade Agreement (ECTA) with Australia, we for the first time made commitments on wine, paving the way for liberalization of sensitive products imported from the UK and EU. Yet, Australian industry is unhappy and the ECTA has not yet been approved by Australia’s parliament. An India-UK interim deal may also be pushed beyond Diwali. Are our trade negotiations losing momentum?.

In partner countries, industries are not happy with fast-track, low-ambition trade deals. India is seen to be extremely restrictive in its commitments on sectors of their export interest. For example, in alcoholic beverages, UK companies are among the biggest investors and largest suppliers of whisky and intermediate products used for manufacturing in India, yet we have made no commitment to open up the market even after four rounds of negotiations. There is a growing anxiety in the UK industry that tariff reduction in whisky may not be a part of the interim trade deal, and without tariff reductions for over 70% of the UK’s agri-exports, there may not be any gains for it.

While the UK hardly has any customs duty for alcoholic beverages, India’s basic customs duty of 50%, plus an agriculture infrastructure development cess of 100%, is among the highest globally. This 150% duty and cess on intermediate products is adversely impacting ‘Make in India’. Duties can be zero on ingredients and raw materials that are not made domestically. This will reduce manufacturing input costs, lead to more investments and create jobs. Duty reduction in bulk imports will facilitate value addition in the country. Indian firms are exporting products like cakes and biscuits to the UK and EU from their manufacturing units in countries like the UAE. If intermediate dairy products are allowed at lower tariffs, such products can also be manufactured in India for export.

Will tariff reduction on final products adversely impact Indian industry?: One of our reasons for high tariffs is to keep the domestic market closed to foreign competition. However, in the case of products like whisky, at present less than 2% of the bottled-in-origin products are imported into the Indian market. Even if tariffs fall to zero, Indian firms can offer competitive prices and imports will not exceed 5%, according to stakeholders in the Icrier-Trade Promotion Council of India consultation in 2022. Similar responses were obtained for the automobile and auto-component sectors vis-a-vis the UK. In products where India has a strong manufacturing base and cost competitiveness, tariffs can be brought down in a phased manner.

Cross-bargaining could lead to deadlocks: Export industries in sectors like textiles and apparel have asked zero-for-zero tariffs with markets such as the UK. Others in products like alcoholic beverages are confident that a tariff reduction will not adversely impact their market share, but they want to use the trade agreement to arm-twist the UK to relax a maturation requirement for a minimum period of 3 years. They argue that due to the warm climatic conditions of India, whisky manufactured here matures faster than in the UK, and if a 3-year period has to be adhered to, there will be considerable evaporation of spirits, resulting in a significant loss of alcohol, pushing up the cost for domestic manufacturers. This argument does not consider that parts of India in the Himalayan region have similar climate as in the UK.

The UK imports Indian-made spirits at zero duty that are sold as ‘Indian spirits’. Indian companies want it sold under the name ‘Indian whisky’. Scotch whisky is a geographical indication (GI) product. Sometimes molasses is used instead of grains to make whisky; some stakeholders want the UK to change its food safety regulation to allow molasses. For exports like basmati rice, grapes and mangoes, Indian producers are working hard at adhering to importing countries’ food safety requirements. In others like alcoholic beverages and dairy products, some stakeholders want importing countries to relax their food safety standards and GI requirements. This is making our trade negotiations difficult. Delays in deal will be at the cost of our exporters, who are facing competition from other developing countries like Vietnam, which enjoy zero duty.

The way forward: In any trade deal, there are stakeholders with different interests. Indian policymakers may examine different views put forth by producers, user industries and consumers, and then take decisions that benefit the country. Intermediate products, GI products and products where India has an export interest or cost competitiveness over its trading partners can be liberalized. Tariff liberalization can be done in a phased manner, so that it does not hurt the domestic industry. In addition, rules-of origin and trade remedial measures should be carefully drafted. Markets like the UK and EU are key export markets with which trade agreements can lead to a significantly positive trade balance if smartly designed. India can work with free trade agreement partner countries to enhance collaboration, capacity building and business-to-business partnerships so that Indian companies are able to export much more to these markets. With political uncertainty in partner countries, it is time for India to demonstrate its interest in closing trade deals by acceding to partner country requests in some high-tariff areas such as alcoholic beverages and automobiles.