Asean's increased muscle

India must align with China-Asean, the fastest-growing region

East Asia’s growth over the last two decades has been underpinned by rapid growth in trade within the region. Between 1986-87 and 2006-07, the share of intra-regional trade (exports plus imports) grew from 34 per cent to 52 per cent. China has been a big contributor. Between 1994-95 and 2007-08, the share of exports of all East Asian economies to China (in their total exports) grew from 7.6 per cent to 21 per cent; for the Asean countries, this share grew from 2.5 per cent to 13.7 per cent. The China-Asean Free Trade Area (FTA) that came into effect on the first of January will give this process of regional integration another leg up. It creates a free trade zone that is the biggest in terms of population (about 1.9 billion) and the third largest in terms of volume after the European Union and the North American Free Trade Area. But will it really help? One criticism has been that the rise in intra-regional trade has done little to buttress East Asia’s defence against the vagaries of the business cycles in the West since it really reflects the flow of intermediate goods to the world’s biggest processing centre, China. China then exports processed products to North America and Europe. The share of components and parts in China’s imports from the region incidentally went up from 18 per cent in 1994-95 to 44 per cent in 2007-08. Thus East Asia continues to depend on the West for its markets and has not been able to effectively decouple.

However, global trading patterns seem due for a major structural change going forward, and the impact of the Asean-China FTA has to be seen in that context. The process of “global rebalancing” that has accelerated with the global crisis means that western markets for Asia’s exports will shrink. The overleveraged, spendthrift American consumer that supported East Asia’s export boom in the past is now repairing his balance sheet and will spend less on imports. Europe with its myriad problems can hardly substitute. Asian currencies, including the Chinese yuan, are likely to appreciate against the US dollar and the euro, further whittling down their competitiveness. Thus China and Asean will have to turn increasingly to markets within the region. The flow of final goods and services (as opposed to intermediates) is likely to pick up sharply and the China-Asean region could emerge as a more self-sufficient economic bloc. The FTA is a step in that direction. While the current FTA is in manufactured goods, an agreement in services and investment flow could follow soon and further strengthen regional ties.

For India that signed an FTA with Asean in August 2009, there are two implications. First, it has to contend with a heavyweight, China, whose competitive edge in Asean markets will increase with the new FTA. Second, the conjunction of the two FTAs could lead to a flood of Chinese products at zero tariffs coming through Asean. The near-term policy implications should be obvious. Rules of origin surveillance have to be stepped up; tariff lines for products where the threat is most acute could be renegotiated. But the narrow arithmetic of short-term costs and benefits cannot take away the fact that India will have to continue to look East for its markets. It needs to align more closely with what is likely to be the fastest-growing region in the next decade. Not only does it need to sell more finished goods and services to the region, but it also needs to integrate into the supply chain and participate in the investment flows.