Do FTAs distort trade and manufacturing?

Three years ago, India signed a comprehensive economic partnership agreement (CEPA) with Japan. However, trade data suggest benefits from CEPA might not have accrued evenly to the trading partners. Imports from Japan rose from $8.6 billion in 2010-11 to $12.4 billion in 2012-13, but fell thereafter. During the same period, exports to Japan rose only marginally - from $5 billion in 2010-11 to $6.1 billion in 2012-13 - indicating a widening export-import deficit. Foreign direct investment (FDI) equity flows from Japan have also slowed from $4.5 billion in 2008-09 to $1.4 billion in 2013-14.

With a similar pattern in trade figures reflecting in other countries with which India has signed such treaties, a senior executive at a large Indian conglomerate says, "It is quite likely that domestic utilisation under free trade agreements (FTAs) is limited," indicating few benefits.

Over the past few years, India has signed a number of FTAs and comprehensive agreements, most notably with the Association of Southeast Asian nations (Asean), Japan, South Korea and Sri Lanka. With imports of goods under these tariff lines zero or low in most cases, industry has been raising concerns on the impact that these agreements have on the domestic manufacturing.

However, not everybody agrees. "It is unfair to blame FTAs. Indian industry should realise that economic and commerce diplomacy is a tool of foreign policy, used during negotiations at the global stage. The focus should be on enhancing their competitiveness and their export capabilities rather than emphasising on issues such as tariffs and incentives. By signing free trade agreements, the country is on a par with all its competitors. Issues with manufacturing in India imply that we are unable to take full advantage of these agreements," says a senior executive with an industry body.

 

Trade data show 44 per cent of India's exports to Japan are of mineral fuels, mineral oils and products of their distillation; bituminous substances and mineral waxes. None of the other prominent items that are exported such as fish, ores, slag and ash, organic chemicals, pearls, stones, jewellery and iron and steel account for more than five per cent of total exports. On the other hand, imports from Japan are more diversified - nuclear reactors, machinery and mechanical appliances; iron and steel; electrical machinery equipment and parts; television image and sound recorders; vehicles other than railway or tramway rolling stock; optical, photographic cinematographic measuring; medical or surgical instruments and apparatus parts, among others.

Arpita Mukherjee, professor at New Delhi-based think tank Icrier, gives an example on how these agreements have altered trade and manufacturing. An Indian consumer goods company wanted to manufacture orange juice in India. However, "as the nonalcoholic beverage sector, especially in the fruits and vegetables category, is largely dependent on imports, high tariff rates and complicated execution of tariff policies created several problems for their operations", says Mukherjee. Under FTAs, both multinationals and domestic companies are free to set up operations in any of the member countries; so, the company opted to shift its operations to Sri Lanka, where the raw materials can be imported at zero tariff. Furthermore, under the trade agreement with Sri Lanka, provisions have been laid out for duty-free imports of processed food and beverages.

Under these FTAs, production facilities can be located in any of the member countries. Says the industry body executive cited above: "Companies would thus operate in countries with greater ease of doing business and where FTAs with other countries ensure lower tariffs. Companies could set up production facilities in African or southeast Asian countries where labour is competitive and which have FTAs with other countries and could thus access markets from there."

The debate over FTAs forces a discussion on India's manufacturing capabilities. As an industry expert puts it, "We need to build our manufacturing base. India should focus on improving the ease of doing business, which is a big stumbling block. States should take the lead on implementing investor-friendly policies to create an enabling environment. The focus should be on two fronts - rationalising tariffs and improving the ease of doing business."