India needs to design policies that will raise FTA utilisation rates

High tariffs and complex compliance requirements continue to deter free-trade agreement utilisation

India has signed several free-trade agreements (FTAs) over the last couple of years, including relatively deep ones with the European Union (EU) and the United Kingdom (UK). The government, in its recent interactions with industry, has repeatedly emphasised the need for increasing the utilisation rates of these FTAs. This is most appropriate, given the growing pressure on India’s balance of payments arising from a combination of factors, including a rising current account deficit, which is expected to widen further due to the persistent West Asian crisis and high prices of imported oil and gas, declining net foreign investment inflows over the past two years, and a fast-depreciating rupee.

 

However, as a return to stability and pre-conflict levels of oil and gas shipment traffic may take several months even after the resolution of the conflict, a longer-term, more comprehensive approach beyond mere exhortation of industry is required to increase the utilisation rates of FTAs. The fact that the FTA with the EU is still to be ratified, the one with the UK is yet to be implemented, and negotiations with Canada have only just restarted gives us valuable time to undertake concrete measures towards maximising FTA utilisation and benefits.

 

FTA utilisation by firms is primarily led by the extent of the “preference margin” (that is, the difference between the most-favoured nation or MFN duty and preferential duty), simplicity of the rules of origin and the administrative ease of compliance with the FTA provisions.  While there is no accepted threshold level of preferential margin, a 3-4 per cent differential between the MFN and corresponding preferential duty is considered worthwhile for firms to use the FTA. The cost of information collection, logistics and compliance is otherwise greater than the small margin of benefit that the FTA may offer the exporter. India, given its high level of average applied MFN duties in the manufacturing sector relative to developed and comparator developing economies, offers a significantly higher preferential margin to the partner country in its FTAs relative to the expected gain for its exporters. 

 

For example, in the case of the India-Asean FTA, commonly used by policymakers as a yardstick to highlight the low FTA utilisation by Indian companies in the past, the preferential margin was favourable to the Association of Southeast Asian Nations (Asean) economies relative to India. At the initiation of the first phase of tariff liberalisation under the FTA in 2010, over 60 per cent of the tariff lines, covering 80 per cent of imports, were under the duty-free or less than/equal to 5 per cent tariff category in major Asean economies. There was, therefore, little, if any, incentive for Indian firms to use the FTA to export. In comparison, India had 45 per cent of its imports in the higher tariff category of 5-10 per cent, thereby giving a distinct advantage to the Asean nations. India’s tariff structure remained the same till the completion of the tariff liberalisation process in the FTA with Asean in 2016.

 

More importantly, India has since undertaken a further increase in its average MFN applied tariffs in the manufacturing sector. The number of tariffs lines in the 10 <=15 per cent and 15 <=25 per cent tariff category has increased markedly in the last decade, from 1.4 per cent and 1.7 per cent (2014) to 33.5 per cent and 14.9 per cent (20241), respectively. Inevitably, this gives a greater advantage to our partner countries in the FTA. This dimension is even more significant now that we are signing FTAs with developed economies such as the European Free Trade Association (EFTA), the EU and the UK, where a majority of tariff lines are in the duty-free or less than 5 per cent tariff category. 

 

With India’s much higher average manufacturing MFN tariff of about 13 per cent, the preferential margin and hence, gain is significantly higher for the European exporter relative to the negligible margin for the Indian exporter. The fundamental reform, therefore, that India needs to undertake is a comprehensive review of its tariff structure, as announced in Budget 2025, to align its average applied MFN tariffs with those of its comparator developing economies, such as in the Asean.

 

The second factor that discourages the use of FTAs is the complexity of the rules of origin (RoO) and cumbersome procedures for certificate/ proof of origin. Countries that want to facilitate their industry’s participation in global value chains (GVCs) allow for simpler and GVC facilitative RoOs in FTAs. 

 

The Comprehensive and Progressive Trans-Pacific Partnership RoOs, for example, allow full cumulation with multiple sourcing of intermediate inputs from across member economies and self-certification of origin with simple and standard information documentation procedures. While India has included bilateral cumulation in its recent FTAs and simplified origin certification procedures in 2025, the requirement of additional supplementary documentation has increased the compliance burden on the importer and the discretionary power of the Customs authority to initiate enquiry. The consequent unpredictability, coupled with higher manufacturing sector tariffs, act as major deterrents for domestic producers to use the FTA to import critical inputs. 

 

Finally, the mere existence of FTAs does not imply that firms will automatically use them. Firms need to be aware of FTA provisions, detailed preference specifications and standards and regulations in the partner country/countries. Simply putting the FTA text on the ministry website may not help as there could be legalese that is not easily comprehended by businesses, especially small and medium enterprises, which are unlikely to have separate trade and legal departments. 

 

This is especially true for the deeper trade agreements that India has signed with the EU and the UK. There is a substantial regulatory- and standards-related learning curve, and related compliance costs, in using these FTAs that these enterprises may find expensive to incur on their own. A thin preferential margin coupled with high costs of compliance can be a major deterrent to using FTAs, especially if trade volumes are also small, as with EFTA nations.

 

 In South Korea and Japan, for example, the state provided technical and financial assistance through specific workshops and programmes designed to educate businesses. This helped them increase their FTA utilisation rates from 20 per cent in the first decade of the 2000s to around 70 per cent in the 2010s. It is, therefore, necessary for the Indian Ministry of Commerce to set up a dedicated portal for information and free consultation for FTA utilisation, as well as organise workshops in collaboration with industry chambers for creating necessary FTA literacy.

 

Hence, alongside the early completion of the announced comprehensive review of its high tariff structure, the government needs to design and implement FTA-specific policy measures and awareness programmes to facilitate increased utilisation of the recently signed FTAs by Indian industry.   

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(The author is professor, School of International Studies, JNU. Her book, India’s Trade Policy in the 21st Century ,was published by Routledge, 2022. The views are personal.)