What ails India's Free Trade Agreements?

09 Mar 2020

Lately India’s trade policy seem to lack a vision. After actively pursuing it for over a decade India decided against joining RCEP at the eleventh hour. The official version is that India runs a large trade deficit with RCEP countries and was expecting specific protection for its industry and farmers from a surge in imports especially from China. Since that did not materialise the government of India does not foresee any gain from joining RCEP. Moreover it may hamper India’s Make in India programme. In hindsight this may be an afterthought of signing several free trade agreements (FTAs) with Far East countries/blocs (Korea ASEAN Japan) in the past (under UPA) the gains of which are not clearly visible. In fact the official view is that poor negotiations of FTAs under previous governments have harmed Indian industry and led to a distorted trade balance. While the outcome variable (distorted trade balance) is shown by statistics the factor behind this trend needs in-depth introspection. The question is whether these FTAs escalate the non-tariff measures (NTMs) leading to higher trade deficit. This is indeed a possibility if policymakers didn’t pay enough attention to creating a complementary ecosystem in terms of trade facilitation measures for efficient functioning of the trade regime at the time of signing of FTA.

Let me explain with evidences from the India-Sri Lanka FTA (ISFTA) one of the earliest FTAs India singed and for which more evidence is available from our recent in-depth study. In 2005 98% of Sri Lankan exports availed the FTA route. This has declined to about 50% in recent years. On the other hand only 13% of India’s exports are routed through FTA. Surely no one expects this trend to be exhibited after signing an FTA. Some argue that this fall in the share of utilisation of the FTA route is due to the implementation of the SAARC Free Trade Agreement (SAFTA) post 2006 and most Indian exporters are using the SAFTA route. This logic falls apart since the rate of tariff concession is higher under ISFTA (up to 100%) than under SAFTA (up to 20%). The question then is why exporters on either side are reluctant to avail benefits of ISFTA.

In general an FTA by changing the rule of the existing trade regime may increase the transaction cost of trading unless complementarity steps are taken so that the ecosystem of trading doesn’t turn out to be inefficient due to additional complexity. All FTAs are bound by the additional rule of the game which needs to be adhered to if one is to benefit from the tariff concessions. For that reason concerned officials for enforcing the rules need to be well-versed with their intricacies. Rarely do policymakers pay attention to this. Another shortcoming in the architecture of India’s FTAs is the avenue of discretionary power of officials in judging tariff concession claims. Both these add to transaction costs

It is also true that NTMs need more introspection while signing an FTA. ISFTA for instance specifies that customs shall not keep goods for more than three days and shall obtain an undertaking from the importer and release the goods. In reality samples are often drawn by customs for testing after arrival of goods and it takes 20-30 days to obtain report from the laboratory and overall 30-40 days to release the goods. While exporters are charged testing fee for each sample importers must pay heavy demurrage and storage charges.

Packaging and labelling issues are also not well-defined under ISFTA raising the compliance cost of availing concessions under the agreement. This is particularly true of high value commodities like Regular Black and Green Tea (loose tea and tea bags) Flavoured Black and Green Tea (loose tea and tea bags) Assorted Flavoured and Regular Black and Green Tea (tea bags) Herbal Tea (regular/flavoured) etc. Therefore if the labelling regulations are clearly defined and made available to traders it makes compliance easy and would not cause problems in clearing shipments during entry into India.

On the export side fragile products like sanitary-ware are usually packed in straw to insulate them from shock and impact. But Sri Lanka does not accept products packed in straw. Instead it demands that such products be packed in five-ply corrugated boxes. Since India does not manufacture enough of such boxes to meet the existing demand they need to be imported. This increases the cost of packaging and affects competitiveness in the international market. These kinds of issues need to be accounted for when introspecting why an FTA leads to an adverse trade balance.

Currently any food item exported either from India or Sri Lanka is tested twice —once at the port of origin and again at the destination port—which unnecessarily increases trading time. This happens because no attention was paid to harmonising standards for food items. Since there is also a shortage of proper storage facilities at ports especially for items requiring cold storage the possibility exists that traders suffer loss due to damage of goods.

Certification is an issue that needs attention at the time of signing of FTA if the interests of traders/manufacturers are to be protected. For example the Sri Lanka Standards Institute has entered into an agreement unilaterally with the Export Inspection Council (EIC) of India on recognition of test reports/certification issued by reliable Indian authorities accredited to provide these. Therefore Indian products do not face unnecessary delays or additional costs in this respect while entering Sri Lanka. On the contrary as Sri Lanka’s authorities have not entered into an agreement that provides for acceptance of test reports/certification issued by Sri Lanka with their Indian counterparts Sri Lankan products face unwanted hurdles. Since government authorities function at their own pace there is a need for a system of third-party certification from private entities in partner countries.

What we have argued here applies to other FTAs as well. There is a need for analysing them before drawing the conclusion that FTAs are harmful to Indian industry! The least one can do is to revisit all FTAs and introduce an autonomic decision-making process to strengthen principle-based economic judgments thereby reducing transaction costs of trading.

The writers Sanjib Pohit is with NCAER & Barun Deb Pal is with IFPRI India Views are personal.

Published in: The Financial Express, March 9, 2020