Trade Agreements can be a game changer, if Negotiated Fairly!
The author is a member of the Institute of Chartered Accountants of India (ICAI). He can be reached at camanaschugh@gmail.com and eboard@icai.in.
1. Introduction: Global Supply Chains & India’s Strategic Shift
International trade plays a notable role in the development of an economy. It is a major source of improving competitiveness, efficiency and innovation. With the rising focus on One World, One Market, each nation is endeavouring to become part of the global supply chain. India too has developed measures to improve its share in the global merchandise exports. The unwritten rule followed by all the nations is making trade agreements a key part of the Foreign Trade Policy. Trade agreements provide access to new markets by offering reduction in tariffs on imported products and addressing issues affecting the free flow of goods and services. The agreement opens up the potential for investments between the negotiating countries and also outlines areas for mutual growth.
Until now, the Indian Government was not opening up India’s economy to the world impulsively. This was evident with India signing 11 Preferential/Free Trade Agreements (FTAs) between 2004 to 2011, but hardly thereafter. However, the Government was in dilemma whether to choose liberalism or first protect its domestic industries as the existing FTAs did not result in much economic gain. India intended to import duty free raw materials or at concessional rate from FTA partners and export value added finished goods, but the negotiations and trade number exhibits faulty administrative approach.
The Landmark India-UAE CEPA (Signed 18th February 2022)
The country is emerging from this stance and has signed the Comprehensive Economic Partnership Agreement (CEPA) with the United Arab Emirates (UAE) on 18th February 2022 which is a landmark move for India’s Foreign Trade. CEPA has holistic coverage area focussing on services, investment, IPR, government procurement, disputes etc. With the special focus on labour intensive sectors, the agreement provides zero duty market access.
The historic agreement which was concluded in a record time of 88 days is expected to usher trade volumes from $60 billion to $100 billion within the next 5 years. The agreement is expected to commence from May 2022 and CBIC will issue tariff concessions with the conditions for classifying the origin of goods under Section 25 of the Customs Act, 1962 and Section 5 of the Customs Tariff Act, 1975 respectively.
This is a significant step for India as it signifies to the world that the nation is ready to negotiate on equal and fair terms.
Pertinent Questions on FTAs:
- Are FTAs the best solution in addressing trade issues?
- Have the FTAs resulted in much economic gain for India?
- Is India ready to face global competition by opening its economy without any barriers?
2. India’s Current Foreign Trade Dynamics
India being a consumption-based economy encashes its 130 billion population. Private plus Government consumption contributing 71.1% share in Nominal GDP (FY 22) showcases that it is the major engine for India’s growth. The next big share in Nominal GDP is of Gross Fixed Capital Formation i.e., Investments. Government’s thrust in the Union Budget 2022 is towards capital expenditure and infrastructure spending with an allotment of Rs. 7.5 Lakh crores.
Table 4: Share of Sectors in Nominal GDP (per cent)
| Sectors | 2019-20 (1st RE) | 2020-21 (PE) | 2021-22 (1st AE) |
|---|---|---|---|
| Total Consumption | 71.7 | 71.1 | 69.7 |
| • Government Consumption | 11.2 | 12.5 | 12.2 |
| • Private Consumption | 60.5 | 58.6 | 57.5 |
| Gross Fixed Capital Formation | 28.8 | 27.1 | 29.6 |
| Net Export | -2.5 | -0.5 | -3.0 |
| • Exports | 18.4 | 18.7 | 20.1 |
| • Imports | 21.0 | 19.2 | 23.1 |
| GDP | 100.0 | 100.0 | 100.0 |
Furthermore, the country’s prime focal point is exports as India aims to become Current account surplus thereby improving the foreign exchange reserves of the country. The current Forex Reserves at $630.19 Billion as on 11th February 2022 displays that India can easily meet its external debt liabilities and offer a buffer in the event of any crises.
To continue the streak, the Department of Commerce is proactively taking steps to extend India’s export to $2 Trillion by 2027. India’s Foreign Trade in FY 22 has shown a good rebound after the Covid hit economy by growing at 11.1% over 2019-20. It is surprising to note that petroleum products continue to be the top exported item followed by pearls, precious and semiprecious stones, iron and steel respectively. United States of America (USA) remained the top export destination for India accounting for approximately 18% of the total Exports followed by United Arab Emirates (UAE) and China.
Government’s path breaking policies in the form of Remission of Duties and Taxes on Exported Products (RoDTEP) Scheme, focusing on districts as export hubs, Manufacture and Other Operations in Customs Warehouse Regulations (MOOWR), Market Access Initiatives etc. will continue to make India’s products efficient and competitive.
Import Dependency & Non-Tariff Barriers:
As the contribution to GDP is Net Exports i.e., Exports – Imports, concentrating on substituting imports is important. The Government has initiated various efforts by pushing for non-tariff barriers like Quality Control for toys imports, approval from concerned ministry for tyres, TVs, High Speed camera imports etc. India has one of the highest average tariffs of 15% in the Asia-Pacific region according to the WTO Tariff Profile 2021.
Despite several efforts and tighter curbs, the dependence on imports specially with China is still surging and is worrisome for the government. Petroleum, oil and lubricants account for roughly 27% of the total imports owing to the rising crude oil price which has already surpassed $100 per barrel. Gold and Silver which accounts for 9.1% in total imports exhibits India’s love for the glittery metal. These numbers indicate our rising dependency on imported products making our overall trade balance for April-January 2022 in deficit ($ -71.19 Billion).
Moreover, the merchandise exports from India hovered around +- $300 Billion since the last 10 years. This demonstrates that the current policies are not paying off much for India. Given the mammoth changes in the global supply chain and for India to claim a pole position in the global trade, Free Trade/Preferential Trade is the only way forward.
3. Free Trade Agreements and India’s Experience
“World Trade Organisation is a global multilateral agreement operationalised in 1995 to ensure that international trade flows between the countries are in harmony, fairly and freely.”
The agreement was signed to provide a framework to resolve disputes arising because of unfair practices and providing structure to negotiate on the trade agreements. After the WTO, Regional Trade Agreements have been prevailing in the trade policies of each country as the world is shifting towards one market. As of 15th October 2021, 350 RTAs were in force globally, corresponding to 568 notifications from WTO members, counting goods, services and accessions separately.
For India, the first trade agreement dates back to 1950 with Nepal, when post-independence, the Government of India realised that trade with the bordering nations should be a stepping-stone for strengthening ties and perpetuating trust globally. 10 Article agreements focussed on reciprocal benefit for the 2 nations, not just for trade and commerce but also peace and harmony.
At present, India has signed 18 Free/Preferential Trade Agreements and one unilateral DFTP (Duty Free Tariff Preference) Scheme latest being signed on 18th February 2022 with UAE. Trade agreements aim to solve a wide range of issues apart from trade, some of these include human rights, environment safety, Visa, Intellectual Property Rights (IPR), education and gender justice.
Bilateral Trade Agreements (12)
- India Nepal Trade treaty (1950)
- India Sri Lanka FTA (2000)
- India Thailand EHS (2004)
- India Singapore CECA (2005)
- India Chile PTA (2007)
- India Korea CEPA (2010)
- India Japan CEPA (2011)
- India Malaysia CECA (2011)
- India Afghanistan (2013)
- India Bhutan Agreement (2016)
- India Mauritius CECPA (2021)
- India UAE CEPA (2022)
Regional Trade Agreements (6)
- Asia Pacific Trade Agreements (APTA) (1975)
- Global System of Trade Preference (GSTP) (1989)
- SAARC Preferential Trading Arrangement (SAPTA) (1995)
- Agreement of South Asian Free Trade Area (SAFTA) (2006)
- India-MERCOSUR (2009)
- India-ASEAN (2010)
The Indian Government was resistant in negotiating an agreement as the major challenge was to give level playing field to MSMEs for enhancing their competitiveness. Therefore, the Government negotiated majorly with the neighbouring countries rather than advanced countries. The data of YoY growth % overall v/s FTA partners reveals that trade agreements hardly influence the growth of international trade.
4. Analysing the Free Trade Agreements: India’s Experience
A. India-Japan CEPA (Signed 2011)
India signed CEPA with Japan in 2011 which aimed to eliminate the tariffs on 90% of Japanese exports to India and 97% of exports from India to Japan. UN Comtrade data depicts that the exports from India has marginally increased from $5.5 Billion to $7.32 Billion but decreased thereafter. The trade deficit also grew from $3 Billion in FY 10 to $6 Billion in FY 20.
B. India-Korea CEPA (Effective 2010) & DGTR Safeguards
India’s CEPA with the Republic of Korea was signed and effective from 2010 spurred Investment and Trade between the two nations. However, India failed to reap the benefits as the deficit has widened since 2010 from $4.5 billion in 2009 to $11.5 billion in 2018.
Also, on 28th January 2021, Directorate General of Trade Remedies (DGTR) issued a notification to levy safeguard duty on Polybutadiene Rubber excluding titanium and lithium grades as the Authority found that import has increased because of reduction or elimination of custom duty under CEPA causing serious injury to the domestic industries.
C. India-ASEAN FTA (Signed 2010)
ASEAN-India FTA was signed and entered into force in 2010 between 10 members of ASEAN and India wherein the respective countries eliminated tariffs on 76% of the goods. The region which comprises 30% of the world population planted seeds for the exponential growth of trade within the region but it resulted in an upsurge in imports into India while India’s exports were hindered by non-tariff barriers, restrictions and taxes. On the contrary, India enjoyed favourable trade balance with most of the ASEAN countries before the FTA but now has resulted in huge deficit.
Findings from NITI Aayog & The Decision to Opt Out of RCEP
As noted in A note on Free Trade Agreement and their cost by NITI Aayog, these trade figures depict that India stands to lose from these trade agreements and the negotiations have made the country more dependent on the imports. The only exception was the SAFTA agreement wherein there was a significant rise in the trade surplus from US$ 4 billion to US$ 21 billion.
With this experience, it was inevitable that India had to opt out from the world’s largest trade deal, Regional Comprehensive Economic Partnership (RCEP). Now, the non-reciprocity has also forced India to re-negotiate these trade agreements as equal market access was not offered.
It was also discovered that the FTAs were heavily misused by the importers by manipulating the country of origin. Goods originating from other countries were routed through FTA partners—such as Stainless Steel routed through Indonesia and copper items through Sri Lanka. Therefore, to clamp down this abuse, the Government introduced CAROTAR Rules in Budget 2020.
5. CAROTAR Rules 2020 & Rule of Origin Framework
Customs (Administration of Rules of Origin under Trade Agreements) Rules, 2020
To guard against the misuse of tariff concession announced under the Free/Preferential Trade Agreement, the government rolled out Customs (Administration of Rules of Origin under Trade Agreements) Rules, 2020 (CAROTAR, 2020) under Section 28DA of the Customs Act in the Budget 2020. The Rules aim to ensure that the Government can monitor all the duty benefits availed by importers and no undue claims are made without fulfilling the requisite Rule of Origin Criteria.
Section 28DA Statutory Mandate: Section 28DA mentions procedure regarding claim of preferential rate of duty which specifies that the Importer needs to declare that goods qualify as originating goods and shall possess sufficient information as regards the manner in which country of origin criteria, including the regional value content and product specific criteria, specified in the rules of origin in the trade agreement, are satisfied.
Rule of Origin Criteria & DVC Formula
In accordance with Section 5(1) of the Customs Tariff Act, each Trade Agreement signed by the Government should mention rules for determining if any article is the produce or manufacture of such foreign country or territory. Therefore, each trade agreement specifies the “Rule of Origin” which is determined by the domestic value addition and substantial transformation of the goods during the manufacturing.
Domestic Value addition requires that a certain minimum percentage of the good’s value originates in a country for the good to be considered as originating while substantial transformation of the goods is verified as Change in Tariff Classification or Process Rule.
Majority of the trade agreements have a single rule for all goods but in some trade agreements, some or all tariff headings have Product Specific Rules.
| Trade Agreement | Originating Criteria Prescribed |
|---|---|
| SAFTA | NOM*** ≤ 60% + CTH* |
| India-Singapore CECA | 35% DVC + CTSH** |
| ASEAN-India FTA | 35% DVC + CTSH |
| Sri Lanka FTA | NOM ≤ 65% + CTH |
| Malaysia FTA (CECA) | 35% DVC + CTSH |
| Nepal FTA | NOM ≤ 70% + CTH |
*CTH: Change in Tariff Heading (4-digit HS level)
**CTSH: Change in Tariff Sub-Heading (6-digit HS level)
***NOM: Non-Originating Material
6. Industry Reaction & Strategic Roadmap Towards 2030
Industry Challenges & CBIC Clarification
The industry feels that after the implementation of these rules, availing the concession of tariff under FTA has become cumbersome and complicated as the seller is resistant in providing information relating to operations and costing which are typically confidential and sensitive for any businesses.
Moreover, some of the trade partners contested to review and repeal the CAROTAR Rules as it is provoking non-Tariff barriers in the international trade. Therefore CBIC issued instructions to authorities to raise queries only when there are ‘sufficient grounds’ of non-compliance of Rule of origin.
The Roadmap Ahead: Targeting $2 Trillion Total Exports by 2030
India has learnt hard lessons from past experiences and was no longer signing FTAs to merely be a part of the group. Signing FTAs with consumption based and developed economies i.e., the US, the UK and EU may be the way forward which could provide India greater access to these markets and tap into their economic perquisites.
India should also work with countries where it can access low-cost raw material to enable our manufacturers to produce goods for exports cost competitively.
Since China is our strategic competitor and their agility to adapt to new technologies and build a resilient trading system can create an economic influence within Asia, India has to take the charge and look for reciprocity of benefits and access to avail fair play in the international trade market to reach the ambitious target of $1 Trillion of merchandise exports and $1 Trillion of Service Exports by 2030.