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India’s Out of RCEP: What’s Next for the Country and Free Trade?

India’s foreign trade policy must be aligned to its self-reliance goals. But it also needs to work towards making domestic industries competitive.

By Prachi Priya and Aniruddha Ghosh for
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India’s Out of RCEP: What’s Next for the Country and Free Trade?
Credit: Flickr/Kailash Giri

The Regional Comprehensive Economic Partnership (RCEP), a mega free trade agreement (FTA) was?signed recently by 15 nations, namely the 10 ASEAN states, Japan, South Korea, China, Australia, and New Zealand. India had decided to walk out of trade pact in November 2019, when Prime Minister Narendra Modi stated: “Whenever I try and gauge India’s interest in light of her joining RCEP, I do not get an answer in the affirmative; neither Gandhiji’s policy of self-reliance nor my wisdom allows me to join RCEP.”

India’s decision to exit the mega trade deal was taken after negotiating the deal for seven years in the backdrop of several unresolved issues concerning market access for China, non-tariff barriers faced by Indian exporters, services trade, and rules of origin criteria, among other issues. While India was often tagged as the “troublemaker” in the deal negotiations, Indian policymakers stood their ground firmly when it came to the interests of domestic producers, especially regarding Chinese exports of subsidized goods to India. Apart from economic factors, India’s decision to not join RCEP had a strategic dimension given China’s domination of, and leading role in, the pact. Since Modi’s announcement, the Line of Actual Control standoff with China in Ladakh has sealed India’s decision to stay firm and leaves no space for any further trade negotiations involving its northern neighbor.

Make no mistake, India had no option but to exit the pact. RCEP in its present form would have not served any purpose for the country. A NITI Aayog paper titled “India’s FTAs and Its Costs,” which we have co-authored with Dr. V.K. Saraswat, a NITI Aayog member,? highlighted India’s experience with its previous FTAs and its reasons for not joining RCEP. The post-pandemic world trade landscape and its associated challenges; China’s unfair trade practices and its constant endeavor to side-line issues critical for Indian industry in RCEP; and, most importantly, rising border disputes with China reiterate that India did the right thing by staying out of RCEP.

Having exited the mega trade deal, the pertinent question is what next for India on trade strategy? In the following we provide some answers.

Choosing Strategic Partners for Free Trade?

The United States and Europe have been India’s traditional trade partners. Given huge trade complementarities between India and these countries, they are our natural allies for trade. Despite having FTAs with major Asian economies like ASEAN, Japan, and South Korea, India’s exports share in these has declined from 51 percent to 46 percent in the last decade. The U.S. and Europe’s share in India’s exports have, on the other hand, increased from 38 percent to 43 percent even though we do not yet have FTAs with these economies. It is time for India to now kickstart the India-EU trade negotiations that haven’t seen the light of the day due to pending issues when it comes to automobiles, pharmaceuticals, data security, alcoholic beverages, and services trade. With the U.S. too, the incoming Biden administration is expected to bring in more policy stability and the U.S. may not close its doors to a limited trade deal with India (before a full-fledged trade deal) as it plans to build a unified front of democracies against China. Focus on deep bilateral trade deals instead of multilateral ones should be India’s goal for the time being.

Getting India’s House in Order First

India ranks 68th out of 141 countries in the World Economic Forum’s Global Competitiveness Report and slipped 10 places in 2019 compared to 2018, with low overall scores for infrastructure, information and communication technologies adoption, skills, labor market, and business dynamism. That India’s manufacturing sector has been an under-performer is no secret. The share of manufacturing in overall GDP has stagnated at around 16-17 percent in the past decades. The manufacturing sector is critical to economic development in a vast and populous country like India as the multiplier effect leads to two to three additional jobs created in other sectors for every job created in the sector. Thus, first and foremost India requires a well-crafted industrial policy to address key concerns of the manufacturing sector, including addressing critical issues deterring industrial competitiveness. Multiple factors have led to India’s poor manufacturing performance and low competitive score, including cost and quality of power, high logistics cost (14-15 percent of GDP compared to the 9 percent global benchmark), low labor productivity, and low R&D expenditure (0.7 percent compared to 2-4 percent globally). A targeted industrial policy addressing these issues is the need of the hour.

Incentive Schemes – While Welcome – Are Not Enough

The Production Linked Incentive (PLI) scheme is a good initiative by the government as it incentivizes investment by manufacturers by providing them with an incentive of a certain percentage on the incremental sale of goods based on certain eligibility criteria for five years. This is a step in the right direction, and India is doing this at an opportune time when multinational companies are looking to establish manufacturing bases outside of China. The scheme is expected to give a boost to sectors where India has a comparative advantage and help India integrate into the global supply chain. The finance minister recently expanded the scheme to 10 new sectors from three initial sectors (pharma, mobile manufacturing and medical devices) under the AtmaNirbhar Bharat (“Self-Reliant India”) program. The 10 new sectors include battery storage, electronics, solar PV modules, auto & auto components, telecom and networking products, textiles, food processing, specialty steel and white goods (air conditioners and LED devices). The PLI scheme also focuses on specific sectors that have been chosen based on their inherent potential and ability to scale up globally. However, business decisions are not taken purely on incentive-based manufacturing but on the overall business and macro environment. Thus, PLI is no alternative to addressing inherent structural issues plaguing India’s domestic manufacturing sector.

Phasing Out Import Duty Protection Gradually?

Safeguarding domestic interests is imperative in the post-COVID world. However, AtmaNirbhar Bharat does not mean resorting to protectionism as good quality imports are inevitable in sectors where domestic capability is lacking. Indian industry needs to be made aware that unlimited protection will do it more harm than good; gradual phasing out import tariffs from time to time, especially with strategic trade partners, should be the norm as critical/champion sectors grow with government hand-holding over time. This does not, however, mean opening India’s markets to trade partners who resort to unfair trade practices and dumping of goods.

Aligning Foreign Trade Policy with AtmaNirbhar Bharat

India’s foreign trade policy for the next five years (2021-25) is also due. India is also revamping its export subsidy (Merchandise Exports from India Scheme, MEIS) scheme to a WTO compliant scheme, the Remission of Duties or Taxes on Export Products (RoDTEP), which will reimburse taxes like electricity duty, VAT on fuel, coal cess (and additional tax) etc. that are not refunded under any other existing scheme. The government has itself stated that MEIS did not fulfill its stated objective of boosting exports. Hence it is necessary that RoDTEP rates and the targeted sectors meet the stated objective. Aligning the goals of foreign trade policy to the AtmaNirbhar Bharat goals is critical at this juncture. Trade facilitation, compliance, and ease of trading are issues that need to be addressed for exporters such that the manufacturing sector can realize its full potential.?

The Indian industry needs to rise to the occasion now and make full use of government’s concerted efforts toward scaling up the manufacturing value chain through schemes like PLI, champion sector reforms, RoDTEP, and many more. However, efforts to raise domestic competitiveness by addressing issues related to logistics, power, labor market productivity, and R&D should be continuous and sustainable. Short-term schemes like the PLI are helpful but cannot be a long-term alternative to structural reforms.

RCEP is over for India, but free and fair trade is not.

Prachi Priya is a Mumbai-based economist; Aniruddha Ghosh (Twitter: @ani_econ) is a Ph.D. student at Johns Hopkins University. Views are personal.