Foreign Trade Agreement Can Boost India’s Exports

In a globalised economy, trade deals between countries – such as free trade agreements (FTAs) and regional trade agreements (RTAs) – are the norm. Being part of such a deal means higher trade volumes, improved economic growth and more opportunities for businesses, both big and small.

Since the 1990s, trade agreements have allowed India to compete on a global scale, be part of the global value chain and meet its economic growth targets. In the three decades since, it has signed 13 FTAs while 30 more are at various stages of consultation and/or negotiation. Despite fully embracing trade agreements, India’s experience with FTAs has been bitter-sweet, especially for its exporting community. While these deals have helped it expand its export basket, the majority of India’s FTAs have proved more beneficial to its trading partners. Given that trade agreements will remain relevant in the years to come, India must work on its FTA strategy.

In this piece, we take a deep dive into international trade agreements and where India stands in this highly competitive global market.

What are FTAs and RTAs?

The terms “free trade agreement” and “regional trade agreement” might be used interchangeably, but there are differences. The World Bank defines a regional trade agreement (RTA) as a “treaty between two or more governments that defines the rules of trade for all signatories”. In the Indian context, it usually takes one of the following forms:      

• Free trade agreement (FTA) – A deal between two or more countries where they agree to reduce/eliminate tariffs (duties) and non-tariff trade barriers on goods and services that account for a significant portion of trade between the partners. This creates a free trade area where goods and services can freely move. For non-members, each partner maintains its own policies and tariffs.
• Preferential trade agreement (PTA) – An agreement between countries where a member unilaterally offers another member trade preferences (such as lower or zero tariffs) on an agreed upon number of tariff lines. The list of products on which the partners agree to reduce duties is called a “positive list”. A PTA is smaller in scale and ambition than an FTA. Another key difference is that a PTA has a positive list while an FTA has a “negative list” on which tariffs are not reduced/eliminated.    
• CECA and CEPA – Similar to an FTA, a comprehensive economic cooperation agreement (CECA) and a comprehensive economic partnership agreement (CEPA) are an integrated package of agreements on goods, services, investment, intellectual property rights, e-commerce, competition and so on.

Furthermore, trade agreements can be categorised as a) bilateral or between two countries, b) multilateral or between three and more countries, and c) unilateral, where one country grants another one-sided, non-reciprocal trade preferences.   

Importance of Foreign trade agreements (FTAs)

• They drive economic growth and job creation
• They open up new markets for exporters and importers
• They create opportunities for foreign investment 
• They make domestic industries more competitive and decrease their dependence on government support
• They help governments lower spending on subsidies for local industries

On the flip side, FTAs – if not negotiated well – can lead to problems:

• Domestic industries can lose out to cheaper and more superior imports
• This can lead to loss of employment
• Natural resources can be depleted/degraded in the absence of strong environment protection laws
• Intellectual property theft is common in countries that do not have strong laws to protect patents and processes    

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Rules of Origin – How to claim FTA benefits?

Under an FTA, an importer/exporter can claim preferential tariffs only on products that have “originating status”. This means the products must be made in the country of export. An FTA comes with a set of rules that lays down the criteria the goods must fulfil to attain originating status. These are called the Rules of Origin. While originating criteria may vary from FTA to FTA, they must fulfil either one or a combination of the following two conditions:

1. The goods must be “wholly obtained”, which means no raw material or inputs from a third country must be incorporated in it     
2. If the goods aren’t wholly obtained, they must have undergone “substantial transformation” during manufacturing and/or processing in the exporting country. Such a transformation can be done through:

• Change in Tariff Classification – This means non-originating inputs must not have the same HS code as the final product (HS code is a standard code assigned to each traded good) 
• Regional or Domestic Value Content – A minimum percentage of the product’s value (which varies from agreement to agreement) must originate in the exporting country
• Process Rule – A specific chemical process must be used to produce the goods in the originating country 

If you’ve heard of Rules of Origin, you might have also heard of Certificate of Origin (COO), which establishes the origin of goods. The import/export of goods under FTA requires a COO issued by a designated authority of the exporting country. In India, the Directorate General of Foreign Trade, Indian Chamber of Commerce, and Federation of Indian Export Organisations are some organisations authorised to issue COOs.

An exporter/importer seeking FTA benefits must familiarise themselves with Operational Certification Procedures (OCPs), which are a part of the Rules of Origin contained in an FTA. In India, the OCPs in each FTA are supplemented by the Customs (Administration of Rules of Origin under Trade Agreements) Rules, 2020, better known as CAROTAR 2020. These rules call for closer scrutiny by Indian importers of the origin status of their goods. While earlier a COO was all it took to import goods under an FTA, CAROTAR 2020 requires the following additional compliances:

• The importer must fill in certain origin-related information in the bill of entry. These include the reference number and date of issuance of the COO and originating criteria, among others.  
• The importer must verify from the exporter that the goods meet the originating criteria and thus possess a minimum amount of origin-related information, the details of which are given in Form 1 of CAROTAR 2020. This form, duly filled up, is to be presented to customs only when asked for.
• The importer must keep this information for a minimum of five years from the date the bill of entry is filed.   

*Asean stands for Association of Southeast Asian Nations and its 10 members are Brunei, Cambodia, Laos, Indonesia, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam; Saarc stands for South Asian Association for Regional Cooperation and counts Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka as members; MERCOSUR is a South American trade bloc comprising Brazil, Argentina, Paraguay and Uruguay.

India’s FTA story – Lukewarm gains for exports

India’s experience with FTAs has not gone to script, especially for its exports. While it has managed to expand its export offerings and access new markets, the general opinion is that trading partners have benefited more from FTAs with India. The problem areas:  

1. Underperforming exports: Indian exports to FTA countries haven’t outperformed exports to the rest of the world, says this NITI Aayog report. Also, India tends to import more and export less under FTAs, creating a trade deficit. A 2018 report by the PHD Chamber of Commerce and Industry shows Indian exports trail imports in Finland, Malaysia, Chile, Japan, South Korea, MERCOSUR, APTA and Asean – all countries and blocs it has trade agreements with. The reverse is true only in Nepal, Afghanistan, Bhutan and Saarc. India’s trade deficit in April stood at $15.24 billion, a 120.34% jump year on year. Its exports for this month were valued at $30.21 billion while imports in March stood at $45.45 billion. The Asean, South Korea and Japan agreements have been deemed to be especially detrimental to India while benefiting the trading partner. India’s trade deficit with these three partners widened after the agreements came into force, says the Niti Aayog report. 

• India-Asean CECA – India’s exports increased from $23 billion in 2010 to $36 billion in 2018 (5% annual growth) while its imports jumped from $30 billion in 2010 to $57 billion (8% annual growth). Its trade deficit with Asean currently stands at $24 billion. What’s more, imports from Asean to India have grown at a much faster rate than imports from the rest of the world.
• India-Korea CEPA – In 2019, exports from South Korea were worth $15.1 billion while exports from India amounted to $5.6 billion. This imbalance has prompted India to seek a review of the bilateral agreement. In 2020, the Commerce Ministry held a meeting with exporters and Export Promotion Councils to discuss the problem areas in this deal.
• India-Japan CECA – Bilateral trade between the two has slumped from $17.63 billion in 2018-19 to $11.87 billion in 2019-20 (April to December). In 2019-20, Indian exports to Japan totalled $3.94 billion while imports from Japan amounted to $7.93 billion. India has sought a review of this pact as well, but Japan is reportedly reluctant for a complete overhaul.

1. Underutilisation of trade pacts: India’s rate of FTA utilisation is less than 25%. According to this Deloitte report, it is shockingly less than 3%. Compare this to a 70%-80% utilisation rate in developed countries. India’s low utilisation rate can be attributed to a lack of awareness about FTAs and Rules of Origin, high cost of FTA compliance, non-tariff barriers in importing countries, and absence of industry in trade negotiations, among others.
2. Blinkered vision: India’s trade agreements suffer from an over-emphasis on “market access” when they should be paying more attention to non-tariff barriers standing in the way of healthy trade, says this opinion piece. These barriers include differences over packaging and labeling requirements, the absence of mutual recognition of certificates, complicated trade financing and inadequate modernisation of procedures. Such factors are stopping India from making the most of its untapped export potential, which the International Trade Center pegs at $201.4 billion.
3. Lack of direction: India has signed the highest number of trade agreements with Asian countries. This might have caused it to neglect other markets with high trade potential. For example, this report says the majority of Indian trade in 2016 was with West Asia (35%) and Africa (32%). The IMC Chamber of Commerce and Industry says India would be wise to explore the trade potential in the African Continental Free Trade Area (AfCFTA). On the other hand, India’s Asia focus suffers from the “spaghetti bowl effect” – a phrase used to describe multiplication of FTAs. For example, India has separate CECAs with Singapore and Malaysia, which are also part of the larger India-Asean CECA. 

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What India is doing to strengthen its FTAs

India is aware of its failings and has, fortunately, taken some corrective steps. These include:

• Reviewing existing FTAs: India is in the process of reviewing its FTA with Asean. Its demands include removal of non-tariff barriers, better market access and stronger Rules of Origin provisions. Similarly, it has demanded a review of the CEPAs with South Korea and Japan.
• Strengthening Rules of Origin: The enforcement of CAROTAR 2020 is a step in this direction.  
• Going back to traditional markets: The market share of Indian exports in Asia has dropped in the past decade, despite a rash of trade agreements. At the same time, market share in traditional markets like the US and Europe has gone up from 38% to 43% in the same period, even though India does not have an FTA with either. India is set to resume formal talks with the EU for an FTA in May, after a gap of eight years. It is also keen on a mini trade deal with the US, even though it figures low on Washington’s list of priorities. Given that both markets are complementary to its export offerings, India shouldn’t waste any effort in forging stronger trade ties with them. India’s untapped export potential for the US (as a percentage of current exports) is 60% while for the EU, it is an astounding 90%. As a step in the right direction, India and the UK on May 4 revealed plans to launch negotiations for an FTA as part of their ambitious Roadmap 2030 engagement. Their aim is to double bilateral trade in the next decade. 
• Into Africa: As we mentioned earlier, Africa holds immense potential for Indian trade. The India-Mauritius Comprehensive Economic Cooperation and Partnership Agreement, which was signed in February and came into effect on April 1, is India’s first trade agreement with an African nation. It is expected to serve as a model for FTAs with other African countries.       

The way ahead

Trade agreements, including FTAs, can be extremely beneficial if done right. Here is what India can do to get a better deal:

• Sign new agreements only after conducting in-depth analysis and taking the opinions of all stakeholders on board
• Firm up safeguard clauses in FTAs, especially with regard to protecting domestic industries against import threats. This can be done, for example, by putting in a provision for a safeguard measure that can be invoked if a volume or price trigger for a certain product is reached
• Make the most of a post-Covid world where many countries are expected to search for markets beyond China to source goods and services from
• Improve India’s global competitiveness. Lowering transaction costs, encouraging foreign investment in infrastructure and research and development, improving ease of doing business are some ways to go about this.