RCEP fallout: Raw deal

Moreover, India had wanted a protection mechanism to be built into the partnership as a safeguard against any sudden inflow of goods after the pact came into effect. The well-grounded apprehension was this: China has been looking for new markets in the aftermath of its ongoing trade war with the US. Many industry sectors, particularly textiles and apparel, had been arguing that the RCEP would pave way for Chinese companies to dump their goods in the face of a trade slowdown on the US front.

India would have been important for China as a trading partner within the bloc. Of the 16 negotiating countries (including both), India would have been the biggest single market for Chinese companies desperate to offload stocks that it was forced to hold as a result of US barriers. One textile trade association even felt that $50 billion worth of finished fabric stock could be dumped in India had the country gone ahead with the deal. The trade agreement was also seen as being counter-productive to the government’s much-pushed Make in India initiative.

India had also opposed 2013 being used as the base year for reducing tariffs and instead made case for 2019 as the talks became deadlocked, particularly since import duties on goods like textiles and electronic items have gone up since 2013. This remained a sore point till the end.

India had a substantial trade deficit with 10 of the RCEP negotiating countries.

The gap with China, Korea, Indonesia and Australia increased to $63.12 billion, $11.96 billion, $12.47 billion and $10.16 billion respectively in 2017–18. The figures were $51.11 billion, $8.34 billion, $9.94 billion and $8.19 billion in the previous financial year.

Opinion remains divided. The advocates of the treaty insist that exiting the RCEP means that India has lost an attractive market in the backdrop of India not having any major bloc to trade with except the Association of South East Asian Nations (ASEAN), with most constituents of which India has bilateral agreements in any case. If your exports take a hit, your domestic industry would also take a hit. Those opposed to the deal were contending that being member of a non-competitive agreement would leave Indian industry and agriculture competing with one hand tied behind its back. The domestic sector, therefore, would be hit.

As a commentator pointed out in an article, the RCEP had turned out to be a Hobson’s choice. The term is said to have originated with Thomas Hobson (1544– 1631), a livery stable owner in England, who offered customers the choice of either taking the horse in a stall nearest to the door or taking none at all. In other words, one may “take it or leave it”. In the end, it was not a choice at all.

Global Trade Scenario

The numbers don’t look good. The WTO, International Monetary Fund (IMF), World Economic Forum (WEF), World Bank—all predict a dismal future.

On October 1, WTO economists downgraded their forecasts for trade growth in 2019 and 2020 on basis of escalating trade tensions and a slowing global economy. “World merchandise trade volumes are now expected to rise by only 1.2 per cent in 2019, substantially slower than the 2.6 per cent growth forecast in April. The projected increase in 2020 is now 2.7 per cent, down from 3.0 per cent previously. The economists caution that downside risks remain high and that the 2020 projection depends on a return to more normal trade relations.” The economists would have factored in the RCEP for their 2020 predictions. But with India’s exit, trade outlook on that front would have to be considerably weaker.

“The darkening outlook for trade is discouraging but not unexpected. Beyond their direct effects, trade conflicts heighten uncertainty, which is leading some businesses to delay the productivity-enhancing investments that are essential to raising living standards,” said WTO Director-General Roberto Azev do. “Job creation may also be hampered as firms employ fewer workers to produce goods and services for export.”

Both trade growth and GDP growth are dependent on each other. The WTO remarked, “The updated trade forecast is based on consensus estimates of world GDP growth of 2.3 per cent at market exchange rates for both 2019 and 2020, down from 2.6 per cent previously. Slowing economic growth is partly due to rising trade tensions but also reflects country-specific cyclical and structural factors, including the shifting monetary policy stance in developed economies and Brexit-related uncertainty in the European Union. Macroeconomic risks are firmly tilted to the downside.

Risks to the forecast are heavily weighted to the downside and dominated by trade policy. Further rounds of tariffs and retaliation could produce a destructive cycle of recrimination. Shifting monetary and fiscal policies could destabilise volatile financial markets. A sharper slowing of the global economy could produce an even bigger downturn in trade. Finally, a disorderly Brexit could have a significant regional impact, mostly confined to Europe.” All this is putting it very mildly.

Also in October, the IMF forecast global growth at 3.0 per cent for 2019, its lowest level since 2008–09 and a 0.3 percentage point downgrade from the April 2019 World Economic Outlook. The IMF qualified this in a blog post, “We estimate that the US-China trade tensions will cumulatively reduce the level of global GDP by 0.8 percent by 2020. Growth is also being weighed down by country-specific factors in several emerging market economies, and by structural forces, such as low productivity growth and aging demographics in advanced economies.”

All predictions come with accompanying riders. The uncertainties to be weathered are too many. The WEF is trying to help on this count. The WEF’s research department has devised a World Trade Uncertainty (WTU) index for 143 countries starting in 1996. Existing measures of trade uncertainty focus either on the United States, or on the global economy as a whole, or on a set of 44 countries. The WTU index is based on the Economist Intelligence Unit (EIU) country reports which follow a standardised process and structure, which helps to mitigate concerns about accuracy, ideological bias and consistency.

In September, WEF researchers, writing about the findings, put it bluntly: “Globally, the trade policy uncertainty index is rising sharply, having been stable at low levels for about 20 years.” They wrote: “The index shows increased uncertainty starting around the third quarter of 2018, coinciding with a heavily publicised series of tariff increases by the US and China. It then declined in the fourth quarter of 2018 as US and Chinese officials announced a deal to halt the escalation of tariffs at the G-20 meeting in December in Buenos Aires. It significantly spiked again in the first quarter of 2019 following a substantial expansion of American tariffs on imports from China on March 1.”

The WTU index recorded high levels of trade uncertainty in US trading partners such as Canada, Mexico, Japan, and large European economies, and in countries geographically close to the US and China. Trade uncertainty remains moderately low in the Middle East, Central Asia and Africa. But it is rising there too, according to the researchers. Global trade being zero sum, it is bound to affect everyone. Sooner or later.

The Trump Effect

Let’s hark back to around the time that the current Foreign Trade Policy (FTP) 2015–20 was formulated.

When the US, and the world to quite an extent, was hit by the financial crisis of 2007-08, China began growing at a phenomenal rate, driven by a strong manufacturing base, and consequently therefore exports too. The US administration of Barack Obama wanted to cut China down to size and began looking for ways to do it. Obama found his means in the TPSEP (Trans-Pacific Strategic Economic Partnership agreement or Pacific-4 among Brunei, Chile, New Zealand and Singapore). The anti-China measures began as negotiations over trade liberalisation of financial services and went on to become the TPP. Discussions over the TTIP went on simultaneously.

China’s well-calculated reaction came in November 2011 when the RCEP was introduced at that year’s ASEAN Summit. It was still 2013 before formal talks could begin. Even as participating countries tried to come to an understanding, Donald Trump was elected to office as US president. He had promised during his election rallies that once elected, he would pull the US out of the TPP. He kept his word, and the other countries barely managed to remain a ragtag coalition called the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).

Trump, in fact, went to take on both the EU and China. The TTIP negotiations came to a standstill, and there was a brief tariff war between the US and EU. Matters were compounded in between by the proposed withdrawal of the United Kingdom (UK) from the EU. Trump also entered into a conflict with India earlier this year over the generalised system of preferences (GSP). The US wants to trade only on its own terms.

And instead of using the TTP (which he rejected on the ground that it would take away American jobs) to counter China, Trump decided to do it himself. In early November, the United Nations Conference on Trade and Development (UNCTAD) released the findings of a study which showed that the US-China trade war has resulted in a sharp decline in bilateral trade, higher prices for consumers and trade diversion effects (increased imports from countries not directly involved in the trade war).

Worse, the study found that consumers in the US were bearing the heaviest brunt of the US tariffs on China, as their associated costs had largely been passed down to them and importing firms in the form of higher prices. Chinese firms too had started absorbing part of the costs of the tariffs by reducing the prices of their exports.

UNCTAD’s director of international trade and commodities, Pamela Coke Hamilton, cautioned: “The results of the study serve as a global warning. A lose-lose trade war is not only harming the main contenders, it also compromises the stability of the global economy and future growth.”

Growth, many had thought earlier, would come from bilateral and regional trade agreements (RTAs) which have flourished in this millennium. The reason: the snail-paced progress in the Doha rounds of talks at the WTO which commenced in November 2001 seeking to lower trade barriers around the world, and thus facilitate increased global trade. It would soon be two arduous decades, and in the meantime RTAs have proliferated. In trade observer parlance, RTAs create a so-called “spaghetti bowl phenomenon” (SBP) in global trade. The term is a metaphor to illustrate the numerous and crisscrossing RTAs, where innumerable applicable tariff rates and a multiplicity of rules of origin must coexist.

But RTAs were seen to be too small in scope, certainly from the point of the developed countries. That was why the mega-deal concept became an obsession in the 2012–15 period. All trade talk hovered around the TPP, TTIP and RCEP. But there were many who had a word of caution.

A WEF document titled ‘Mega-regional Trade Agreements: Game-Changers or Costly Distractions for the World Trading System?’ had examined the pros and cons of big-ticket deals. Richard Baldwin, Professor of International Economics at the Graduate Institute of International and Development Studies in Switzerland, wrote about the impacts of such deals: “Mega-regionalism is good news and bad news for the world trade system. Trade liberalisation has progressed with historically unprecedented speed in the 21st century. Trade volumes are booming; hundreds of millions have been lifted out of dire poverty. The policy reforms that underpinned this trade liberalization was implemented by a “spaghetti bowl” of deep RTAs, unilateral reforms and BITs (bilateral investment treaties). The good news is that mega-regionals will tidy up the spaghetti bowl—making the spaghetti into lasagne plates, so to speak.

“The bad news is mega-regionals may undermine world trade governance—WTO-centricity in particular. Trade liberalisation in the past decades has had three parts: deep RTAs, BITs, and unilateralism. Unilateralism is not a systemic threat to the WTO and BITs have long co-existed with the WTO. But deep RTAs—and even more so mega-regionals—are very likely to erode the WTO’s central place in world trade governance. The threat is not on the tariff-cutting front; it is on the rules-writing front. The danger is that mega-regionals may enfeeble the WTO as a forum for agreeing on new trade rules—specifically, the rules necessary to foster the trade-investment-services nexus that is the core of today’s international commerce.” The TTIP is part of history, and the CPTPP and RCEP are shallow without the US and India respectively.

And, world trade governance is becoming more chaotic by the day.

India and its FTAs

In August 2018, a briefing paper by the Indian government’s policy think-tank NITI Aayog had called for a review of India’s existing free trade agreements (FTAs) before negotiating new ones. It noted that a growing wave of protectionism had been dominating global trade and it was difficult to assess whether this would lead to a significant shift in the global trade paradigm. To be fair, India needs to protect itself as well.

The NITI Aayog study jotted down a number of facts: India’s exports to FTA countries had not outperformed overall export growth or exports to rest of the world; FTAs had led to increased imports and exports, although the former had been greater; India’s trade deficit with ASEAN, Korea and Japan had widened after FTAs; and, India’s exports were much more responsive to income changes as compared to price changes and thus a tariff reduction/elimination did not boost exports significantly. Last, it had also taken cognisance of the fact that the utilisation rate of RTAs by exporters in India was very low (5-25 per cent). The latter factoid, as such, was from an assessment done by the Asian Development Bank (ADB) more than five years ago. The numbers have not changed since.

FTA utilisation is supposed to be as high as 70–80 per cent in developed countries. A paper by Deloitte in 2017 remarked, “The low utilisation highlights the alarming failure to utilise the benefits available to the industry through bilateral and multilateral trade agreements. The Indian industry needs to take notice of the latent opportunity waiting to be harnessed.” Lack of information on FTAs, low margins of preference, delays and administrative costs associated with rules of origin, non-tariff measures, are the major reasons for underutilisation. Any new FTP will have to address these issues. If exporters are unable to exploit a trade agreement, such an agreement loses its import.

In its submission to the Parliamentary Standing Committee on Commerce looking at India’s engagement with FTAs, think-tank CUTS International had pointed out, “The government should revisit these trade agreements through cost-benefit analyses including sustainabi lity impact assessment of FTAs being negotiated or to be negotiated and regulatory impact assessment of existing FTAs. While negotiating new agreements, particularly deeper FTAs with developed countries, India needs to set its targets clearly and take steps for improving its domestic preparedness, particularly those of regulatory bodies.

“For instance, due to an unfavourable exchange rate regime and low difference between preferential and MFN tariff rates in Japan, India-Japan CEPA is not creating more market access opportunities for Indian products, but with diligent application of safeguards, careful selection of products/services sectors and complementary policies to attract Japanese investment with technology transfer, it is expected that there will be a huge overall gain to the Indian economy.”

The NITI Aayog paper had recommended:

•     Before getting into any multilateral trade deal India should first, review and assess its existing FTAs in terms of benefits to various stakeholders like industry and consumers, trade complementarities and changing trade patterns in the past decade.

•     Second, negotiating bilateral FTAs with countries where trade complementarities and margin of preference is high may benefit India in the long run.

•     Third, higher compliance costs nullify the benefits of margin of preference, thus reducing compliance cost and administrative delays. This aspect is critical to increasing the utilisation rate of FTAs.

•     Fourth, proper safety and quality standards should be set to avoid dumping of lower quality hazardous goods into the Indian market.

•     Fifth, circumvention of rules of origin should be strictly dealt with by the authorities. In case of India-Sri Lanka FTA, Sri Lanka had started exporting copper by under-invoicing imported scrap to show higher value addition to qualify for preferential rates under the FTA. Thus, rules of origin norms can easily be circumvented by simple accounting manipulation to flood Indian markets.

It concluded: “The over-arching conclusion of this report is that FTAs have to be signed keeping two things in mind, mutually reciprocal terms and focusing on products and services with maximum export potential.”

Just as the NITI Aayog paper had advised the government against rushing into the RCEP deal, numerous other Parliamentary and other panels have repeatedly cautioned against mindless FTAs, particularly one with the EU. Incidentally, the EU is the largest source of FDI inflows into India, accounting for over one-fourth of the total investments.

There has been no headway in the India-EU Free Trade Agreement, or the Broadbased Trade and Investment Agreement (BTIA), launched in Brussels in June 2007. Negotiations broke off in 2015. Indian exporters have been hard-hit since preferential access is given to countries like Bangladesh, Cambodia, Pakistan, South Korea, Turkey and Vietnam. The latter recently signed a landmark trade deal with the EU and is expected to eat into Indian exports, particularly those of textiles and apparel.

Meanwhile, a report by the PHD Chamber of Commerce and Industry in November stated that India has failed to benefit from the ASEAN–India Free Trade Agreement (AIFTA), signed in 2009, bolstering the NITI Aayog paper’s claims. India’s imports from ASEAN increased in comparison to its exports to them after signing these agreements. Exports to ASEAN countries was $23 billion in 2010, which increased to $36 billion in 2018, with a compound annual growth rate (CAGR) of 5 per cent, while India’s imports from these countries increased from $30 billion in 2010 to $57 billion, a growth of 8 per cent. It found that India’s total trade deficit with ASEAN increased from $8 billion in 2009–10 to about $22 billion in 2018–19. The share of ASEAN in India’s total trade deficit increased from about 7 per cent to 12 per cent during the same period.

Towards Another FTP

India’s FTP 2015–20 had envisaged the country becoming a significant trade player at the global level by 2020. Clearly, that has not happened. Moreover, as mentioned earlier, the ground realities have changed drastically. The only good thing about FTP 2015–20 is that it expires early next year, and it is almost time to have a new one.

The withdrawal of India from the RCEP as also the changed ground truths call for a recalibration of the FTP which is not only in tune with the changing times, but factor in future uncertainties as well.

India will need to look at new deals, re-open negotiations which have run into bottlenecks, strengthen existing bilateral agreements, work towards more effective utilisation of existing FTAs, and maybe also take the lead in forming new trade groupings. The next FTP needs to be future-proof.