Free trade fears

Print edition : May 20, 2005

China's proposal for a free trade agreement with India meets with resistance from Indian industry.

THE initial euphoria over a free trade agreement between India and China, which was high on the agenda during the recent visit of Chinese Prime Minister Wen Jiabao to the country, appears to have evaporated quickly. Under pressure from Indian industry, the India-China Joint Study Group (JSG) put forward the proposal for a Regional Trading Arrangement (RTA) between the two countries. The JSG's report on comprehensive trade and economic cooperation, which advocated the formation of the RTA, was released during Wen Jiabao's visit. Although the JSG has recommended a Joint Task Force to examine the feasibility of an RTA, it is unlikely that it will happen soon.

At an electronics factory in Dongguan, China.-GRISCHA RUESCHENDORF/BLOOMBERG

It was obvious that China was keener than India on such an arrangement. The reasons are not difficult to understand. Tariffs on imports into China are generally lower than those in India. It is generally accepted that China, which was a late entrant into the World Trade Organisation (WTO), gave in much more on tariff reduction at the WTO than many other similarly placed developing countries. It is believed that China's eagerness to reduce tariffs was driven by the desire to avoid being left out of the multilateral system. As a result, the average applied tariffs on goods imported by China are about 12 per cent; in comparison, the tariff on imports into India is about 29 per cent. Chinese tariffs on agricultural goods are about 19 per cent, almost half that of Indian tariffs on imports. Chinese tariff on non-agricultural goods, mostly manufactured goods, is about 11 per cent, compared to the average Indian rate of 28 per cent. The Chinese enthusiasm for a bilateral arrangement with India rests on the logic that such an arrangement would basically result in equalising tariffs.

India-China trade has increased significantly in the past few years. In the past five years alone, total trade between the two countries increased five-fold - from $3 billion to $13.6 billion in 2004. Between 2003-04, bilateral trade increased by 79 per cent; in comparison, India-United States trade increased by only 23 per cent during the same period. Statistics released by Chinese customs authorities indicate that India enjoyed a trade surplus of $1.75 billion. Indian industrial associations have predicted that China could well become India's biggest trading partner within the next two or three years, displacing the U.S. from that status; China is already India's second most important trading partner. Enthused by the rapid increase, Tarun Das, Chief Mentor to the Confederation of Indian Industry (CII), envisages that the two countries need to develop a vision to increase this to $100 billion, punctuated by milestones of $25 billion and $50 billion "every few years".

However impressive these figures may appear, the pattern of two-way trade reveals some disturbing features. The most important of this relates to the fact that Indian exports have been mainly primary commodities. For instance, ores, minerals, iron and steel account for 57 per cent of all Indian exports to China. In contrast, Chinese exports to India is not only far more diversified, reflecting a better balance in terms of export capability, but dominated by manufactured goods. The incessant flood of Chinese-made electronic items on Indian streets is well known, but less known is the import of Chinese machinery, particularly electrical machinery into the country. It is obvious that serious imbalances could result if cooperation on trade between the two countries only means more of the same in the years ahead.

Prof. Biswajit Dhar, who heads the Centre for WTO Studies at the Indian Institute of Foreign Trade, observed that China "stands to gain enormously more simply because its exports are focussed on the higher end of the value chain". He told Frontline that the Indian export basket reminds him of a colonial style trading regime in which the colonies exported raw materials to the colonial powers. "This kind of trading pattern implies that India will be fuelling the growth of the Chinese economy," he pointed out.

Indian industry's fears have blunted the enthusiasm for an RTA with China . Its fears about being swamped by cheaper Chinese imports (not to be confused with poor quality) are not entirely without basis. But its plea for continued protection against such imports has a hollow ring. After all, since 1991 it has, without critical evaluation, accepted and promoted the logic of globalisation, implying lower tariffs levels. And its critics have repeatedly stressed that it has failed to utilise whatever protection it has enjoyed since the evolution of the import substitution regime to develop a vision for itself. Instead, say its detractors, it has sought to seek rents from whatever protection it has enjoyed.

Indian industry complains that it is hampered by unreformed labour. It points out that India's infrastructure is poor compared to China's and that the "opaque" nature of the Chinese economic system is responsible for its lack of competitiveness with China. O.P. Garg, president of the Federation of Indian Export Organisations (FIEO), said that "unfriendly" labour policies and the reservation schemes for the small-scale sector hampered Indian industry. Indian industrialists also lament that the Chinese banking system, unaffected by the kind of prudential norms that govern its Indian counterpart, are lending to Chinese industry at very low rates of interest (2 per cent a year, according to one Indian industrial lobby). These "subsidies", they allege, enable Chinese industry to outbid every other competitor on the world stage.

However, others advocate an honest soul-searching by Indian industry to examine the strengths of Chinese manufacturing and see how best it can compete. Biswajit Dhar said: "The Chinese have done wonders using economies of scale. What we have learnt in theory we are seeing being practised in China. See the way they have flooded all segments of the international market and the price at which they are selling. Even the poor quality is an old story. The Chinese are stamping their presence even in the high-end segments of market such as those for white goods. Where does Indian industry see an advantage in getting a deal such as an FTA with China? Indian industry is completely unprepared for an FTA."

The fact that China did not get a good deal at the WTO has made it search for bilateral and regional trading partners to offset the disadvantage. It gave in to pressure much more than it ought have - in terms of offering market access. It is clear that China would want to get greater market access for its exports after having given in earlier. The series of RTAs and FTAs that China has worked out, particularly in the Asian region, indicate that it would now like to level the playing field. Biswajit Dhar does not believe that an India-China RTA "is on the cards". He pointed out that it was unlikely that the South Asian Association for Regional Cooperation (SAARC) or the South Asian Free Trade Area (SAFTA) would have a separate deal with China. "I do not think an RTA is feasible," he said.

IN an effort to get access to markets for its products China has negotiated a series of FTAs and RTAs in recent years. It signed the Closer Economic Partnership Arrangement (CEPA) with Hong Kong and Macao, effective from January 1, 2004. Moreover, it has entered into a partnership with the Association of South East Asian Nations (ASEAN), which includes an "early harvest programme". China is also a member of the ASEAN+3 arrangement, which includes South Korea and Japan. Besides, it is negotiating trade deals with the South Africa Customs Union (SACU) for an FTA, apart from those with Chile, the Gulf Cooperation Council, Australia and New Zealand. These efforts are aimed not only at diversifying the target destinations of its export base, but also at reducing tariff barriers that exist against its products. China sees FTAs and RTAs as offering some insurance against the WTO process, apart from helping it recover the ground ceded earlier at the WTO. This is especially important in the wake of the protectionist lobbies that have become active in the U.S. and Europe (for instance, against Chinese textile exports). Significantly, soon after his visit to India, Wen Jiabao went to Australia to negotiate an FTA. It is expected that such an arrangement would generate an extra $82 billion in joint economic benefits over the next 10 years.

Bilateral or regional trading arrangements are mainly meant to reduce tariffs between participating countries. The contrast between India and China in terms of efforts to enter into such deals cannot be starker. India's efforts to bolster SAFTA have failed. In fact, despite years of efforts, Indian exports to SAARC countries are just over half the exports made by the ASEAN countries to SAARC-member countries.

Domestic industry has been clamouring against India's FTA with Thailand. Biswajit Dhar said: "The deal with Thailand really surprises me. Thailand has an interest in increasing agricultural exports. At some point it would push for more market access for its products. What would India do at that point? I do not see the move as being very clever."

It is often said that Indian industry fancies better chances as an exporter of services to China. But this could well be a mirage caused by the inflated expectations from the export of Information Technology-enabled services. But it is evident that China does not need an FTA to trade in services with India. Statistics released by the WTO warrant a more sober evaluation of Indian capabilities in the export of services. China's exports of services in 2003 were valued at $46.4 billion; Indian exports were a little over half the Chinese level, $25 billion. Moreover, recent controversies about the move to allow Foreign Direct investment (FDI) in retailing indicate the extent of political opposition to a liberalising trade in services.

THE Chinese economy has grown at an average rate of almost 9.5 per cent over the past 20 years, which is unparalleled in the history of any national economy in the world. Despite predictions made in 2004 about impending preparations for a "soft-landing", its economy continues to grow. Meanwhile, exports from China have swamped markets worldwide. Recent data indicating the phenomenal growth of Chinese textile exports to the U.S. and European markets provide further evidence of this trend.

Although reforms in China have attracted the attention of Indian industry, it has failed to comprehend the "sequencing of reforms" in the former. For one, the liberalisation in China, despite its negative effects on income distribution and the differences between town and country, has been far more broad-based. For instance, soon after the reforms started in 1978 they raised agricultural productivity and incomes in rural areas. Thus, despite other problems, the reforms with "Chinese characteristics" laid a basis for increasing the demand for a wide range of goods and services, which, in return, gave a boost to industrialisation. This expansion of demand explains why companies from across the world are eager to set up shop in China. In contrast, Indian industry has merely latched on to the cliches about "rigid labour markets" and its inability to hire and fire workers at will.

In an ironical twist to the trade issue, the Indian government recently refused to accord "market status" to China. A senior official of an influential industrial lobby told Frontline that this implied that if India accorded China market economy status, it would be difficult to proceed with anti-dumping measures against Chinese imports. He alleged that there was no transparency in the pricing mechanism because of the opaque nature of the subsidies that the Chinese government gave its producers. On the other hand, the "non-market economy" status offers protection to Indian industries against Chinese imports. China alleges that this method prevents it from taking advantage of the low labour costs. An informed source in the industry said that the Ministry of External Affairs, rather than the Commerce Ministry, is pushing the idea of an RTA.

Despite the setback that the RTA is likely to suffer, observers see great scope for India-China cooperation at other multilateral economic forums like the WTO. A durable partnership between India and China can present a formidable challenge to the developed countries at the next ministerial meeting of the WTO in Hong Kong later this year.

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