India-ASEAN FTA: A Welcome Move

India-ASEAN FTA: A Welcome Move

 

The proposed India-ASEAN FTA is set to usher in a gamut of opportunities to both the contracting parties. But to reap maximum benefits, the ambit of the negotiations should be extended to include services and investment sectors also.

 

India is all set to seal the long pending Free Trade Agreement (FTA) for goods with the 10-member Association of Southeast Asian Nations (ASEAN) in August 2009 soon after the endorsement of the deal by the parliaments of the ASEAN member countries. The agreement with ASEAN is poised to end seven years of stalemate and it will be the fourth regional trade agreement after the FTA with Sri Lanka, Thailand and the Comprehensive Economic Cooperation Agreement (CECA) with Singapore. Under the deal, tariffs on 80% of the commodities (including key raw materials, like iron ore and aluminum, plastic goods and certain kinds of machinery) traded between the two sides, would be reduced and ultimately eliminated by 2015. And the negotiation is likely to clear the tag on India as being a stubborn trade negotiator, a label attached to India particularly by the US. As well, the agreement will facilitate an open market environment between the two partners with a combined population of over 1.7 billion people and GDP of almost $2.4 tn. By 2010, the trade volume between two of the fastest growing parts of the world is expected to go up to $50 bn and once talks for trade in services and investment are also concluded, it is bound to increase even further.

The impact of this historic event would be much more than just the boost in trade and investment. The deal is likely to push India more to the center stage of Asia. The trade agreement could help India in bolstering its geopolitical status not only in ASEAN, but also in wider Asia. Similarly, a strategic association with India, beyond just an economic one could provide a credible alternative to ASEAN over its China exposure.

Benefits Galore

This proposed India-ASEAN FTA is of immense importance to India as this would take India a few notches up in rankings of the Asian countries and will help it play a bigger role in emerging broader regional architecture in Asia. India had started to engage with ASEAN since 1992, just after the end of the cold war (following the collapse of the Soviet Union) as a part of the Look East Policy. Look East Policy was a strategic shift and was perhaps the outcome of the growing recognition of East Asia's prospects to emerge as the centre of gravity with rapid growth sustained over the past three decades in contrast to rather docile economic performance of its western counterparts. Apart from this, even the creation of regional trade blocks, such as EU, NAFTA, MERCUSOR, etc., across the globe, has spurred the creation of this FTA. Moreover, in the present era of globalization, regional or bilateral free trade arrangements have become so important that a country can ignore FTAs only at its own peril. Data shows that more than 350 regional or bilateral trade arrangements are currently in different stages of negotiations and the bulk of world trade now takes place within the FTAs. Hence, it makes great sense to set up India-ASEAN FTA from the trade policy perspectives of both the parties.

GDPs of ASEAN countries and India are $1.3 tn and $1.1 tn respectively. In 2007, ASEAN grew at a rate of 6.4%. Trade volumes of these two entities are currently valued at approximately $2 tn and $400 bn respectively. As of the end of 2007, they enjoyed a market capitalization of $1.4 tn (main five exchanges) and $1.8 tn respectively. They have a population of 575 million and 1.1 billion respectively and savings rate of 30% or more. From the above figures, it is quite apparent that both sides have strong economic and demographic bases, which would get better with time. However, despite solid performance on international trade on both sides, the trade between India and ASEAN has still remained much below the potential, at $38.4 bn in 2007, which represents less than 2% of their total combined external trade. This offers a great opportunity to increase the trade volume, especially given the complementarity of markets and resources. Edible oil, wood and pulp, timber and forest products, energy basket (which includes natural gas, coal and oil), manufactured products such consumer durables, electronics and communication equipment, as well as agri- and marine-based products are in abundance in ASEAN countries and are likely to be imported by India. Again, a range of agricultural, metal, equipment and heavy engineering goods, are probable export items from India.

Interview with Aekapol Chongvilaivan, Fellow, Institute of Southeast Asian Studies, Singapore

How do you see the proposed FTA between India and ASEAN? The India-ASEAN FTA involves the integrated market of over 1.5 billion people with a joint GDP of $1.2 tn. The gains from liberalizing trade in goods between India and ASEAN, however, are not straightforward – it is unlikely that both signatories will tap benefits from tariff reductions and elimination directly. The reason is that India shares an infinitesimal stake of 1% in ASEAN's trade, and hence ASEAN's gains from India's market access are negligible. Moreover, since ASEAN's tariffs on goods import have already been relatively low, further tariff reductions are unlikely to significantly entail trade creation as well as India's welfare gains. However, given that the India-ASEAN economic relation tends to be closer, the agreement will be welfare-enhancing. The proposed FTA in goods serves mainly as a stepping stone of a Comprehensive Economic Partnership Agreement (CEPA), which includes not only trade in goods, but also trade in services and investment. Liberalization of trade in services and foreign direct investment is where the maximum benefits of the India-ASEAN FTA in terms of economic opportunities lie. What could be the benefit of FTA? The benefits of the India-ASEAN FTA are as follows. First, the agreement brings trade liberalization and free market access to more than 1.5 billion people. These are expected to generate the net welfare gains—the welfare gains from trade creation outweigh the welfare losses of trade diversion—for both parties since the production structures of India and ASEAN are different; hence, the agreement will enable both signatories to tap their complementarities and synergies. Second, the India-ASEAN FTA may serve as a building block of the multilateral agreement under the Doha Round. Last, but not least, the India-ASEAN FTA will provide the two entities opportunities to go beyond trade in goods as the talks include a wide rage of areas – trade in services, investment, research and development, science and technology, tourism, and human resource development. What could be its impact on Indian industry as well as the farm sector? The India-ASEAN FTA will largely benefit India's industries as trade liberalization with ASEAN will make India a key part of global business. That is, India's industries, especially electronics, and spare parts and components, have long been a major source of offshoring and outsourcing from developed countries, especially the US and the EU. The agreement will provide new opportunities for companies in India to be integrated into ASEAN markets as a hub of spare parts and components outsourcing. The issue of reducing India's tariffs on highly sensitive farm products – tea, coffee, pepper, crude palm oil, and refined palm oil – has emerged as hurdles of the recently concluded India-ASEAN FTA. Millions of acres of arable land in India will be swamped by cheap farm products from Indonesia, Malaysia, and Thailand. Tell us something about the international experience of FTA? One of the most important debates is whether a FTA is a building block or a stumbling block of the multilateral agreement. Among others, the Rule of Origin (ROO)—the rule specifies which products are originated from the partner countries and which products are not—has often been a major obstructive factor that makes an economic block to stumble. There is always a danger that a FTA will end up with the complicated and inconsistent ROO that may ultimately be non-tariff barriers. The welfare-enhancing India-ASEAN FTA, therefore, requires a harmonized ROO that would be mutually agreed upon by the signatories. Any other comments? India has emerged as the world's hub of IT-enabled services. Therefore, the potential benefits from trade liberalization between India and ASEAN countries are from trade in services and investments. That is, India will be integrated into the Asia block as a source of services outsourcing, and, at the same time, companies located in ASEAN countries improve their competitiveness in the global market by contracting out service activities—such as IT services, information technology, and operators—to India's service providers. These necessitate that the India-ASEAN FTA must not be restricted to trade in goods.

The FTA will result in import tariffs on 4,000 goods out of 5,000 that are traded between the signatory nations being reduced to nil in a phased manner. The deal would be beneficial to sectors such as steel, some types of auto components and engineering goods. And the benefits and synergies arising out of this market are bound to expand further as the ASEAN trading bloc is already in talks with countries like China, Japan, South Korea, Australia and New Zealand, for free or preferential trade pacts. If some of these materialize, they would lead to the creation of a gigantic European Union-style common market, to the benefit of all parties.

Reasons to Worry

Huge markets on both sides are a point of great attraction to both the contracting parties. However, there are serious concerns among those that are already involved in these businesses about the impact of free trade on their existing business. The issues of lowering tariffs imposed by India on highly sensitive agri-products, like tea, coffee, pepper, crude palm oil, and refined palm oil have emerged as the biggest hurdles of the recently concluded India-ASEAN FTA. It has been agreed in the proposed negotiations that, by 2018, there will be partial elimination of tariffs - 45% for tea and coffee, 50% for pepper, 37.5% for crude palm oil, and 45% for refined palm oil - and hence will exert tremendous pressure on Indian farmers.

In other words, markets in India will be swamped by cheap farm products from Indonesia, Malaysia, and Thailand, much to the peril of Indian farmers. But historical evidence shows that expanded trade favors competitive incumbents given their first-mover advantage. So, to counter the onslaught of foreign farm products, the existing players should be more competitive and advanced. Moreover, as in case of any negotiation, here also India has given up some ground to accommodate specific demands of ASEAN countries, such as Vietnam, Indonesia and Malaysia. But FTA is not a one-way street. The member countries of ASEAN have also budged from their earlier stand on India's long exclusion list of goods that are to be kept free from any mandatory tariff cuts. Resultantly, the agreement permits India to have an exclusion list of 489 items, instead of ASEAN's target of only 400. In addition, an even longer list of 606 sensitive goods is identified for only partial duty cuts.

Bright Prospects

It is predictable that India-ASEAN FTA would generate net welfare gains, i.e., the welfare gains arising out of opening up of trade would offset the welfare losses of trade diversion. And both the negotiating parties are likely to reap net welfare gains as the production patterns of India and ASEAN are different. So, the agreement will be beneficial to both the regions. However, the maximum benefits of India-ASEAN economic cooperation will be garnered only when the ambit of such agreement is broadened to include sectors such as services and investments. In fact, to include services and investment in the agreement is the upcoming plan that is likely to be implemented by the two sides in the near future. And, for India, the services sector holds special interest because of its inherent strengths in it. In fact, India has emerged as the world's hub of IT-enabled services. And the potential benefits from trade liberalization between India and ASEAN countries can be maximized by free flow of trade in services and investment. These call for the India-ASEAN FTA to look beyond trade in goods. The FTA negotiations took almost seven years of deliberations to reach a result; and it is hoped that investment and services will come on board in a much shorter span of time.