Expanding India's global stamp: FTAs are the way to go if gaps are plugged

The complexities of rule of origins may end up distorting trade instead of fostering it

Policymakers have shown renewed interest in India’s attempt to increase its global presence by integrating with global value chains (GVCs). Various policy initiatives, from Make in India to Make for the World, to the recent Free Trade Agreements (FTA) with UAE and Australia point towards an increasing emphasis on global trade. This is also evidenced by recent trade figures, which document a 30.7 per cent growth in India’s merchandise exports, which stood at $40.19 billion in April 2022. Moreover, to boost post-pandemic recovery, the policymakers have set an ambitious target of $1 trillion in merchandise exports by 2030.

However, in order for such a challenging target to materialise, greater integration with GVCs is required. According to the Economic Survey (2019-20), the GVC exports could contribute a quarter of the increase in value-addition needed to achieve the $5 trillion goal. They could also generate four million jobs by 2025 and eight million jobs by 2030 under the Make in India initiative. Moreover, in an industrial landscape dominated by Micro, Small and Medium Enterprises (MSME)s, these firms can play a key role in GVCs integration by being suppliers to multi-national corporations (MNCs). Hence, such developments are pivotal for India’s growth trajectory. However, swift and rapid integration with supply chains rests on various factors. The tariff structure is regarded as a crucial factor influencing GVC integration.

In a GVC set-up, a firm engages in sourcing intermediate inputs from abroad and exporting its product to other countries. Given the increasing flow of cross-border goods trade, the tariff structure of a country can significantly impede or foster its global trade ambitions. In India’s case, despite three decades of attempts to remove trade barriers, its import tariff structure still is skewed. According to the WTO (World Trade Organisation)'s tariff profile, India has the highest tariff in the Asia-Pacific region at 15 per cent. Such a high tariff rate can hinder the sourcing of intermediate products for an economy that is attempting to integrate with GVCs. This issue has far-reaching consequences for small and medium enterprises (SME)s dependent on intermediate inputs for their participation in global markets.  

Further, data from World Input-Output Tables highlight that during 2005-2015, India’s backward participation in GVC – the extent of intermediate imports used for producing output by the sector for exports – has increased by 18 per cent. In contrast, India’s forward integration –the export of intermediate goods used as inputs for production in other’s countries’ export baskets – declined 16 per cent. These figures clearly highlight that India’s GVC presence is driven by its sourcing of foreign intermediates. Therefore, higher tariffs on Imports could significantly hamper India’s participation in GVCs.

In this regard, Observer Research Foundation (ORF) and ORF America jointly conducted a firm level survey with the objective of building resilient GVC linkages in India. Thirty-three per cent of the survey respondents found high domestic tariffs a major obstacle for GVC integration. Moreover, this was more prominent for SMEs, with 55 per cent of respondents considering high domestic tariffs as a major challenge. Further, 44 per cent of the respondents found high tariff on inputs as a key factor impeding firms from achieving scale economies. This further translates into foreign firms’ decision to enter the domestic market, with 52 per cent of the firms attributing low tariffs on inputs as a key factor in shaping FDI decisions in India. In this regard, Apple’s move to India portrays the importance of ensuring liberal trade policies that can plug India deeper into GVCs. The report also documents that lowering of input tariffs was among the top three policy priorities suggested by the respondents.

Therefore, to combat issues of tariffs, countries enter FTAs that levy preferential tariff on imported goods at concessional or nil rates. Even though India backed out of RCEP (Regional Comprehensive and Economic Partnership Agreement), it has tried fostering bilateral agreements with multiple countries. Currently, there are more trade negotiations underway with theUK, the European Union, Canada, Israel, and the Eurasian Economic Union. Our newly-found zeal for FTA is a step in right direction. However,the implementation of certain policies goes against the essence of such FTAs. For instance, the tariff concessions available under trade agreements rest upon the principles of ‘‘origin’’, wherein a good is eligible for tariff concessions if it originates from the partner country. The rules of origin are important under such agreements to prevent trade deflection, i.e., to make sure that products from non-partner country do not claim the benefits of concessional tariff by shipping the product through the partner country. For example, Francis and Kallumal (2021) document that Vietnam was the biggest source of Imports for electronic industry in India. However, only 15 per cent of imports originated in Vietnam, and the majority came from South Korea.

In this context, the Government of India has implemented the Customs (Administration of Rules of Origin under Trade Agreements) Rules, 2020 which implement multiple procedural obligation on the importer to evaluate whether a particular item is eligible for preferential tariffs or not. In addition, other complexities associated with rule of origin include the presence of different FTAs with different partner countries, resulting in the “spaghetti bowl effect” that leads to confusion in trading rules and slows down trade between partner countries. At present, India has comprehensive trade agreements with over ten countries. Hence, any firm trying to establish its foothold in the global market will find it arduous to keep track of different rules under different agreements and track the origin of a product in its true essence. Moreover, the linkages from one trade agreement do not translate across different agreements due to rules of origin restriction. As a result, the rule of origin rules also lowers the available options for domestic firms. Consequently, firms may substitute higher-quality imported inputs with inefficient ones. This may affect the firm’s chances of integrating value chains set up for large multinationals as meeting quality requirements is an important aspect of GVC participation. In this regard, use of new technology such as blockchain can improve the implementations of RoO and reduce the dependence on large amount of paperwork. Given that the pace of GVC participation is driven by the underlying trade costs between partners, trade agreements become an extremely vital channel of fuelling growth of GVCs. However, the complexities and restrictiveness of rule of origins may end up distorting trade instead of fostering it, making the issue an important element for trade policy to consider moving forward.

Ketan Reddy is an Assistant Professor of Economics at the Indian Institute of Management, Raipur and a Visiting Research Fellow at King’s India Institute, King’s College, London. Subash S is an Associate Professor of Economics at Indian Institute of Technology, Madras. Badri Narayanan Gopalakrishnan is former Lead Adviser and Head, Trade and Commerce, NITI Aayog, Government of India