Adopt a strategic posture on trade

It is almost certain that the government of India will respond to China’s aggression on the Line of Actual Control by making it harder for China to export goods to India. The very one-sided India-China trade relationship has been flagged as a concern at various points in the last decade, but never brought into focus quite as sharply as now. While it is true that any ac­tion via tariffs, safeguards or non-tariff barriers will only hurt China to a limited extend — its exports to In­dia are around 3 per cent of its total exports — it will provide breathing space to Indian manufacturing, perhaps even a playing field to prosper.

The fact is that India’s mood on tra­de, particularly imports, has sou­red over the last five or six years. The government has been slowly raising its tariffs across thousands of tariff lines in the last six years. And it will continue to do so with a special focus on targeting goods made in China. As such, it is a re­actionary approach. If the government is serious about using trade policy as an instrument to spur Make in India, it must be strategic in its approach. It mu­st not be shy of its intent, face the naysayers who will scream protectionism (they already do!), and aggressively promote (a better narrative than protect) manufacturing.

One of the reasons that the government’s reactionary measures on hiking tariffs have not worked in spurring ma­nufacturing (with some exceptions like mobile phone assembly) is that India has free trade agreements with certain nations which, like China, have a much stronger and cost-efficient industrial base — ASEAN countries, South Korea and Japan. Raising the MFN tariff rates doesn’t deter imports from these countries. In fact, China routes some of its exports from these countries. All their manufacturing sectors have close ties with Chinese supply chains. Given the difficulties in enforcing rules of origin, it would not be surprising to see a surge in imports from these FTA areas should action be taken on direct imports from China.

The other unintended consequence of these FTAs is inverted duty structures in several goods categories where the MFN tariff rate for a primary or intermediate input is higher than the zero-duty rate on the imported final good. This dissuades value-added manufacturing in India.

In the decade after these three FTAs came into effect, India’s tra­de deficit with ASEAN has risen from $7.7 billion to $23.8 billion; the trade deficit with South Korea has risen from $5 billion to $11 billion; and the trade deficit with Japan has risen from $3 billion to $8 billion. Any strategic trade policy would require, at the very least, a renegotiation of these FTAs. There are in-built mechanisms for review. They must be used properly. All trade deals are ultimately about hard-nosed negotiations more than principles of free trade and, on evidence, India does not seem to have negotiated any of these to the country’s advantage. In fact, one could question why India chose to sign FTAs with countries that had a comparative advantage in manufacturing in­stead of targeting FTAs with those (like the advanced countries) where Indian manufactured goods would have a comparative advantage. It’s time for a strategic course correction.

Is this a recipe for autarky or for a return to the pre-1991 era? It ought not to be, because it is well known that India did not create a competitive manufacturing base in the 40 years after Independence. There must be clear differentiators. First, there should be a publicly available time frame for the tariff measures with a defined sunset cla­use. Before 1991, there was no end point to state support. Second, and this is something the government has mostly done, remove all barriers to foreign direct investment, irrespective of sector. Third, there must be incentives for exports and for employment generation. It is important to keep all manufacturing outward oriented. That is the surest way of ensuring it becomes glo­bally competitive. Equally, in the Indian context it is important not to shy away from scale, particularly in labour-intensive manufacturing. Incentives tied to em­ploying a certain large number of persons would help in this con­text. Fourth, continue implementing domestic market re­forms in land, labour, capital and ease of doing business. There must be no internal barriers to competition and cost competitiveness.

Needless to say, in the short term, there will be a price to pay in terms of higher cost of goods. India has borne that cost while building its automobile industry. But there is little point in incurring that cost and not achieving any positive outcomes in terms of growth, employment and exports which is what will likely happen in the absence of a strategic approach. Of course, even a strategic approach is not without risks but at least it has a much better chance to succeed, like in automobiles.  

The author is chief economist, Vedanta