FTAs: Learning from peers

India should emulate its peers and adopt more flexible negotiating approaches in its FTAs

In India’s free trade agreement (FTA) negotiations with the UK and EU over the last two months, the contentious elements have been reported to include tariff liberalisation, rules of origin, dispute settlement, and labour and environment provisions. These are all issues that have long been at the core of India’s inability to successfully negotiate FTAs, including the recent regional comprehensive economic partnership (RCEP). While India’s trade policy vis-à-vis FTAs remains beset by impediments, it may be useful to highlight how comparator emerging market economies adapted their trade policies with the evolving nature of FTAs over the last three decades.  

Tariff liberalisation was the core agenda of shallow economic integration that characterised FTAs in the early stages of their evolution into the 1990s. The US-Canada auto pact in 1965, which was among the earliest to offer duty-free access for Canadian auto parts to the North American market, is credited with invigorating the Canadian auto industry.  Similarly, the Thai auto industry developed through participation in the Asean Brand to Brand complementation scheme, introduced in the late 1980s, which offered a preferential tariff margin to select regional economies.

Successive reduction of tariffs in the next decade, coupled with the abolition of local content rules, following the Asian Financial Crisis, and full foreign ownership of automobiles and parts manufacturing helped Thailand outcompete its other Southeast Asian neighbours in attracting Japanese investment and increasing production and export performance. The common effective preferential tariff liberalisation under the Asean free-trade area helped bring the trade-weighted average tariff in the region down to between 0 and 5 per cent by 2010. Asean’s FTAs with its regional neighbours like Japan, Korea, and Australia-New Zealand, all signed in the first decade of the 2000s, included tariff liberalisation commitments in the range of 87 per cent to 99 per cent of all tariff lines. The Asean-India FTA was an exception with less than 80 per cent tariff liberalisation. India’s tariff commitments have invariably been less than the World Trade Organization-mandated liberalisation of “substantially all trade”. Even in its most recent trade deal with Australia concluded in 2022, India has committed to liberalisation of only around 70 per cent of tariff lines as against 100 per cent by Australia.

Subsequently, as there was increasing recognition among developing economies of the advantages of integrating with global value chains (GVCs), FTAs graduated to deep trade agreements. Reflecting the trade-investment-services nexus underlying GVC production, FTAs were designed to include, in addition to tariff liberalisation, trade in services and investment, as well as additional policy areas like intellectual property rights, dispute settlement and competition policy. In these deep trade agreements, the rules of origin (RoOs) are central to GVC-led trade. Stricter rules of origin work against GVC-type of production by effectively restricting the preferential market access offered by an FTA. When combined with cumbersome administrative procedures for obtaining certificates of origin (CoO), preference utilisation in an FTA becomes diminished further. This is particularly relevant in trade in parts and components, underlying GVCs, where value addition at each border crossing may not always be substantive. India has invariably negotiated for a complex set of RoOs in its FTAs by insisting on dual criteria of change in tariff heading/ classification and substantial value addition. Furthermore, in 2020, the change in the Customs Act has made utilisation of FTAs even more burdensome as the importer is now liable for satisfying scrutiny by the government of India on the question of origin of the imported product, over and above obtaining the CoO.

 In contrast, Asean simplified its RoO criteria early in the 2000s, allowing regional cumulation of value-added content to facilitate integration with and development of regional value chains. RoOs of Asean FTAs, as well as of its member states with East Asian economies (for example, Asean-China, Japan-Singapore), are also simple with flexible cumulation rules. The RCEP, with 15 Southeast/ East Asian economies signed in 2020, also includes common and cumulative RoOs to ensure further intensification of economic integration in Southeast/East Asia. India, as we know, citing RoOs as one of the difficult areas, withdrew from the RCEP negotiations in 2019.  

 As for investment liberalisation in FTAs, India draws upon its model bilateral investment treaty (BIT) introduced in 2016. Accordingly, in the investment chapter, India insists on including an investor-state dispute settlement mechanism that is complicated and sequential, making prior exhaustion of local remedies mandatory. Such provisions, while reinforcing the restrictive nature of the FTA, also limits India’s attractiveness as a destination for foreign investment. In contrast, China evolved its BIT with economic development in the country. While the first-generation BITs, concluded between 1982 and 1989, limited dispute resolution to determining the compensation amount in case of expropriation, the next generation BITs also provided for the investor to approach the International Centre for Settlement of Investment Disputes. The third generation BITs of 1998 and after extend beyond compensation amount disputes only and provide for stronger international law protection to foreign investors. China’s BITs are applicable even in the special economic zones (SEZs) just as they are to investors otherwise in the country. SEZs, it may be noted, have contributed a significant proportion of foreign investment and exports in China.

 As for sustainability provisions in FTAs, these have moved from being side agreements in FTAs, such as the NAFTA in 1994, to becoming integral chapters in almost all modern FTAs, driven partly by domestic political priorities given the backlash against trade liberalisation, especially in developed economies. Admittedly, empirical evidence of their positive impact, particularly in the case of labour provisions, is as yet debatable.  However, India’s position of classifying sustainability provisions as “non-trade” issues is also outdated, given the increasing number of FTAs that are including commitments on internationally recognised labour rights and climate cooperation towards fulfilment of sustainable development goals. The Comprehensive and Progressive Trans-Pacific Partnership with four of the Asean economies, including Vietnam, for example, has detailed chapters on both the environment and labour.  
 

 So, accepting that FTAs are both shaped by the global trade context and simultaneously help shape trade rules and outcomes, India must overcome the lag in its trade policy and incorporate necessary flexibilities in its negotiating approach to take full advantage of the FTAs.

The writer is professor of economics, School of International Studies, JNU, and author of India’s Trade Policy in the 21st Century, Routledge: London, 2022. The views are personal