Prioritise deep trade agreements

India's global competitiveness and investment appeal hinge on these agreements

It is encouraging to note that the Ministry of Commerce organised a “Chintan Shivir” last month to develop strategies and standard operating procedures for future free-trade agreement (FTA) negotiations. It is a timely initiative given that negotiations towards deeper FTAs with the European Union and the UK have seen repeated postponements of deadlines, and review of other FTAs, including with the Asean, is yet to be concluded long after initiation.

In this context, it would be useful for India to formulate its FTA strategy with a focus on core issues in deep trade agreements rather than continuing with limited, shallow trade liberalisation as in the past. Developing an understanding of deep FTAs as instruments facilitating movement of intermediate goods across multiple borders, and, hence, integration with global value chains (GVCs) will help yield better outcomes in future FTA negotiations.

The guiding factor in India’s FTA negotiations, thus far, has been the past experience of increasing bilateral trade deficits with FTA partner economies. Consequently, FTA negotiations by India are undertaken with a degree of scepticism. Instead, the appropriate experiential learning from our earlier FTAs should have been to reduce the preferential margin offered in FTAs and increase manufacturing sector export competitiveness. Compared to the global average most favoured nation (MFN) tariffs of 0-5 per cent that ensure negligible preferential margin in FTAs for most economies, India’s relatively high and progressively increasing applied MFN tariffs, especially in the manufacturing sector, inevitably create the scope for a higher preferential margin (clustered around 10-15 per cent) and, hence, bilateral trade in favour of the FTA partner. Therefore, a reduction of average applied MFN tariffs in the manufacturing sector in India and aligning them with those of comparator emerging market economies should be a necessary trade policy reform for future FTA negotiations. This should be combined with carefully calibrated preferential tariffs offered in the FTA such that GVC dynamic sectors are at an advantage. Comparative advantage at the task level, coupled with possible complementarities in the partner country/ member economies’ production networks, should be the basis of calibrating the extent and time schedule for tariff preferences in the FTA. This will also assist India in deepening its tariff liberalisation in the FTAs to the World Trade Organization-stipulated “substantially all trade” levels. 

Manufacturing sector competitiveness can be enhanced through participation in deep FTAs, as they help anchor domestic producers in GVCs. Deep FTAs cover regulatory policy issues in addition to liberalisation of trade in goods and services. Their focus, broadly, is on liberalisation of investment, protection of intellectual property rights (IPRs) and environment, social and governance (ESG) issues. Constituent provisions in these areas are invariably WTO-plus, that is, they extend beyond commitments made at the WTO and/ or include aspects not covered by the WTO.

India has thus far found negotiating the deeper provisions of investment liberalisation and ESG difficult. This has been a limiting issue in its FTA negotiations with both the EU and the UK. The Australia-India economic cooperation and trade agreement, signed in 2022, also does not include an investment chapter. However, globally, the number of deep trade agreements and deeper provisions therein has increased in the last decade. While the EU and the US have been in the lead, the East Asian economies have also upgraded with membership of the Regional Comprehensive Economic Partnership (Rcep) and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Although the coverage and depth of provisions in these areas in deep FTAs has been idiosyncratic and tailored to context, India’s approach of classifying these policy areas as “non-trade” issues and refusing to negotiate is probably outdated and unproductive.  Empirical literature provides evidence that deep trade agreements facilitate the movement of intermediate goods/GVC trade, which continues to be the predominant component of global goods trade post-pandemic and despite trade shocks. Hence, it is important for India to focus on participation in deep trade agreements from the perspectives of increasing its integration with GVCs and facilitating import of intermediate goods to enhance its manufacturing and export competitiveness and even for the success of its production-linked incentive scheme.

Intermediate goods in GVC-led trade are differentiated parts and components, each being highly specialised to its intended use and, therefore, customised to the requirements of the buyer. So, GVC related-investments involving cross-border transactions in differentiated intermediate goods require specific contractual obligations, safeguards and distinctive rules and standards to be negotiated among participant countries. A coordinated and complementary approach towards trade policy, investment and protection of IPRs, given the scope for investment accompanying transfer of technology/ know-how across borders, therefore becomes essential for the multiple countries involved across complex GVCs.

Empirical analysis also shows a positive relationship between additional provisions on investment liberalisation, facilitation, IPRs and investor protection on foreign direct investment (FDI) inflows that are integral to GVC participation. Appropriately designed investment and related regulatory provisions not only help the investment inflows and transfer of technology but also signal commitment towards upgrading the domestic regulatory framework in this respect. There is, therefore, the additional advantage of MFN applicability of the regulatory framework and certainty of business environment. Together with goods and services trade liberalisation, the investment-related provisions in deep FTAs help reduce costs of doing business and trade costs for MNCs operating in multiple locations and production networks. In comparison, standalone bilateral investment treaties (BITs) are a far more restrictive tool and empirical evidence of their impact on FDI inflows has been largely ambiguous.

Negotiating the investment provisions in its FTAs would also require India to evolve its position on the appropriate investor protection mechanism. Most countries have adopted a combination of investor-state dispute settlement and state-state investor protection mechanism, whereas India, drawing upon its model BIT 2016, continues to insist upon exhaustion of domestic remedies as a prior mechanism. However, this may become increasingly difficult as the CPTPP, already in effect, and of which both the Asean and UK are members, enables investors to commence arbitration without any prior recourse to domestic processes. The EU in its FTAs has proposed an alternative akin to a multilateral court for dispute resolution, but this has yet to be ratified.

Therefore, FTA negotiations cannot be business as usual anymore. To be an attractive alternative investment location in the GVC diversification strategy of large corporations and thereby enhance its manufacturing and export competitiveness, India will need to aim for an early conclusion of the deeper trade agreements.

The writer is senior fellow, CSEP, professor, SIS, JNU (on leave) and author of India’s Trade Policy in the 21st Century, Routledge: London, 2022. The views are personal