Who will India trade with?

Regional consolidation of trade may leave India out in the cold

Global trade seems to be getting consolidated along regional contours. Selective and exclusionary trade policies are gaining ground, especially in major regional trade blocs such as North America and the European Union. The phenomenon that was triggered by trade tensions between the United States and China in 2018 is becoming more widespread following the pandemic and the Russian invasion of Ukraine. The imposition of higher tariffs on select commodity exports by the US in 2018 played out largely as a bilateral phenomenon driven mainly by trade imbalance in favour of China and the “bring jobs back home” sentiment that had ramifications for domestic politics in the US.
 

While this unilateral action by the US was in violation of the most-favoured nation (MFN) principle of the WTO, it had limited implications for other economies.
 

The subsequent events, the pandemic and Ukraine crisis, could have far more severe, long-lasting and deeper ramifications for global trade. Both events hit, most severely, the fundamental mechanism underlying global trade, that is, the global value chains (GVCs). The pandemic’s wave-like spread and the timing and severity of the lockdowns, most significantly the zero-Covid policy of China, led to the unravelling of GVCs. Their vulnerability due to single source dependency for inputs and assembly production on the “factory of the world”, China, stands highlighted. The “China plus one” strategy of GVC diversification that had been set in motion after the global financial crisis but had progressed in slow motion gained significant momentum as a result of the pandemic.
 

The Ukraine crisis, while aggravating these concerns, has added a strategic dimension to GVC diversification and re-structuring. Geo-political considerations are now the underlying factors in making GVCs resilient, and identification of safe, secure, “friendly” nations as alternative locations is being undertaken often at the expense of efficiency and low-cost production. Trade policy is now often deployed widely towards strategic autonomy and national security. Strategic autonomy, interpreted as reduced dependency, involves classification of  “concentrated risk” and “critical” and strategic products/sectors including high technology, environment and energy. The Inflation Reduction Act (IRA) in the US and the Carbon Border Adjustment Mechanism (CBAM) in the EU, as passed in 2022, are prime examples of such strategies that, while enabling diversification away from the “concentrated risk”, also have the potential to lead to intensification of trade and economic integration in regional blocs and alliances that are more inward-looking.
 

The CBAM, while ostensibly an attempt to align trade rules with climate change mitigation and make prices more accurate indicators of carbon content of imported products, effectively implies trade and production getting located in countries with similar high-grade climate policies and EU-compatible climate regulatory framework. The imposition of tariff on carbon-intensive imports in the identified product groups like cement, electricity, aluminium, iron and steel, fertilisers and hydrogen while enabling diversification away from concentrated risk countries (China and Russia among others) also leaves other developing and least developed economies at an inherent disadvantage given their lower capabilities to fulfill the carbon-emission requirements and/ or less stringent climate policies. The inherently discriminatory nature of the CBAM, in apparent contradiction with the MFN principle of the WTO, also creates potential possibilities of retaliatory protectionist trade measures by the affected exporters.
 

Similarly, the IRA in the US addresses environmental concerns and supports energy security. However, the local content rules (LCR) provisions in the Act reveal the underlying motivation to favour domestic manufacturing in the US, encourage near-shoring and friend-shoring of supply chains towards further deeper integration in North America and diversification away from sources classified as “concentrated risk”. The North American producers in the electric vehicles (EVs) sector are favoured with the rules of origin (RoOs) specified such that the tax credits on EVs are linked to (a) mineral content of batteries that is extracted in the US or its free-trade agreement (FTA) partners or recycled in the US and (b) to components’ value being assembled in North America. It is also indicated that the percentage requirements for both, mineral content and component value, linked to tax credits will increase over time. Notably, tax credits will not be applicable for components coming from “foreign entities of concern”. Clearly, a means to strengthen the North American value chain in the EVs sector, the IRA undermines the rules-based multilateral order, not just in terms of the MFN principle but also on the WTO criteria for preferential trade agreements.
 

The third regional trade bloc of ASEAN-East Asia is also progressing towards higher levels of economic integration. Unlike the EU and North America, the Asian economic integration process is deepening with the WTO-compatible, mega regional trade agreements — the Regional Comprehensive and Economic Partnership (RCEP) and the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP). The cumulative, common RoOs coupled with the streamlined regulatory procedures, technical regulations, standards and trade remedies will all contribute towards deeper economic integration in Asia. The RCEP, operationalised in January 2022, and while including several flexibilities and varying time lines that are accommodative of member economies’ developmental differences, has built-in provisions towards deeper integration over time. Furthermore, with seven members of the RCEP overlapping with the more rigorous and higher order CPTPP that is already in force in the region, the strengthening of economic integration in the Asian trade bloc seems inevitable.
 

Notwithstanding the potential challenges — technical, methodological and institutional — that may stall or delay the implementation of the EU or US initiatives, it is undeniable that the trend towards regional consolidation of trade in Asia and inward-looking and discriminatory trade and value chains in the EU and North America is an emerging reality.
 

This developing context, therefore, raises the big question: Who will India trade with in the medium- and long-run? Not having acceded to the RCEP, not having applied yet for membership of the CPTPP, the trade agreement with the EU still only under negotiation and an FTA with the US not even under consideration, may just leave India out in the cold. There is therefore an urgent need to re-think our vision for a viable, growth enhancing trade policy beyond the short run.

The writer is professor of economics, School of International Studies, JNU. The views are personal