Making FTAs happen

Though the prime minister is keen on establishing free trade areas (FTAs), it appears that both the Thailand and the Singapore ones have run into some trouble, with some parts of the government insisting that stiff 'local content rules' be maintained, ostensibly to prevent a rush of third-country imports through the FTA partner countries.

While that would suit large parts of the Indian industry, such as the auto components manufacturers who feel this is the thin end of the wedge, the prime minister's office's argument is: if imports are to be restricted so severely, what is the point of the FTAs?

And, in any case, if India's import duties are to be brought down to Asean levels by 2005, as foreign secretary Kanwal Sibal had stated when the Bali agreement was signed, having high local content requirements may indeed be counter-productive.

Indeed, it runs counter to the very idea of specialisation in manufacturing and using countries as outsourcing hubs.

If India, for instance, becomes a global outsourcing base for small cars, this means its manufacturers will have to import other car models, even parts, from different countries.

Now, if high local content norms are to restrict this, the very process of specialisation gets hit. Another issue that has been paid lip service all these years, but is now critical, is the distorting role of state taxes and other levies.

All together, various calculations suggest, taxes at the central and state levels comprise anywhere between 20 and 25 per cent of the cost of a product.

Now, while lower import duties through an FTA or whatever are clearly desirable, the government just has to make serious efforts at fixing this imbalance between local and imported products.

So, for the FTAs to work, it would be necessary to have a comprehensive value added tax (VAT) legislation that covers all forms of tax.

Similarly, unless the much-talked of 'second-generation' reforms take place (in terms of allowing units to close down, labour to be laid off, land acquisition to be speeded up, etc.), it's difficult to see just how local firms are going to be able to compete efficiently.

This is not to suggest that the FTA process be held back till the reforms happen, but to point out that the next government needs to work on this area at break-neck speed.

A repeat of the situation where the implementation of VAT has been put off twice already simply cannot be allowed.

As for the second generation reforms, it's pointless expecting a government just about to fight a major election to do anything. That is usually a luxury only a newly-appointed government has.

This, in fact, is the big advantage of the FTAs that the prime minister is signing. It forces the government's hand in terms of pushing reforms. That, needless to say, is precisely what the Chinese strategy was while joining the WTO.