Sunday, 5 January 2014

Shutting doors on FTAs is a bad idea, push through reforms instead

News of finance minister P Chidambaram and chairman of the National Manufacturing Competitiveness Council, V Krishnamurthy, speaking out against India’s growing penchant for free-trade agreements (FTAs) invited a quick clarification from the commerce ministry.
Yesterday, The Times of India reported that Chidambaram and Krishnamurthy differed with Planning Commission Deputy Chairman Montek Singh Ahluwalia on the benefits of FTAs. According to the report, both Chidambaram and Krishnamurthy said FTAs had not been advantageous for India.
By evening the commerce ministry put out a press release pointing out that the effects of FTAs had not been as detrimental as they have often been made out to be and that there is an in-built mechanism of review in all agreements.
The last paragraph of the press release was a gentle rebuke – “. . . Indian exports to different regions are crucially dependent on competitiveness which is guided by other factors such as ushering in the second generation reforms on taxation, rolling out of GST, reform in labour laws, upgradation of infrastructure relating to power, ports and roads.”
Indeed, the lament over FTAs is really a lament over the complete lack of competitiveness of Indian industry and hence of its exports. That is why import of goods at zero or low duties under FTAs are possible and hurt domestic manufacturers (though the consumer benefits) even as Indian goods are not able to make significant inroads into markets that are now open to them.
Interestingly, Indian companies are using the FTA route innovatively, setting up manufacturing bases in countries with which India has signed these agreements and then importing the finished goods under the low duty regime. They do this for two reasons. One, the raw materials are available in those countries and importing them are costly. Two, it is easier to do business in those countries.
It is not as if Chidambaram and Krishnamurthy are not aware of this fundamental problem. Way back in 2006, The National Strategy for Manufacturing document put out by NMCC noted that “in order to attain competitive edge in manufacturing the constraints being faced by the sector have to be mitigated.” It then listed some ‘generic issues’ – lack of proper infrastructure, higher transaction costs, higher interest rates, inadequate power and other disabilities and regulatory issues, among others – that it would take up.
The report also notes that India suffers on competitiveness due to various factors such as higher import duties, including inverted duty structure; higher incidence of indirect taxes; sub-optimal levels of operations; lower operational efficiencies; higher transaction costs; lower labour productivity; higher cost of capital; and inadequate infrastructure. Taken together all of these are estimated to push up the cost of Indian manufacturing by between 15 percent and 30 percent.
Needless to say, keeping the cost of manufacturing low is the first step to being competitive. Chidambaram can address some of these issues – those relating to taxation and cost of capital - as they fall within the purview of the finance ministry. What is preventing him from doing so?
The solutions to the other problems are also well known and have been repeated any number of times for more than a decade now by economists, chambers of commerce, global consultancy firms and, yes, even by NMCC.
It is a telling comment on economic policy making in India that there has been no progress on these, with successive governments putting them on the backburner. By lowering import duties, without addressing these issues, FTAs can hurt domestic industry really badly. But using the poor competitiveness of Indian industry – because of bad policies – to stall FTAs is not the right remedy, since the country will lose out on the benefits they bring. And even if we take that approach, there is always multilateral trade liberalisation through the World Trade Organisation (WTO) to deal with.
Another WTO ministerial is scheduled for December in Bali and it is not clear which way it will go. If the Doha Round gets revived, then countries will have to prepare themselves for greater trade openness. If the deadlock continues, the popularity of FTAs (which became the preferred route to trade liberalisation because of the WTO logjam) will increase. Either way, it is clear that we are getting into a scenario of greater integration with the world economy. It has its advantages and disadvantages. It is necessary to maximise the first and minimise the other.
For India, both require a very strong dose of internal economic reforms. There is simply no getting away from this – for either this government or any government that comes to power after the next general elections.

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