Shying from multilateral trade bodes ill for GDP growth

After pulling out of the China-led Regional Comprehensive Economic Partnership (RCEP) in 2019, India pulled out of the trade a part of the U.S.-led Indo-Pacific Economic Framework (IPEF) earlier this month. If the RECP is a mega trading bloc of 15 Asian countries contributing 30% to global GDP and accounting for more than 25% global trade in goods and services, the IPEF is even bigger with its 14 members contributing 40% to global GDP and 28% to global trade in goods and services.

Pulling out of the IPEF’s trade pillar is inscrutable, particularly since it is an outcome of the anti-China strategic grouping, called Quadrilateral Strategic Dialogue or Quad, of which India is a willing and enthusiastic member. The others are the US, Australia and Japan. India had pulled out of the RCEP to protect domestic industries from imports, particularly from China. The reason for the pull-out from IPEF is vague and unconvincing. Commerce and Industry Minister Piyush Goyal said: “We have yet to see what benefits member countries will derive…” But the other 13 countries didn’t go by such logic. It’s intriguing when Goyal said India was keeping its option open or that India was part of three other IPEF pillars involving supply chains, tax and anti-corruption and clean energy.

Staying out of mega multilateral trade pacts is unwise as it would harm India’s trade and growth, notwithstanding bilateral free trade agreements (FTAs) with one country at a time. Bilateral FTAs are, by design and definition, limited in scope and restricted to fewer items. The incongruity in India’s approach to trade is conspicuous but very worrisome and calls for a rethink.

Joining global supply/value chains without trade?

It is amazing that India wishes to join global supply and value chains with limited trade with big and powerful trading blocs – as is the case with its approach to the IPEF. Supply or value chains are intrinsic to trade, not silos operating on their own to achieve some standalone goals.

For example, take the case of the US major Apple’s decision to shift manufacturing of iPhones out of China. Would it shift to India when it already has a manufacturing presence in Vietnam, which has a better manufacturing environment than India in any case, and which is also part of the IPEF’s trade pillar? Similarly, the US import of textile and apparel from Vietnam is higher and has been growing faster than that from India in recent years. Going forward, why would the US change the equations and prefer India over Vietnam?

That trade and supply/value chains are intrinsic is undisputed. Economist and trade expert Nisha Taneja of the ICRIER says Vietnam and Bangladesh export more textile and apparel than India because these countries have achieved “greater integration” with global value chains. A 2016 study of the Dhaka University on Bangladesh’s export growth in textile and apparel, “The Effect of Integration with Global Apparel Value Chain: The Case of Bangladesh Apparel Industry”, is even more relevant for India. It says, “a firm’s integration with the global apparel value chain, not the conventional backward linkage with domestic suppliers, that defines success of Bangladesh apparel industry in a globalising world”.

What it says is that not just forward linkages or integration with global supply/value chains, but even backward linkages or integration with global supply/value chains are critical for higher exports and exports-led growth.

But trust India’s Ministry of Textiles to fall back to protectionism in the name of “Make in India”, in its “Vision 2024-25” document. It calls to develop the conventional backward integration, rather than backward integration with global value chains to drive manufacturing (as against Bangladesh’s experience).

What logic and evidence drives Indian trade and value chain policies? Indian policymakers would do well to know that Vietnam and Bangladesh have left India behind (apart from China) in global exports in textile and apparel even though (i) neither Vietnam nor Bangladesh is in top 10 cotton producing list, while India is (along with China) and (ii) neither Vietnam nor Bangladesh is in top 10 synthetic fibre (yarn or staple) producers either, while India is (along with China).

These two, cotton and artificial/synthetic fibre, are the primary raw materials for the textile and apparel sector. This sector happens to be labour intensive, which India needs to boost urgently to address the chronic and severe job crisis.

This contradiction between the urge to avoid multilateral trade while keen to join global value chain emerges from the very concept of “Aatmanirbhar Bharat”, first publicly spelt out in May 2022 by the Prime Minister and which embodies his two slogans “vocal for local” (protectionism or import substitution) and “local for global” (part of global value chains).^[ix] For him, “‘Aatmanirbhar Bharat’ is about transforming India from being a passive market to an active manufacturing hub at the heart of global value chains.”

But that is more of a wishful thinking, not a sound policy based on facts and evidence.

Although first spelt out in 2020, the “AatmaNirbhar Bharat” project has been in the making since 2014, as former CEA Arvind Subramanian had pointed out, stating that India reversed its trade policy then to reintroduce protectionism. Beginning with 2014, India raised import tariff of 60% or 3,200 product categories, out of 5,300 products traded with the Most Favoured Nations (MFN), which is governed by the WTO. The average tariff rose from 13% in 2014 to 17.9% in 2020, impacting about $300 billion or about 70% of total MFN imports. The practice endures with both the budgets of 2021 and 2022 raising import tariff on several more items. Outside budgets too import tariff has been rising. For example, import duty on gold was raised from 7.5% to 12.5% in July this year. Then, there are sundry bans on wheat, steel, iron pellets and lately, broken rice etc.

These are very anti-thesis of sound (predictability and stability in) trade and tariff policies.

Higher emphasis on bilateral FTA

India is now laying greater emphasis on bilateral FTAs, as against multilateral FTAs that the RCEP and IBEF represent. It has gone on to sign bilateral FTAs with the UAE and Australia and is negotiating with the UK, Canada as well as the European Union (EU).

Interestingly, Vietnam, Australia and Japan are part of both the RCEP and IPEF.

Ask trade experts and they would say no evidence (study) exists to suggest that bilateral FTAs are better than multilateral FTAs for boosting trade or growth. In fact, bilateral FTAs are a burden. Each country would need to negotiate and carry trade in every item separately. Each bilateral FTA would have its separate terms and conditions to govern the trade. Every time a country decides to import or export an item, it would have to look at (excel) spreadsheets to know which tax rate and which governing conditions best suits its need at any given time. The spreadsheets would also have to be periodically updated to incorporate changes in tax rates and governance norms for each country.

On the other hand, multilateral FTAs provide one template (tax and governance) to deal with multiple items with multiple countries at the same time – 13 for IPEF and 15 for IPEF, controlling 70% of global GDP and over 50% of global trade in goods and services.

India’s contribution to global GDP is mere 3.5% and its’ share in global trade is insignificant too – 1.57% in exports and 2.1% in imports in 2020. Therefore, it makes better sense for any bilateral FTA partner of India to prefer trade with the RCEP and IPEF. That is another drawback for India.

Interestingly, India is also renegotiating FTA with the European Union (EU), suggesting it may not be averse to multilateral trade but needs it to suit its requirement. But such a contradictory move is difficult to fathom because India doesn’t have a clear and stated policy on trade.

The Economic Survey of 2021-22 seemed to suggest that India was re-negotiating bilateral and regional FTAs to ramp up exports because despite diversifying its export destinations in last 25 years, “more than 40 per cent of India’s exports is still accounted by only seven countries”. But that sheds little light on the apparently contradictory approach to trade.

NITI Aayog’s 2018 report “A note on free trade agreements and other costs” said existing FTAs had led to more imports than exports and India’s trade deficits with ASEAN, Korea and Japan have widened post-FTAs. It talked about “unfavorable gains” to trade partners and “worsening” trade balances with FTA partners.

But it didn’t explain how the trend can be reversed with protectionism on and without making domestic companies globally competitive or India becoming part of global value chains.

China and Russia factors

In spite of withdrawing from the RCEP in 2019 for the fear of China and actively discouraging trade with it in the past few years, India’s dependence on China has only grown, pointing to the futility of withdrawing from the multilateral trade agreement.

According to official data, Indian imports from China, as percentage of the total imports, have risen from 13.5% in FY15 to 15.4% in FY22 (it was 13.7% in FY19) – or from $60.4 billion in FY15 to $94.6.2 billion in FY22. Exports to China remains low and has gone up from 3.85% of the total exports in FY15 to 5% in FY22 – or from $11.9 billion to $21.3 billion. As a result, India’s trade deficit with China has seen a quantum jump from $48.5 billion in FY15 to a whopping $73 billion in FY22.

The trend continues in FY23. During April-June 2022 (four months), India’s imports from China stood at $34.5 billion or 13.5% of total imports and exports at $5.9 billion or 3.7% of the total exports. The deficit, thus, is at $28.6 billion.

India’s total trade deficit has also grown over the years from -1.48% of the GDP in FY15 to -4.8% in FY22 – indicating that India has failed to boost exports to drive growth and also the failure of its trade protectionism. This failure is also evident from the fact that from a peak of about 25% or more of the GDP during FY12-FY14, exports fell to 22% in FY22 (even as exports crossed $422 billion to create a record in FY22). The trend in FY23 is unlikely to be different. Already, in July 2022, trade deficit touched a record high of $30 billion. In August, it came down a bit to $28.7 billion, as imports climbed to $61.7 billion but exports declined to $33 billion – repeating the old pattern.

Significance of trade to growth

The significance of exports to growth was spelt out by former CEA Arvind Subramanian in an article (co-authored), “India’s export opportunities could be significant even in a post-COVID world” in 2020. It argued: “India's GDP growth of over 6 per cent after 1991 was associated with real export growth of about 11 per cent. Pre-1991, a 3.5 per cent growth rate, was associated with export growth of about 4.5 per cent. There is no known model of domestic demand/consumption-led growth, anywhere or at any time, that has delivered quick, sustained, and high (say 6 plus) rates of economic growth for developing countries.”

“Nominal” growth in India’s exports in the past 10 fiscal of FY13-FY22 is just 4.4%. What GDP growth will it bring?

Meanwhile, the Russia-Ukraine war has brought more trouble to Indian trade. The trade between India and Russia boomed in the post-war phase as Russia offered oil and other commodities (fertilizer is a big item) at discounted prices. India encouraged rupee trade with it. But Russia now wants payment in ruble (until now, it was in USD) – jeopardizing trade as neither the Indian government nor businesses have adequate ruble reserves or access to it.

Besides, global recession is looming large – which will dry up global demand.

In such circumstances, India should act wise and listen to Subramanian and his co-author (mentioned earlier). They argued: “If domestic producers are competitive internationally, they will be competitive domestically and domestic consumers and firms will also benefit. The reverse is not true: Being competitive only domestically is no guarantee of efficiency and low cost”.