Trade Pacts: Tread Carefully

Text : T Murrali

Partners for Trade Agreements have to be chosen carefully considering the potential for mutual trade and economic co-operation. Economic factors should be the basis for any decision on Free Trade Agreements (FTA). Decisions based on factors other than business and economics would be inequitable, benefiting only one partner. The FTA partners should be complementary and not competing markets.

Trade Agreements help manoeuvre the run of the free market economy in desired directions and reach mutually beneficial targets without major mishaps. India has so far signed 19 trade agreements including about 10 (see table) relating to automotive industry. It is pertinent to take a close look at their real time impact and draw lessons for future agreements, especially for finalising the proposed FTA with the European Union (EU).

Studies have shown that adhering to the complex rules of origin to get preferential tariff treatment under Preferential Trade Agreements (PTAs) or Free Trade Agreements (FTAs) have paved the way for increased transaction cost and consequently lower net realisation from trade. Hence there had been only limited trade routed through PTAs.

According to Asian Development Bank, India’s PTAs range from 5% to 25%. Therefore, a consensus-based multilateral trade regime under the WTO framework might be better for India.

Disadvantage India

India seems to be a victim in most of the FTAs rather than a collaborator. Director General of the Society of Indian Automobile Manufacturers (SIAM) Vishnu Mathur says that India’s FTAs in the last decade have largely been with competing economies. They have, therefore, put the Indian industry at a comparative disadvantage in many sectors. The defensive position of industry makes it difficult for the negotiators to extract the best deal for the country.

FTAs in the auto sector, done earlier with SAARC, where all the neighbouring countries are big markets for India, have been one-sided. India allowed these countries access to its market. But they did not reciprocate. For example, Sri Lanka, which till recently has been a major export destination, increased import duty, affecting the large US $ 700-million export of the Indian auto sector.

FTAs help the end-customers as they get products at cheaper prices, says Vijay Kakade, Vice President, Automotive & Transportation Practice, Frost & Sullivan. But they have made some imported components cheaper than the locally manufactured products. Imports of auto components have increased 20-25%. FTAs have led to dumping of goods and created inverted tax structures. An inverted duty structure emerges when import duties on finished products are lower than those on parts and raw materials. This in effect encourages imports of goods rather than imports of parts and inputs for local manufacturing. Taking a cue from the rubber industry, Kakade says while the import duty on finished rubber products is between 0 and 10%, it is 5% to 70% on rubber industry raw materials.

Mathur says that FTA with ASEAN is another case in point. “While some of the ASEAN countries are large potential markets for the Indian auto industry, we had a defensive position only with some others who are our competitors. They are the manufacturing arms of some MNCs. The negotiations happened in such a way that while each of the ASEAN market gave separate negative lists, India gave a common negative list for all the ASEAN markets. India’s negative list was based on the sensitivity to ASEAN countries only. Therefore the Indian industry was unable to utilise the FTA for the positive export agenda with the rest of the ASEAN markets’’.

History is repeating itself in the Regional Comprehensive Economic Partnership (RCEP) negotiations where the auto-industry would have extreme sensitivity with a few RCEP countries and a positive export agenda with the others.

The Executive Director of Automotive Components Manufacturers Association (ACMA) of India, Vinnie Mehta, states that, “ACMA favours free trade and considers FTAs as a vehicle for free trade. However such agreements should benefit both the signatories and not one. Till date, of the various trade agreements that India has signed, none has benefitted us. As the import duty on auto components in the countries that we have signed the FTAs is lower than that of ours, they have not brought any additional benefit to the Indian auto component industry. India, by reducing its import tariffs, allows cheaper imports from other countries.”

Need for a level-playing field

There are about 20 trade agreements on the negotiation table. They include the Indo-EU, RCEP, India -Australia and India-GCC. Hastening FTAs without creating a level-playing field for domestic businesses will never propel India’s exports. It is necessary to take into account the negative impact of the multilateral Information Technology Agreement that India signed in 1997. Duties on final goods were removed. This catalysed software sector growth. However, it stifled the growth of the indigenous electronics and computer hardware industry.

Therefore, trade agreements should make both the parties complementary to each other. Kakade suggests that in any FTA the duty levied on those raw materials not produced in the country must be given exceptions, to help local manufacturing add value.

Mehta wants the Union government to sign trade agreements with the highly protected markets such as Mexico, Brazil, South Africa and West Asian countries. “These countries are the potential markets for the Indian auto component industry and will benefit the Indian industry,” he says.

The countries that do not have a local automotive industry and import auto products from other countries would be ideal, says Mathur. Irrespective of the country to be associated with, the trade agreements should be thrifty and need to give a level- playing field for both the countries, he adds.

Mathur says that the FTA partners have to be chosen carefully considering the potential for mutual trade and economic co-operation. Economic factors should be the basis for any decision on FTA. Decisions based on factors other than business and economics would be inequitable, benefitting only one partner. The FTA partners should be complementary and not competing markets. “We would like to see government working out an FTA so that we could pursue our export interest with our markets and defend ourselves from our competitors,” Mathur says.

FTA with European Union

Among the pending trade agreements, one with the European Union (EU) is the most sensitive. So far, 15 rounds of negotiations have been held alternately in Brussels and New Delhi. Several unresolved issues have been preventing its progress.

Last year the then Prime Minister Manmohan Singh visited Germany with plans to finalise the contours of the India-EU Free Trade Agreement. This FTA negotiation for a broad-based Bilateral Trade and Investment Agreement (BTIA) began in Brussels, Belgium, on June 28, 2007.

These negotiations were pursuant to the commitment made by political leaders at the 7th India-EU Summit held in Helsinki on October 13, 2006, on the basis of the report of India-EU High Level Technical Group.

The negotiations cover trade in goods and services, investment, sanitary and phytosanitary measures, technical barriers to trade, trade remedies, rules of origin, customs and trade facilitation, competition, defense trade, government procurement, dispute settlement, intellectual property rights & geographical indications and sustainable development.

Both the parties believe that a comprehensive and ambitious agreement, consistent with WTO rules and principles, would open new markets and expand opportunities for Indian and EU businesses.

The European car companies want the agreement through as early as possible to push their uber-luxury cars with minimum hurdles. The EU is said to be pushing for a concessional rate, say half of the existing import duty on CBUs that currently comes under 60% tariff rate.

If this is allowed, the European car companies will refrain from investing in a manufacturing facility in India while grabbing the market by paying just 30% duty. The pressure appears to be mainly from Germany as most of these luxury car companies are based there.

Mathur says that the European Union is a major automotive powerhouse. Some of the world’s largest vehicle manufacturers are based out of EU. Today the EU produces about 15 million cars every year as against 2.5 million cars by India. Most of the state-of-the-art automotive technologies currently reside in the developed markets like the US, EU and Japan. However, these automotive markets are fast becoming saturated and are looking at the high-growth markets of Asia, especially India, the largest free market.

Caution, risky road ahead

Automotive industry is apprehensive about an Indo-EU FTA and they caution about the risky road ahead. Mathur has highlighted three major distortions that an Indo-EU FTA
can create in the domestic automotive market:

There would be unfair advantage for a section of players in the Indian domestic market vis-à-vis other players who have made much heavier investments in the country, have been using India as an export base and have operated in the Indian market for a long time. This could seriously impact on their domestic competitiveness.

The proposed India-EU FTA has significant implications on trade and manufacturing of both the sides. For passenger cars, EU’s Most Favoured Nation (MFN) duty rate is 10% against India’s import duty rate of 60% to 100%. Obviously, India will not gain much by further reduction of EU duties for cars locally made but if Indian duties are reduced by even 50%, it will be a substantial reduction in tariff. The gains will not be for India.

Considering the trade figures and the diminishing future export potential to EU, a reduction of tariff for CBUs under India-EU FTA, will be a total reversal of the policy of high tariffs to induce investment, local manufacturing, value addition and employment. It will not result in any incremental market access to the Indian auto-manufacturers.

Auto sector needs tariff protection

EU is demanding heavy duty cuts to ensure sale of its automobiles. Kakade says that the auto industry in India is strongly opposed to it. About 25,000 cars are to be exempt from duty and above this number there is a lesser tax slab. This would lead to flooding of the Indian market with cars (now CBU imports are taxed 125%). Also some imported components would become cheaper than the locally manufactured ones, nullifying the competitive edge of local suppliers.

Any liberal car imports from EU may affect the country from a different perspective. The SUVs powered by high capacity engines are fuel guzzlers and primarily run on diesel. India may not want to incentivise this, as the diesel subsidy has been hitting hard the country’s economy.

Mathur says that, “India is perhaps the most open economy for the automotive industry. Our strategy has been to offer free market access to any MNC through the investment route though not through trade. Such policies would encourage local manufacturing, value addition and technology absorption. In the absence of any mandatory localisation policy or other NTBs, which are non-compliant with WTO, we are left only with tariff protection. This has to be preserved at least till the OEMs in India reach globally viable scales and maturity. This rationale has been accepted by the government in all the earlier FTAs.”

The import duty on CKD and SKD kits is between 10% and 30% and if the EU proposal is accepted, CBU rates will fall to that of CKD thus disincentivising even limited assembly operations in India. It may become a double-whammy due to the other proposal, which is to lower duty on used cars. The EU wants ‘non-new goods’ be treated on a par with new goods. This can lead to the country being flooded with used cars junked by the European customers.

Over the last 10 years, the Indian market has developed its own price equilibrium in each segment of vehicles. Allowing some car brands to import CBUs at lower duty will disturb this segment-wise pricing equilibrium which can seriously hurt some of the largest automotive players in the country.

There is a perception that inclusion of automotive CBUs in the Indo-EU FTA would help in increasing exports of small cars from India to EU. Various reports emanating from the EU state that while India is exporting 300,000 cars to the EU, export of cars by EU to India is only 6,000, implying that there is a large positive trade balance in favour of India.

“Nothing can be further from the truth,” Mathur says. Quoting the trade data of the Ministry of Commerce, he says that in 2010-11, EU exported USD 3.4 billion automotive products to India including USD 400 million worth of car CBUs. Remaining items were mainly car CKDs which are nothing but unassembled cars that are classified as auto components. On the other hand, India’s car export to EU is valued at USD 1.7 billion worth of CBUs. India does not export any CKDs to EU.

While India exports mostly small cars to EU with an average price of Euro 6,000 – 7,000, the cars being exported by EU to India are large luxury cars costing Euro 20,000 and above. This makes the trade balance hugely in favour of the EU even without the FTA being operational. If duties on car CBUs are reduced under the FTA, this trade imbalance in favour of EU will only be further enhanced at the cost of domestic value addition.

Imports of CBUs from EU actually increased from 5,000 large cars in 2009-10 to 11,000 in 2010-11. Imports of CKDs increased from 17,000 numbers in 2009-10 to 22,000 in 2010-11. However, during the same period exports of small cars from India declined from about 300,000 in 2009-10 to around 225,000 in 2010-11. These exports were also mainly as a result of the European scrappage scheme which spiked export of Indian small cars to EU in 2008-09 and 2009-10. The future potential of small car export from India to EU is much less as this scrappage policy has since been discontinued by EU.

Automotive products export of EU to India grew by 51% last year, including 109% growth in car exports. This is against 11% growth in import of automotive products from India to EU and (-) 15% in cars. If under FTA, a 3% reduction in tariff is
made by EU and a 30-40% by India, this chasm would further widen against India.

And finally, Mathur says, “if the duties on automotive CBUs are reduced under the Indo-EU FTA, the same facility would be demanded by Japan, Korea and ASEAN. This will in effect reduce CBU duties for most of the auto-producing countries in the world. This may also lead to opening the door for duty reduction on MFN basis. If that happens, it will be disastrous for the domestic manufacturers who have entered the global arena only recently’’. ACI

Trade Agreements : Under Negotiation

1 India – ASEAN (Services and Investment) ASEAN

2 RCEP (Regional Comprehensive 16 Member Nations (ASEAN + China, Australia, New

Economic Partnership) Zealand, Korea, Japan & India)

3 India – Australia Australia

4 Bay of Bengal Initiative for Multi-Sectoral 7 Member Nations : Bangladesh, India, Myanmar,

Technical and Economic Cooperation Thailand, Sri Lanka, Bhutan, Nepal

(BIMSTEC)

5 India – Bangladesh Bangladesh

6 India – Canada Canada

7 India – Colombia Colombia

8 India – European Free Trade 4 Member Nations : Liechtenstein, Iceland, Norway

Association (EFTA) and Switzerland

9 India – European Union 28 Member Nations: Austria, Belgium, Bulgaria,

Croatia, Cyprus, Czech Republic, Denmark, Estonia,

Finland, France, Germany, Greece, Hungary, Ireland,

Italy, Latvia, Lithuania, Luxembourg, Malta,

Netherlands, Poland, Portugal, Romania, Slovakia,

Slovenia, Spain, Sweden, United Kingdom

10 India – Gulf Cooperation Council 6 Member Nations : Bahrain, Saudi Arabia, Oman,

Qatar, Kuwait and UAE

11 India – Indonesia Indonesia

12 India – Israel Israel

13 India – Mauritius Mauritius

14 India – New Zealand New Zealand

15 India – South African Customs Union 5 Member Nations: Bostswana, Lesotho, Nambia,

Swaziland & South Africa

16 India – Sri Lanka Sri Lanka

17 India – Thailand Thailand

18 India – Uruguay Uruguay

19 India – Venezuela Venezuela

Source: Acma

S. No Agreements already concluded Countries Date of Signing Date of

of the Agreement Implementation

1 India – Thailand Early Harvest Thailand 01.09.2004 01.09.2004

Scheme (EHS) under the

Framework Agreement

2 India – Singapore Singapore 29.06.2005 01.08.2005

Comprehensive Economic

Cooperation Agreement

3 Agreement on South 8 Member Nations: 04.01.2004 01.01.2006

Asia Free Trade Bangladesh, Bhutan,

Area (SAFTA) India, Maldives,

Nepal, Pakistan,

Afghanistan and

Sri Lanka

4 Asia-Pacific Trade Agreement Nations: Bangladesh, 01.06.1975 01.09.2006

(APTA) formerly known as the China, India,

Bangkok Agreement 5 Member Republic of Korea,

Sri Lanka

5 India – Chile Preferential Chile 08.03.2006 11.09.2007

Trade Agreement

6 India – MERCOSUR Preferential 4 Member Nations:

Trade Agreement Argentina, Brazil,

Paraguay, Uruguay 25.01.2004 01.06.2009

7 Trade in Goods under the India 10 Member Nations: 13.08.2009 01.01.2010

– ASEAN Comprehensive Brunei Darussalam,

Economic Agreement Cambodia, Indonesia,

Laos, Malaysia,

Myanmar, Philippines,

Singapore, Thailand,

Vietnam

8 India – Korea Comprehensive South Korea of 07.08. 2009 01.01.2010

Economic Partnership Republic

Agreement

9 India-Malaysia Malaysia 18.02. 2011 01.07.2011

Comprehensive Economic

Corporation Agreement

10 India-Japan Comprehensive Japan 16.02.2011 01.08.2011

Economic Partnership

Agreement

Source: Acma

Top 10 countries of import as a % of total auto
component imports to India- 2013

1. China 20.97 6. USA 6.29

2. Germany 14.97 7. Italy 3.65

3. Japan 12.44 8. UK 3.42

4. South Korea 11.97 9. France 2.26

5. Thailand 7.46 10. Spain 2.17

Top 10 countries of export as a % of total auto
component exports from India – 2013

1. USA 20.50 6. Brazil 4.03

2. Germany 8.08 7. Thailand 3.41

3. UK 6.16 8. France 3.32

4. Mexico 5.20 9. South Africa 3.04

5. Turkey 4.93 10. China 2.77