Demystifying India-China Trade Possibilities

Policy Brief

Photo: Frederick Noronha

September 2011

Developing India

Demystifying India-China Trade Possibilities Should India sign a free-trade agreement with China? V Anantha Nageswaran & Ritwick Ghosh Geopolitics & Foreign Policy Programme

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Contents Executive Summary

3

Section 1: China’s remarkable transformation

4

1.1 China and the WTO

4

1.2 China’s search for FTA

7

1.3 China and trade barriers

Section 2: Is India’s manufacturing sector prepared?

10

19

2.1 Indian manufacturing

19

2.2 Can trade help improve manufacturing competitiveness?

30

Section 3: India in an FTA with China: Unreal possibility 3.1 Enforcement

35 35

3.2 The trickle-down effect on communities could be negligible 36 3.3 But there are benefits to India

Section 4: What is needed from here on?

38

44

4.1 Summing up

44

4.2 The other steps

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

EXECUTIVE SUMMARY An Indian proverb rings true of the economic ties between India and China - ‘for the friendship of two, the patience of one is required’. The time is not yet ripe for an IndiaChina free-trade agreement though this discourse is vital in understanding where the two countries stand and how each of their futures could shape up. At this stage, a free-trade agreement with China would largely confer one-sided benefits to China as has already been happening in the bilateral trade relations without the FTA. The idea of an FTA with China has to be used as a thought-experiment or as a horror scenario to hasten all the crucial reforms and decisions that India has deferred or avoided taking, for fear of the damage that pursuing them would cause to the political future of the ruling parties. For the most part, these fears are imaginary. They can also be overcome through persuasion and communication. The Indian political class has shown itself to be either unwilling to or incapable of engaging in communication with the society on the policy imperatives. The last two decades have been dotted with Indian achievements but one can say without the slightest hesitation that India is far from its potential. Economic liberalisation has been piecemeal. What started with a scamper for liberalisation in the 1990a has been reduced to a clamber for growth. The Indian economy continues to grapple with half-baked reforms and a driven private sector unable to stretch its arms. There is a lot that needs to be done before India can achieve a competitiveness status commensurate with its human and resource capital. By realising its manufacturing potential and developing mature and competitive industries, India will be prepared to face competitive pressures from China and other prospective FTA partners. Without such reforms and more, an FTA with a manufacturing behemoth like China may lead to a destruction of its domestic industrial architecture and probably have a detrimental effect on poverty through loss of workeroriented industries. V Anantha Nageswaran is fellow for geoeconomics at Takshashila and blogs at The Gold Standard http:// tgs.nationalinterest.in. Ritwick Ghosh is a research associate at the geopolitics and foreign policy programme. The authors may be contacted via http://takshashila.org.in/contact .

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TAKSHASHILA POLICY BRIEF

SECTION 1: CHINA’S REMARKABLE TRANSFORMATION The economic transformation of China since the beginning of the 1980s has been a remarkable achievement. Real GDP growth averaged 10.4% in the 30 years beginning 1981. Per capita Nominal GDP growth averaged 11.1% during the same period. Per capita GDP that stood at USD 205 in 1980 now stands at USD 4,833 dollars1 . In Purchasing Power Parity (PPP) terms, China’s GDP is said to have already exceeded that of the United States. With a population in excess of 1.3 billion and a growing per capita income, China is an ideal market for countries. So it is not surprising that it has become the highest export partner to many countries in Asia and around the world. More surprisingly, the exports to China haven’t been much for its population as much for the consumers in many other parts of the world. China is a factory of assimilation and some production. With cheap labor and cheaper credit, it has become the manufacturing epicentre of the entire world. It has become dominant player in the game of global trade. But to reach here, the players had to ensure that China would play by the rules. That is why it was essential that China joined the World Trade Organisation (WTO). The WTO, successor to General Agreement on Tariffs and Trade (GATT) is unlike other United Nations institutions or other multilateral institutions. The elegant ‘One-Nation, OneVote’ system, safeguards the voices of all members. Any member of the WTO can bring a complaint/dispute against the trade practices of another WTO member and the matter would be adjudicated without reference to their respective economic sizes or clout. Hence, it was important for the rest of the world that China became a part of this rule-based organisation. 1.1 China and the WTO China became a member of the WTO in 2001. It specifically committed itself to several conditions of membership. Primarily these included dismantling of trade barriers to 1

At current prices, latest data responds to 2010

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

imports. Measures such as tariffs for agricultural products from the US, and non-tariff barriers such as excessive quality control, quotas or even unfair competition from state owned enterprises (SOEs) were scaled back or removed completely to promote free trade. All previous Regional Trade Agreements (RTA) were harmonised with WTO agreements so as to allow for fair and free trade among all WTO members. With respect to markets involved in trade, China made the commitment to transition to a more market-based economy, privatising SOEs where possible. This was to allow for fair competition among local and international firms. The development of certain trade institutions, and regulatory management was also required to enforce the new trade laws, and to maximise ease of business for exporters and importers. China is impelled to provide WTO members and the general public with information pertaining to trade laws, statistics, the names of SOEs involved in trade, details of special economic and trade zones, and lastly documented evidence of a transition to a market based economy. The information is released according to a minimum schedule and standard set by the WTO. It also benefits from the information available on the laws and regulations in each of its trading partners; the provision of which is mandated by the WTO. Now, what has happened since China acceded to the WTO? Let us examine the evolution of trade between different regions and China, pre-and post-WTO accession of China. We take five geographical entities: US, European Union, ASEAN, Japan and South Korea.

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Chart 1: China’s trade with the EU and the USA shows why China was so desperately seeking the WTO stamp of approval. Its trade with USA and EU has increased manifold.

Chart 2: China has found its niche of trade dominance with its Asian neighbours too.

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Bilateral trade between India and China India’s trade experience with China has followed a similar design. Based on data available, initially, the total volume of India-China trade was USD895 million in 1994. By the end of 2009, this has reached USD 43.4 billion---a jump of nearly 50 times in 15 years.

Chart 3: In the case of India and China, even without a free-trade agreement, trade between them has picked up substantially over the years.

1.2 China’s search for FTA China has been active in seeking trade agreements. Post WTO-accession, China has embraced trade agreements while simultaneously boasting its export oriented industries (See Table 1 below).

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Status

Year

Agreement

Notes

Signed/In effect

1976

Asia Pacific Trade Agreement

In effect since 1976; PRC acceded in 2001

2003

PRC-Thailand PTA

Early Harvest Program of ASEAN-PRC CECA

2004

PRC- Hong Kong, China CEPA

2005

ASEAN-PRC CECA

2006

PRC-Chile FTA

2007

PRC-Pakistan FTA

2008

PRC- New Zealand FTA

2009

PRC-Singapore FTA

2010

PRC-Peru FTA

2010

China-ASEAN FTA (CAFTA)

In effect since 2010

2005

PRC-GCC FTA

Framework agreement signed in 2004; under negotiation

2005

PRC-Australia FTA

2006

PRC-Iceland FTA

2007

PRC-Norway FTA

2009

PRC-Costa Rica FTA

2003

PRC-India FTA

2003

PRC-Japan-Korea FTA

Investment agreement initiated in 2007

2004

EAFTA (ASEAN+3)

Initiated study in 2004; report completed in 2006

2004

PRC-SACU FTA

2005

PRC-Korea FTA

2006

FTAAP

2007

CEPEA (ASEAN+6)

2009

PRC-Switzerland FTA

Under negotiation

Proposed

Framework agreement signed in 2002; TIG Agreement in effect since 2005; TIS Agreement in effect since 2007

ASEAN = Association of Southeast Asian Nations; CECA= Comprehensive economic cooperation agreement; CEPA= Comprehensive Economic Partnership Agreement; CEPEA=Comprehensive Economic Partnership for East Asia; EAFTA= East Asian Free Trade Agreement; Source: ARIC

Table 1 - China’s Free Trade Agreements Governments negotiate FTA but they are used mainly by the businesses to achieve higher profits and expand their end-use markets and input sources. In China, the business community has been enthusiastic in using these trade agreements to further their agenda. Surveys have revealed that of the total firms they surveyed 48% percent have used at least one FTA and another 32% of the respondents indicated plans to use

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

them in the future (See Table 2).

Agreement

Use

Plan to use

ASEAN-PRC CECA

Number of firms Share of FTA Users, % 67 65.7

Number of firms Share of respondents 50 22.1

PRC-HK, China CEPA

47

46.1

32

14.2

PRC-Chile FTA

33

32.4

28

12.4

PRC-Pakistan FTA

22

21.6

31

13.7

PRC-New Zealand FTA

15

14.7

37

16.4

PRC-Macau, China CEPA

15

14.7

25

11.1

PRC-Australia FTA

41

18.1

PRC-Singapore FTA

25

11.1

PRC-GCC FTA

17

7.5

PRC-Costa Rica FTA PRC Iceland FTA

11 12

4.9 5.3

PRC-Japan-Korea FTA

39

17.3

PRC-SACU FTA

35

15.5

PRC-India FTA

33

14.6

CEPEA (ASEAN+6)

31

13.7

EAFTA (ASEAN+3)

29

12.8

PRC-Korea FTA

24

10.6

PRC-Peru FTA

20

8.8

PRC-Norway FTA

17

7.5

Under Negotiation

Proposed

Source: Zhang, Y. 2010. The Impact of Free Trade Agreements on Business Activity: A Survey of Firms in the People's Republic of China. ADBI Working Paper 251. Tokyo: Asian Development Bank Institute. 2

Table 2 - China’s FTAs and business activity With ASEAN, a kindred economic entity both culturally and economically, China has had the most efficacious trade agreements. Currently there exists a China-ASEAN FTA (CAFTA), which came into effect on 1st January 2010. Prior to the CAFTA, the two entities had signed a Comprehensive Economic Cooperation Agreement (CECA). Surveys from before the initiation of the CAFTA, show that the China-ASEAN CECA was already the most commonly used trade agreement with 65% of all the FTA users, 2

Available at: http://www.adbi.org/working-paper/2010/10/12/4088.impact.fta.business.activity.prc/

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far ahead of the second most used agreement, which was the CEPA with Hong Kong3. Chinese businesses were also excited about other upcoming trade agreements with partners in Asia. Enterprises were also looking forward to the signing of the ChinaAustralia FTA, which is currently under negotiation. Interestingly another 14.6% of the total respondents specified that a China-India FTA would be useful for them and they would plan to use it. Thus, the advantage of a China-India FTA appears to be clear to Chinese firms and supports intuitive logic that an export driven economy will find it beneficial to seek trade agreements in search for new markets and new suppliers. 1.3 China and trade barriers With a purists’ perspective, an FTA is implemented with the objective to achieve an economic equation where all parties involved individually reach a higher productivity level. Achieving a Pareto optimal scenario, the long-term impact on a trade agreement should be the reorganisation of economic structures to capture the comparative advantages in both economies. But where both parties operate with fundamentally distinct economic models, an open trade regime could lead to unequal economic progress between the entities and possibly be even counter-productive. In China, non-tariff barriers are more important than tariff barriers. Starting from the issue of the mandarin language which is difficult to understand since it is phonetically different from the European languages, the list of non-tariff barriers that exporters into China faces is endless. Indeed, more often, China is on the top of the list of disputes brought to the WTO by other member nations.

The survey does not include information about the CAFTA. But the high usability of the PRC-ASEAN CECA is an excellent indicator of how Chinese businesses must be reacting to the CAFTA. 3

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Reactions by trade partners When a company charges lower prices for its exported goods than what it charges for the same good in the domestic market, it is classified as an act of dumping. The term has been broadened to specify unfair practices by export industries so that they export goods at lower prices and making them more attractive to international markets. Dumping is the single most discussed issue at the WTO. India has been the most vociferous complainer. Of the 1061 anti-dumping complaints logged at the WTO since 2005, a quarter of them have been registered by India, being the most vocal nation against anti-dumping activities. On the other end, China has been the chief recipient of anti-dumping charges. 366 complaints have been logged against China of the total 1061 complaints logged since 2005. In addition India has been the most disgruntled by Chinese trade manipulations having lodged a total of 137 cases with the WTO against China in the last 15 years 4. Some countries have gone beyond just lodging complaints. Frustrated with the seemingly invisible non-tariff barriers in China and impossibility of resolution, countries have taken regulations into their own hands. In 2010, Argentina announced that it planned to impose a tax on cheap Chinese shoes to protect local producers. The belief was that Chinese companies were unfairly subsidising footwear makers and the currency manipulation from China was preventing Argentinean shoemakers to compete on level grounds. In reaction, China suspended an order for more than 2 million tons of soya oil from Argentina citing safety concerns5 . The case continues to be sore issue between the two countries. Most recently, the EU imposed a five-year hike in duties on imports of Chinese paper. The authorities announced the duties to balance Chinese state aid to the industry 6. After a 15-month enquiry, the verdict was that China's government had granted cheap loans, ‘No Paper Tiger: Subsidies to China’s Paper Industry from 2002-09’, Usha Haley, 2009, Alliance for American Manufacturing; Downloaded from http://www.americanmanufacturing.org/files/briefingpaper264_final.pdf 4

‘Who really benefits from China's trade with Latin America?’, Guardian. Downloaded from http://www.guardian.co.uk/global-development/poverty-matters/2011/feb/16/china-latin-america-trade-benefit 5

‘European Union slaps first anti-subsidy duties on China’, Economic Times, 17th May 2011, Downloaded from http:// articles.economictimes.indiatimes.com/2011-05-17/news/29551970_1_anti-subsidy-duties-eu-commission-karel-de-gucht 6

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land below market value and various tax incentives to its coated fine paper industry. This was the first time the EU had slapped such a duty against Chinese exporters. Studies have found that USD33.1billion in government subsidies have been fed into the paper industry through 2002 to 2009. Europeans believe that this is an unfair trade practice since China does not have a natural comparative advantage in paper production since it is not a labor-intensive industry. Only 4% of production costs are directed to labor while two thirds are raw material. For this reason, the EU believed that the low cost of Chinese paper imports were not a result of a Chinese comparative advantage but dumping related issues. China’s government has shown displeasure at the ruling but has not yet imposed any similar duty on EU imports. Excessively low cost of capital Being a state dominated economy, the various concessions that state enterprises receive confer an unfair export advantage on China. State enterprises operate outside the typical market and are not subjected to the constant stress over liquidity and fund raising. According to China's Ministry of Finance, assets of all state enterprises in 2008 totaled about USD6 trillion, equal to 133% of Chinese GDP in 20087. By discounted lending rates to SOEs the Chinese government is enhancing their profit margins and creating a distorted market structure. The SoE are also the major exporters in China and this is causing effective competition distortions in the international market. Financial repression is an unpleasant fact in India and in China. In India, the State appropriates savings for funding the fiscal deficit. In China, the State does not directly appropriate savings for its fiscal deficit. Most of China's fiscal deficit is by way of contingent liabilities - to bail out State-owned banks and local governments. China's financial repression is through the cornering of household and corporate savings to finance large-scale infrastructure and capacity-creation projects in the State sector with

7

China's 'State Capitalism' Sparks a Global Backlash, AWSJ, 16th Nov 2010. Downloaded from

http://online.wsj.com/article/SB10001424052748703514904575602731006315198.html

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State-owned banks providing the funding at ultra-low cost of capital that bears no relation to the economic cost of capital. “…more aggressive increases in interest rate are impossible, as they would encourage capital inflows adding to the already high liquidity in the banking system. Instead, the [Peoples Bank of China] has had to rely on administrative controls on credit to curb investment and credit growth. The resulting financial repression has directly conflicted with the need to develop the financial system and created further economic distortions. A sustainable solution to the problems that China faces requires more effective use of monetary policy, not more administrative measures. And the obvious way to do this is to let the Renminbi appreciate more quickly.” - Jahangir Aziz and Kalpana Kochar 8 But unfair financing is not limited to state owned enterprises. For example: a private Chinese automaker, Zhejiang Geely Holding Group, made worldwide headlines in March when it agreed to buy Sweden’s Volvo marque from Ford. Much of the USD1.5 billion purchase price came not from Geely’s relatively modest profits, but from local governments in northeast China and the Shanghai9 . The steel industry is a stark example. An energy guzzling industry, fuel marks the largest input cost in steel manufacturing. Studies by the Alliance for American Manufacturing determined that the total energy subsidies to Chinese steel from 2000 to mid year 2007 reached USD27.11billion. Subsidies for thermal coal to the Chinese steel industry for the same period reached USD 11.16 billion10. The government openly offers tax rebates to certain export oriented industries. Tax rebates are an indirect form of subsidy. In 2008, the government raised its rebates. The export tax rebate for some toys, textiles and garments was raised to 14%. There will be a

8

China’s Monetary Policy: Lessons for India” Business Standard, July 5th 2007

9

China Fortifies State Businesses to Fuel Growth, NYT, 29th August 2010, Downloaded from http://www.nytimes.com/2010/08/30/world/asia/30china.html 10

‘Shedding Light on Energy Subsidies in China: An Analysis of China’s Steel Industry from 2000-2007; Usha Haley, 2008, Alliance for American Manufacturing; Downloaded from http://www.americanmanufacturing.org/files/energy-subsidies-in-china-jan-8-08.pdf

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9% rebate for certain plastic products, 11% for daily necessities and porcelain artifacts, 11 and 13% for some furniture goods11. These are some of the non-tariff tools used by the Chinese government to support export-oriented industries: •Income

tax reductions and refunds available to companies that satisfy certain export

performance requirements •Value-added tax

(VAT) exemptions available to companies that satisfy certain export

performance requirements •Tariff

exemptions available to companies that satisfy certain export performance

requirements •Exemptions from mandatory

worker benefit contributions available to companies that

satisfy certain export performance requirements •Import

substitution subsidies: Income tax refunds available to companies that purchase

Chinese-made equipment and accessories rather than imports. VAT refunds available to companies that purchase Chinese-made equipment and accessories rather than imports

11 Downloaded from http://news.xinhuanet.com/english/2008-10/21/content_10229531.htm

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Box: A look at China’s WTO Cases Here we take a look at 2 case studies of WTO disputes about non-tariff barriers to trade that China has utilized at one point or another, and their current status (quoted from WTO Website): 1. Export restrictions on 9 raw materials in their various forms. (bauxite, coke, fluorspar, magnesium, manganese, silicon carbide, silicon metal, yellow phosphorus and zinc).). Dispute DS398 Complainant: Mexico. In this ongoing case, Mexico alleges export restrictions on these 9 materials are in violation of China’s Accession Protocol to the WTO, and GATT treaty. The economic implications of a large scale restriction include a warping of the price structures in various markets and an unfair advantage to local manufacturers who will get better pricing for the materials. A panel of third party WTO members was convened and its judgment is awaited. 2. Undue influence and competition on financial information services by Xinhua; a stateowned company in the same market that also holds a de-facto regulator status. Dispute: DS373 Complainant: Canada, US. Canada made claims against a number of Chinese measures affecting financial information services and foreign financial information service suppliers in China.  Such measures included no fewer than a dozen legal and administrative instruments which require foreign financial information suppliers to supply their services through an entity designated by Xinhua News Agency. According to Canada, China prohibits foreign financial information suppliers from directly soliciting subscriptions for their services, requiring that solicitation of subscriptions to be done through a Xinhua-designated entity.  China likewise prohibits users of financial information services in China from directly subscribing to services supplied by foreign suppliers. They are also to provide detailed and confidential information concerning their financial information services, their customers and their foreign suppliers.  Canada contends that these and other requirements and restrictions accord less favorable treatment to foreign financial information suppliers than that accorded to Chinese financial information services and service suppliers which are not affected by these requirements and restrictions. Canada also claims that China is preventing foreign financial information service suppliers from establishing any commercial presence in China other than limited representative offices. Canada therefore considers that the measures at issue are inconsistent with several Articles in GATT and China’s Accession protocol. In late 2008, Canada, US and China reached an agreement in the form of a Memorandum of Understanding.

Currency manipulation Among the non-tariff barriers, the single largest complaint against China has been its exchange rate. China follows a managed float regime for its interventions in the foreign exchange market. This implies that the Chinese central bank allows some movement of the exchange rate with respect to a basket of currencies. The current regime was

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TAKSHASHILA POLICY BRIEF

introduced in 2005, prior to which the Renminbi was pegged to the US Dollar. However, at the peak of the financial crisis the authorities quietly reduced the float and re-pegged the currency to the US dollar. This was to avoid volatile movements of the currency. The complaint against the Renminbi is that it is being held unfairly low by the central bank. To keep the currency low, the central bank purchases US dollars and sells Renminbi. As a result, the central bank has amassed a giant vault of foreign currency reserves, climbing over US$ 3.0 trillion. Most complainants cite this in support of their hypothesis that the Renminbi is highly undervalued. By keeping the exchange rate undervalued, the export industry has a price advantage. The prices of its exports are effectively reduced (by the same margin as the currency is undervalued). In addition, this also leads to imports being more costly than they would in an open economy. This creates an extra hurdle of competitiveness for companies exporting to China The latest IMF Article IV notes that the renminbi is significantly below its medium term equilibrium value. It cites the following reason to arrive at the conclusion •

Pace of accumulation of international reserves.

•

The exchange rate has not risen with the higher level of productivity. The authors

compare the exchange rate to a time when there was no obvious imbalance in current account and find that there have been substantial productivity improvements since then, especially in comparison to China’s trading partners. •

Imports will increase as a share of domestic consumption, the current account would

decline modestly and thus the exchange rate adjustment will be negligible. The Peterson Institute’s latest calculations suggest that China would have to let the Renminbi appreciate by about 15% on a trade-weighted basis and about 25% against the dollar to achieve equilibrium, defined as cutting the Chinese current account surplus to 3% of GDP

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

An RBI study found the long run trade elasticity between India and China. Interestingly India’s import elasticity is higher than its export elasticity12. Its import elasticity is calculated to be 2.86 while that of exports is 2.38, possibly explaining why the current trade deficit is so heavily skewed against India. With an undervalued Renminbi exchange rate, Indian consumers and businesses are enjoying deceptively cheap Chinese imports and its exporters are finding it hard to overcome the handicap of lower prices of exports in China. Intellectual Property Rights With free movement of goods, labor and ideas, FTA need specific clauses on how to protect IPRs. China has shown a desire to take steps to punish acts of IPR violations in the country. However, the earnestness of the claims has been shrouded in constant doubt. •

Statistics from the 8th Annual Business Software Alliance report, released in 2009, shows that China continues to be a major player in the software piracy market. While the US and Europe have piracy rates of 20% and 33%, China has a much higher rate of 78%. India’s rate too is high but less than China at 64%.

•

More numbers about automobile parts indicate that of the USD 45million counterfeit auto parts worldwide market; about 83% are produced in China13 .

•

The latest report from EU Commission on IPR enforcement noted that China continued to be the main source country from where goods were suspected of

12

‘The Implications of Renminbi Revaluation on India’s Trade’, S. Arunachalaramanan and R. Golait; RBI Working Paper Series: 2/2011, Department of Economic and Policy Reseach, Mar 2011 13http://plasticsnews.com/china/english/printer_en.html?id=1297372383

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TAKSHASHILA POLICY BRIEF

infringing an IPR14. 64% of imported goods that were not released were sourced to China. Notably only 2% of Indian goods were ceased15. India has been no saint on IPR violations; it too continues to be a recipient of complaints. However, with the country stretching for higher innovation standards and projecting itself as a prospective R&D hub in South Asia, India must become intolerant to IPR violations by itself or a FTA partner. China’s history of questionable indigenous innovation may not be fitting with India’s stern approach to intellectual rights. However, it is worth noting here that India will not be in a position to coerce China into real action, as its negotiating strength will be tarnished by its own image as a nation of relatively high IPR violations. Thus, India too needs to step up its IPR legal framework and improve implementation around IPR legislature quickly while at the same time demanding higher standards from its major trade partners.

14http://ec.europa.eu/taxation_customs/resources/documents/customs/customs_controls/counterfeit_piracy/statistics

/

statistics_2009.pdf Do note that this has not been normalized for the volume of imports from both countries. Chinese exports to the EU outsize Indian exports considerably. 15

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

SECTION 2: IS INDIA’S MANUFACTURING SECTOR PREPARED? 2.1 Indian manufacturing India's recent success and renaissance has been rooted in services rather than in manufacturing. It is not an accident but a consequence of the state-orchestrated rigidities and inefficiencies that had accumulated over the years since independence. An FTA between India and China will focus almost entirely on manufacturing. Intracountry trade in services between India and China face three major hurdles. First, there is the barrier of language. Indian languages are far more in tune with western classical languages. They are fundamentally different from Chinese languages, which are phonetically based. Further, few schools in India offer Chinese language courses. While foreign languages like French have included in the high school CBSE curriculum, Mandarin is still not offered. The rest of the world has constructively embraced Mandarin, yet India has been laid back about the language. Second, free trade in services involves free movement of labor. For two of the world’s most populous countries, movement of labor across borders is an important policy consideration. Both countries follow strict visa policies and any flexibility of labor movement will only be partial. Third it is difficult for FTA to facilitate free trade in services for they are difficult to measure and not malleable for duty imposition, to begin with. Thus for an IndiaChina FTA, manufactured goods will be the critical trade. Initially, the Indian State took upon itself the task of growing the manufacturing sector because of perceived lack of capacity and skills in the private sector. The State was to be in the forefront of catch-up growth in the post-Independence environment. Comprehensive Industrial Development and Regulation restricted the space for private sector to develop. The State decided how much would be produced, by whom and where through a comprehensive web of policies of licensing, capacity restrictions, etc. Hence, for a long time, the agricultural sector contributed the most to economic growth which, in itself, was mostly modest. Manufacturing share was, at best, 30%. Once the service sector took off in the 1990s after economic liberalisation in India, liberalisation in

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TAKSHASHILA POLICY BRIEF

global trade particularly in services, the manufacturing share came down but at least the economic pie was becoming bigger, faster. In recent years, India has tasted niche successes in manufacturing - in the automobile sector, both in vehicles and in ancillaries. It needs to examine the sources of these successes and explore ways of replicating them nationwide. Infrastructural constraints - ports, power and roads The chances of an Indian manufacturing revival - closer to levels that prevailed in East Asian economies in their boom years - in the very near future are slim. The main reason is India's infrastructural bottlenecks and the rising cost of land. In terms of infrastructure, the rate of completion of national highways has slowed to a crawl. The turnaround time in Indian ports has improved but there is room for efficiency gains, compared to other East Asian and Chinese rivals. A McKinsey report from 2010 illustrates the weaknesses of India’s infrastructure relative to its competitors and complementors. According to the report, USD 45 billion is lost every year due to inefficiencies in India’s logistics network. For instance, rail and coastal shipping costs in India are approximately 70% higher than those in the US. Likewise, road costs in India are higher by about 30%. The most glaring infrastructure failures are in the areas of continued and reliable availability of power and water, the former being more critical than the latter. Utilities To be sure, both India and China suffer from electricity under-supply. The situation in China is further exacerbated by high energy costs, and an uneven supply between different regions. During winter, the northern regions need heating, and during summer, the air-conditioning used down south is the primary driver of demand. This summer there is predicted to be a 30-gigawatt deficit in the electricity market in China16. 16http://in.reuters.com/article/2011/04/28/china-power-idINL3E7FS2O420110428

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

The ensuing production shortfalls will affect manufacturing and overall economic output in 2011. Usually however the situation is not that bad and the gap is much smaller year-round. India on the other hand suffers a regular 70-gigawatt supply gap17 . Its problems are structural rather than situational. Exacerbating the situation is a very inefficient transmission system with an estimated transmission loss of over 30%. There is also the issue of electricity theft that is still a major concern in India (Chart 4).

Chart 4 - Power scenario Source: Power Sector in India, White paper on Implementation Challenges and Opportunities For release at the Energy Summit, Nagpur - January 2010 (KPMG IN INDIA)

Roadways The costs are hidden. Though the absolute costs of road transport in India may be lesser but effective costs are higher. For example, the average speed of a truck is 35 km per hour on India’s highways as compared to over 75 km per hour in the US. Similarly, the

17http://www.powermin.nic.in/JSP_SERVLETS/internal.jsp#

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TAKSHASHILA POLICY BRIEF

average speed of freight trains is 25 km per hour in India while it is close to 45 km per hour in the US. There is an excessive reliance on roads for transport even for long hauls where road transport is structurally unsuited. The following graphic illustrates the point. Besides being expensive, road transport is also an unfriendly option for the economy and environment as a whole (Chart 5).

Chart 5 - Transport scenario

India has a plan to expand its national highways aggressively. It involves a 7-phase plan. However, the implementation of the plan is behind schedule. Together with similar delays in regional highways and large roads, it accounts for the low growth in the percentage of paved roads in India (See Table 3).

22

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Status of National Highways (as on 31.3.2010) Lane Status Length in km (% of total Highway length) 6 lane and above 731 (1%) 4 lane (2 lane dual carriageway) 14,584 (22%) 2 lane (7 meters) 37,488 (52%) Single/Intermediate lane 18,131 (25%) Total length of National Highways 70,934 Source: “The working group report on Road Transport for the eleventh five year plan” Government of India, Planning Commission

Table 3: National highway scenario An excerpt from an article in 2008 reflects the frustration with delays clearly “Majority of the 17 road works awarded under the public private partnership (PPP) as part of Phase-I of National Highways Development Programme (NHDP) were delayed, according to a recent report by Comptroller and Auditor General of India on roads states. Of the 17 projects, only five were completed in time, while there were delays of 2-42 months in others….”18 However by comparison, the original plan NHDP plan called for phase I,II and IIIA to be completed by December 2009. All 3 of those phases are incomplete as of February 2011, with only Phase I near completion.

18

http://www.livemint.com/2008/12/14132135/NHAI-pulled-up-for-delays-in-P.html

23

TAKSHASHILA POLICY BRIEF

Charts 6 and 7 : India lags far behind China on the measure of roadway development

Ports Indian Ports are suffering from relatively poor performance. The overall average turnaround time has actually increased from 3.96 days in 2008 to 4.54 days in 2009 19. By 19

Port Performance, Indian Ports Authority

24

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

comparison, from 1998-2003, the turnaround time shortened from 5.23 days to 3.47 days. There is an under-capacity issue in Indian ports. There have been complaints of hindrance by port employee unions and of very inefficient investment in upgrades to the ports themselves. They have missed their collective turnaround time targets by 4.5%.There is however a lot of regional variation. Haldia, JNPT, New Mangalore and Chennai Ports were the ports that accounted for the greatest underperformance. These 4 ports out of the 14 largest accounted for over 80% of the total performance gap while several other ports exceeded targets. Without a revival in India's manufacturing capacity and competitiveness, India would have little to gain from a free trade agreement with China whose prowess in manufacturing is vastly superior. The size of the Chinese economy and the recent rise in wages might have led to some temporal loss in competitiveness, but China retains a vast edge in manufacturing over India. Total factor productivity India’s manufacturing industry is plagued with low productivity. Explanations are many. Perhaps the most important are overly bureaucratic regulation and corruption. That firms have to “play the game” contributes to the inefficiency of setting up and operating any business in India. The endless paperwork and glacially slow legal system are two specific examples. Low capital investment is also a significant factor; firms find the cost of capital too high and are forced to keep using dated manufacturing methods. Finally, entrenched labor and stifling labor laws prevent the free upgrades to more capital-intensive methods of production. It is often said that firing a worker in certain states in India is nigh impossible. The presence of government led firms in the industries is a significant contributor to this type of inefficiency.

25

TAKSHASHILA POLICY BRIEF

The situation is not universal and often varies between the different states. Several studies place Indian manufacturing efficiency at 10-13% behind China’s20,21. The difference can be accounted for by China’s massive labor retrenchment program, it changing from government ownership models, and its more streamlined and more business friendly legal environment. Both countries are significantly behind advanced nations such as the US in terms of efficiency. If capital and labor were used as efficiently as in the US, China could expect a 30-50% increase in Total Factor Productivity (TFP), and India could experience a 40-60% increase21. Furthermore, legal and labour reforms in India will particularly help foreign earned firms as compared to locally run and owned firms22 . This would help attract FDI into India in the long term, speeding up growth of the economy. In one sense, the idea of a FTA with China could be harnessed to address structural issues that have capped India's growth at 8%. Any time India has tried to exceed that growth rate, it has triggered an inflationary backlash with potentially devastating consequences, especially for India's poor. Inflation, fiscal deficit and cost of capital India's persistently high rate of inflation is the most damning evidence of its inability to address structural growth constraints such as power, water, roads and ports. Its education system is a serious and soft infrastructural constraint for its medium-term growth constraint. Its dysfunctional and deficient education system - government control and politicisation of curriculum, remuneration of teachers and funding of

“Manufacturing Productivity in China and India: The Role of Institutional Changes”, Pandey and Dong, Journal of Economic Literature Classification Numbers: O38, O40, O57, May 15rg 2007 20

“Misallocation of Manufacturing TFP in China and India” Hseih and Klenow, The Quarterly Journal of Economics Vol CXXIV, November 2009 Issue 4 21

22“Services

Reform and Manufacturing Performance: Evidence from India” CEPR Discussion Paper No. DP8011, Sept 2010

26

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

educational institutions, bureaucratic meddling - places big question marks on its medium-term growth potential. Another cause of India's inflation that places a ceiling on economic growth is India's fiscal deficit that is both structural and inefficient. India has been unable to get rid of its addiction to high fiscal deficit due to the penchant of successive governments to engage in feudal and paternalistic handouts that are done with an eye on elections. These handouts also are fertile grounds for bureaucratic corruption and breed a culture of dependency among the poor, while keeping them in the ranks of the poor. To the extent that these deficits fail to bridge India's infrastructural gaps, they do not add to the economy's growth potential but actually as a drag on it by siphoning off resources from other productive uses. The arguably big impact of the fiscal deficit comes from its effect on the country' cost of capital because the cost at which the sovereign can borrow sets the floor on the cost of capital. At one level, India's cost of capital can be deemed consistent with its nominal GDP growth rate. After all, one of China's big contemporary competitive advantages and a source of big but yet unquantifiable risk is its ultra-low cost of capital. India's cost of capital has resulted in a relatively higher investment discipline. That is why India’s stock market performance has closely tracked the performance of its economy (Chart 8). Similar is the story with respect to Brazil (Chart 9).

27

TAKSHASHILA POLICY BRIEF

Chart 8 - Stock market performance has tracked economic performance

Chart 9 - Stock market performance has tracked economic performance (Brazil) !

Sources: Datastream, Bloomberg

28

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

However, China’s record is remarkably different (Chart 10). Its stock market performance bears no relation to its stellar economic growth record. That is because its ultra-low cost of capital has spawned so much of excess investment that its return on investment, by definition, is a lot lower (Chart 11).

Chart 10 - China’s record is very different

Source: ‘The fail of China’, Asianomics, 9th May 2011

Chart 11 - ROI in China is lower

29

TAKSHASHILA POLICY BRIEF

The abnormally low cost of capital, state ownership of banks, their preference for lending to State-owned enterprises and China’s desperate gambit to stave off the effects of the global financial crisis through a massive State orchestrated credit boom have all left big question marks hanging over the health of the banking system and hence, of the economy, in the medium-term. Nouriel Roubini points out that no country that has funded an investment boom excessively through credit has escaped a crisis sometime in the future. Fitch Ratings Agency recognises this risk. Its rating of the health of the Indian banking system is far higher than of its rating for China. However, even if there is a big banking crisis in China with negative impact on growth, it might not dent China’s manufacturing edge. Barring the risk for social instability that such a crisis would entail, the deflationary forces that it would unleash would arguably make China’s manufacturing more and not less competitive. But, that is another story for another occasion.

2.2 Can trade help improve manufacturing competitiveness? India has been an active participant in FTA talks Understanding the economic benefits of trade agreements, India has been actively sourcing new opportunities. It currently has 11 trade agreements in effect which includes the most recently signed India-ASEAN Comprehensive Economic Cooperation Agreement, which came into effect in 2010. The landmark India-Japan FTA signed in 2011 is another addition to India’s arsenal of trade agreements to open markets for its domestic businesses (See Table 4). The recent Indian Economic Survey, an annual publication from the Ministry of Finance, unambiguously notes that India is often the lesser beneficiary of free trade agreements.

30

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Agreement

Year since in effect

India-ASEAN CECA

2010

Asia Pacific Trade Agreement

1976

India-Afghanistan Preferential Trading Agreement  India-Chile Preferential Trading Agreement 

2003 2007

India-Korea Comprehensive Economic 2010 Partnership Agreement  India-MERCOSUR Preferential Trade Agreement 2009 India-Singapore Comprehensive Economic Cooperation Agreement  India-Sri Lanka Free Trade Agreement

2005

Indo-Nepal Treaty of Trade

2002

South Asian Free Trade Area (In Effect)

2006

India-Bhutan Trade Agreement

2006

2001

Table 4: India’s FTA in effect Source: ARIC Notes: MERCOSUR is a trading bloc in Latin America comprising Brazil, Argentina, Uruguay and Paraguay.

The net gains from incremental exports from India are small and sometimes even negative. (See Indian Economic Survey 2010/11). This raises the question of export competition and complementarities. As mentioned earlier a trade agreement aims to maximise efficiency where both countries can concentrate on goods and services for which they have a comparative advantage. Firms in sectors of lower comparative advantage to their counterparts in the other economy would suffer unless they are able to increase productivity. On the other hand, both economies can also find economic complementarities by plugging into each others’ manufacturing supply chains and lead to higher overall productivity. The short-term impact of an FTA will have negative implications for India. The restructuring of the manufacturing industry will take time and in the short term the costs will be borne by Indian industry. In addition, China has lower tariffs than India in almost all categories of goods (See Table 5 below).

31

TAKSHASHILA POLICY BRIEF

If all tariffs are reduced to zero, India will suffer a sudden loss of tariff revenue which was being collected from the import of Chinese goods. This would instead transfer into a gain for the Chinese exporters. Indian firms will have less to gain from the zero tariffs in China. This would apply to any economy with which India is seeking a trade agreement and that economy has lower tariff structures to India. However the gain to India is lesser only relative to China. The argument for an FTA remains firm as long as India finds itself better off with an FTA, particularly in the longer term. Whether there would be a loss or profit to Indian exports as a whole will be discussed in later sections.

India 33.1 33.7 30.4 56.3

Max China 25 20 30 32

India 100 60 100 100

24.2

32.2

65

150

Oilseeds, fats and oils Sugars and confectionery Beverages and tobacco Cotton Other agricultural products

10.9

18.2

30

100

27.4 22.9 15.2

34.4 70.8 12

50 65 40

60 150 30

11.5

21.7

38

70

Fish and fish products Minerals and metals Petroleum chemicals

10.7 7.4 4.4 6.6

29.8 7.5 3.8 7.9

23 50 9 47

30 10 5 10

Wood, paper etc Textiles Clothing Leather, footwear etc

4.4 9.6 16 13.4

9.1 13.6 16.1 10.2

20 38 25 25

10 246 68 70

Non-electrical machinery7.8 Electrical machinery 8 Transport equipment 11.5 Manufactures, n.e.s 11.9

7.3 7.2 20.7 8.9

35 35 45 35

10 10 100 10

Animal products Dairy products Fruit, vegetable, plants Coffee, tea Cereals and preparations

Average China 14.8 12 14.8 14.7

Table 5: India-China comparison of MFN applied duties (Source: WTO Statistics Database)

32

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Box: The India-ASEAN CECA – a success or disaster? The FICCI-Deloitte White Paper has conducted an interesting study matching the complementarities of ASEAN and India. They calculated the export intensities of India and ASEAN vis-à-vis each other. The export intensity index indicates whether or not a country exports more (as a percentage) to a destination than the world does on an average. It is defined as the ratio oftwo export shares.The findings show that the index value is greater than 1 for both, indicating that on average both economies export more to each other than the rest of the world (Chart 12). Another tool, the trade intensity index which measures the import flows between the two economic entities. The index is the ratio of the total trade share of a region to the share of world trade with a partner. This statistic shows that India and ASEAN enjoy an intense trade relationship, although the relationship is more intense for ASEAN trade relationship than for India. Nonetheless, these results show that an ASEAN-India trade agreement would benefit both parties (Chart 13).





Chart 12









Chart 13

Source: Delloite- FICCI White Paper

Furthermore, the paper finds that the export pattern of India matches that of ASEAN. Using the sum of the absolute value of the difference between the import category shares and the export shares of the regions and dividing by two we can ascertain the

33

TAKSHASHILA POLICY BRIEF

complementarities between India and ASEAN. We find that complementarities of Indian exports stood at 52.9% for 2007 whereas the complementarity of ASEAN exports to India stood at 69.1%. This too supports the argument for an ASEAN-India FTA. The paper also pinpoints the Indian and ASEAN industries that enjoy greater competitive advantage vis-a-vis their counterparts in each other’s country. The authors use a Revealed Comparative Advantage (RCA) index where the country’s export shares of a particular sector are compared with global shares to determine whether a country has a comparative advantage in that particular sector. We find that the following Indian industries enjoy a greater competitive advantage relative to their counterparts in the ASEAN countries –chemicals, medical and pharmaceutical, textiles, apparels and accessories, and handicrafts & carpets. On the other hand, the following industries in ASEAN enjoy a larger competitive advantage over their counterparts in India machinery and appliances, electrical equipment. Drawn from: ‘India ASEAN Free Trade Agreement: Implications for India’s Economy’, A Deloitte-FICCI White Paper, Mar 2011, Available at www.deloitte.com/in

34

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

SECTION 3: INDIA IN AN FTA WITH CHINA: UNREAL POSSIBILITY Growing FTA in Asia: Why the FTA is important Currently in Asia itself there are 93 FTA in operation with another 27 which have been signed and will soon be implemented. Asian countries are in further negotiations all over the world including in Asia on new FTA proposals (Table 6).

   

Under negotiation  Framework Agreement   Proposed Signed/Under Negotiation 

Concluded Under Negotiation

Signed

In Effect

Total

All Asia 1995 2000 2005 2009 2010 2011 2011

1 3 45 53 55 55 India

0 0 18 16 19 19

0 6 28 45 45 44

16 20 28 26 27 27

14 25 51 86 92 93

31

9

4

8

1

11

33

2

3

1

11

25

54 170 226 238 238

China 2011

8

Source: ARIC

Table 6: FTA proposals in Asia In this study, we shall examine how India would go about implementing an FTA with China and how Indian firms will react to such an agreement. 3.1 Enforcement An FTA between India and China could pose some foreseen hurdles. These are due to the diverse economic regimes of the two countries. For smooth enforcement, the FTA should contain provisions to ensure predictability, consistency and transparency in its application of customs rules and administrative processes to ensure efficient clearance of goods. Table 7 highlights some of the chief concerns.

35

TAKSHASHILA POLICY BRIEF

Issues

Details Extant of coverage and tariff• Issues related to the size of the undertaking will be the structure major point of negotiation. • Should the agreement encompass all goods including electrical equipment? • India has higher tariffs than China, so reducing nonsensitive good tariffs to zero would take longer for India. • A framework should be setup for resolving trade and Dispute resolution investment related issues. • There must be a platform for further cooperation. • Provisions for an arbitrary tribunal should be included in case bilateral talks fail. Such a tribunal must be given a timeline for decision. • Only products originating in China or India should benefit. Rules of origin (ROO) • Will products which use materials from a 3rd country also come under the same purview? • There will be a need to minimize compliance costs for exporters on both sides of the border. • Bureaucracy Customs processes should be predictable, consistent and transparent. • A stipulated time frame (such as 24 or 48 hours) should be established for release of goods through customs. • WTO standards should apply for dumping related issues. Dumping • Prohibition of all export subsidies. • Bilaterally determined standards should apply for product Product safety specific safeguards. • There must be a reduction of technical barriers like local Technical barriers to entry standards, regulations and assessment processes (standards and regulations should be as per the rules set in the agreement). • Exporters on both sides should meet the testing and certification standards of the other country. • Transparent laws must exist in both countries, in Competition, IPR accordance with international standards. WTO Trade Related Intellectual Property Rights Agreement (TRIPS) should apply. • An additional bilateral mechanism should exist to handle IPR queries and complaints.

Table 7: Some fragile issues related to enforcement and suggestions for the FTA 3.2 The trickle-down effect on communities could be negligible Authors Rhys Jenkins and Chris Edwards studied China’s trade with a number of countries and its impact on the poverty distribution in the countries. The results are interesting. In some cases where higher trade is leading to higher economic growth, the lower income groups are being ignored or they become worse off. The results of their analysis are summarised in Table 8.

36

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Exports to China

 

Bangladesh Little or no effect

Cambodia India

Indonesia Pakistan

Vietnam

Bolivia

Competition in 3rd markets Imports from China Significant harm from Significant imports but not competitive threat displacing local production Significant imports but not displacing local production. Significant harm from Opportunity -cheaper competitive threat consumer goods. Small harm Low impact

Little or no effect Little or no effect Challenges from negative spillovers; Opportunities from increased government Moderate harm from revenues competitive threat Significant harm from Little or no effect competitive threat Challenges from negative spillovers; Opportunities from increased government Moderate harm from revenues competitive threat

Brazil

Little or no effect Little or no effect Challenges from negative spillovers; Opportunities from increased government revenues Little or no effect

Honduras

Little or no effect

Mexico

Little or no effect

Nicaragua

Little or no effect Little or no effect Challenges from negative spillovers; Opportunities from increased government revenues Little or no effect

Peru

Little or no effect Low harm (to poor) from competitive threat

Not a major threat Not a major threat Not a major threat. Opportunity - cheaper consumer goods Challenge – reduced employment; Threat cheaper consumer goods.

Limited threat to local production. Limited threat to local production. Limited threat to local production. Challenge – reduced employment; Threat cheaper consumer goods.

Limited threat to local production.

Source: ‘How Does China’s Growth Affect Poverty Reduction in Asia and Latin America?’; Rhys Jenkins and Chris Edwards, Presented at the 2004 LAEBA Annual Conference, December 3-4th 2004

Table 8: Summary of Likely Effects on Poverty of China’s Trade Growth The reason that higher trade with China may have negative spillovers on poverty in some South American countries is attributed to the nature of the export from South America. To feed China’s insatiable appetite for natural resources, funds are being diverted to these industries. Being capital-intensive projects, these factories have little

37

TAKSHASHILA POLICY BRIEF

impact on the populations of the region. However, the counter-point is that with higher outputs for resource industries, there are higher revenues for the government, which may then be diverted for poverty alleviation projects. The authors believe that with the dismal condition of governance the trickle down of the higher government revenues will be far less compared to the alternative and longer term solution of developing more population-centric projects in low-income regions. An India-China FTA could have a negligible impact on poverty reduction. However policies should be carefully determined so as to avoid any negative effects on poverty. •

Indian exports to China will need to expand beyond primary goods support. Resource exports have little impact on the local communities if the process of resource extraction is low labor intensive. The only benefit could occur through increased governmental revenue through taxes and these would then have to be diverted back into the communities for the loss of opportunity cost for the sake of the lack of employment opportunities in the region.

•

India will need to expand its manufacturing base and find its comparative advantages against the growing Chinese businesses. Sectors such as R&D and higher level manufacturing should be the target but this would take many years as the Indian economy undergoes its transformation.

3.3 But there are benefits to India Exports to China Let us not brush aside the fact that China is also a growing market for goods. Indian manufacturers will be exposed to the opportunity to export goods to this huge Chinese market. However, the concern is competing with Chinese and international companies, which are all trying to find their bearings in China. India will look to harness two areas – (1) Meet China’s demand for consumer goods which it cannot produce; (2) Plug into the Chinese supply chain by exporting resource based products not found in China.

38

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

A study by Bhattacharya and Bhattacharyay delves into the likely impact of an IndiaChina trade agreement using a Gravity Model. The authors take various comparativestatic scenarios. The scenarios include: (1)

Scenario 1: 25% across the board tariff cuts by the PRC and India

(2)

Scenario 2: 50% across the board tariff cuts by the PRC and India

(3)

Scenario 3: 75% across the board tariff cuts by the PRC and India

(4)

Scenario 4: 100% tariff cuts, i.e., FTA between the PRC and India

The results of the study are listed in Tables 9 and 10.

39

Increase in India's Imports ( Million Increase in India's Imports USD) (Percentage)

Name of the Commodities Electronic goods

Total MFN Imports ($ Tariffs Scenario Scenario Scenario Scenario Scenario Scenario Scenario Scenario Million) (2004–05) I II III IV I II III IV 2,069 40.4

973.2

1946.3

2919.5

3892.7

47.0

94.1

141.1

188.1

Coal, coke, and lubricants

780 27.8

208.0

416.0

623.9

831.9

26.7

53.3

80.0

106.6

Organic chemicals

607 34.4

497.3

497.3

745.9

994.5

41.0

82.0

123.0

163.9

Nonelectrical machinery

424 40.4

147.8

295.6

443.4

591.1

34.8

69.6

104.5

139.3

Electrical machinery Medical and pharmaceutical products Other textile yarn, fabrics, madeups

211 40.4

73.6

147.1

220.7

294.2

34.8

69.6

104.5

139.3

193 40.4

90.7

181.4

272.0

362.7

47.0

94.1

141.1

188.1

173 30.4

67.8

135.6

203.3

271.1

39.2

78.4

117.6

156.8

Silk yarn and fabrics

157 30.4

61.3

122.7

184.0

245.4

39.2

78.4

117.6

156.8

Nonferrous metals

145 34.4

59.5

119.0

178.4

237.9

41.0

82.0

123.0

163.9

Silver

139 20.4

33.7

67.3

101.0

134.6

24.3

48.6

72.8

97.1

Iron and steel

136 58.3

94.5

188.9

283.4

377.8

69.3

138.7

208.0

277.4

Inorganic chemicals

131 40.4

63.0

126.1

189.1

252.2

48.0

96.1

144.1

192.2

Raw silk Non-metallic mineral manufactures Man-made filament/spun yarn/ waste Metaliferrous ores and metal scrap Professional instruments, optical goods, etc

123 30.6

145.1

290.2

435.4

580.5

117.7

235.3

353.0

470.6

121 20.4

28.8

57.6

86.4

115.1

23.8

47.5

71.3

95.1

116 40.4

60.3

120.6

180.9

241.2

52.1

104.2

156.2

208.3

103 58.3

71.4

142.8

214.2

285.7

69.3

138.7

208.0

277.4

99 40.4

46.7

93.4

140.1

186.8

47.0

94.1

141.1

188.1

Transport equipment

89 40.4

30.8

61.6

92.4

123.3

34.8

69.6

104.5

139.3

Metal manufactures

88 40.4

41.4

82.8

124.3

165.7

47.0

94.1

141.1

188.1

1867.7

3735.4

5603.1

7470.9

27.6

55.2

82.8

110.4

All commodities

6,769 28.3

Source: ‘Free Trade Agreement between People’s Republic of China and India: Likely Impact and Its Implications to Asian Economic Community’, Swapan K. Bhattacharya and Biswa N. Bhattacharyay, ADB Institute Discussion Paper No. 59, 2006; Trade data used is for 2004

Table 9: Possible impact of an India-China trade agreement on India’s imports

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Increase in India's Exports (USD Million)

Name of the Commodities Iron ore

Total Exports ($ Million)

Increase in India's Exports (Percentage)

Average Tariffs Scenario Scenario Scenario Scenario Scenario Scenario Scenario Scenario 2004 I II III IV I II III IV

2,084

9.6

300.2

600.3

900.5

1200.6

14.4

28.8

43.2

57.6

Primary and semifinished iron and steel

489

9.6

70.4

140.8

211.1

281.5

14.4

28.8

43.2

57.6

Plastic and linoleum products

439

9.6

50.3

100.5

150.7

201.0

14.4

28.8

43.2

57.6

Processed minerals

231

9.6

33.2

66.5

99.7

133.0

14.4

28.8

43.2

57.6

Inorganic/organic/agro chemicals

218

9.6

31.4

62.8

94.1

125.5

14.4

28.8

43.2

57.6

Other ores and minerals

192

9.6

27.7

55.4

83.2

110.9

14.4

28.8

43.2

57.6

Drugs, pharmaceuticals, and fine chemicals

106

9.6

15.3

30.6

45.9

61.3

14.4

28.8

43.2

57.6

Machinery and instruments

98

9.5

7.3

14.6

22.0

29.3

7.5

14.9

22.4

29.8

Residual chemical and allied products

77

9.5

10.9

21.9

32.8

43.8

14.3

28.5

42.8

57.0

Nonferrous metals

65

9.6

9.4

18.8

28.3

37.7

14.4

28.8

43.2

57.6

Marine products

65

9.6

9.4

18.8

28.2

37.7

14.4

28.8

43.2

47.6

Cotton yarn, fabrics, made-ups, etc

65

9.5

6.7

13.3

19.9

26.6

10.2

20.5

30.7

41.0

Electronic goods

45

9.5

5.0

10.1

15.1

20.2

11.3

22.7

34.0

45.3

Castor oil

41

9.6

5.9

11.8

17.7

23.6

14.4

28.8

43.2

57.6

Oil meals

36

9.6

5.2

10.3

15.5

20.6

14.4

28.8

43.2

57.6

Finished leather

31

9.5

2.0

4.1

6.1

8.1

6.6

13.3

19.9

26.5

Manufacture of metals

29

9.5

3.3

6.6

9.8

13.1

11.3

22.7

34.0

45.3

Ferro alloys

28

9.6

4.1

8.2

12.3

16.4

14.4

28.8

43.2

57.6

Dyes, intermediaries, etc

19

9.6

2.7

5.4

8.1

10.7

14.4

28.8

43.2

57.6

Gems and jewelry

18

9.5

2.1

4.2

6.3

8.4

11.3

22.7

34.0

45.3

5,345

9.8

610.2

122.5

1850.7

2440.9

11.4

22.8

34.3

45.7

All commodities

Source: ‘Free Trade Agreement between People’s Republic of China and India: Likely Impact and Its Implications to Asian Economic Community’, Swapan K. Bhattacharya and Biswa N. Bhattacharyay, ADB Institute Discussion Paper No. 59, 2006; Trade data used is for 2004

Table 10: Possible impact of an India-China trade agreement on India’s exports 41

TAKSHASHILA POLICY BRIEF

Competitiveness pressures could lead to much needed economic restructuring The comparative advantages of China are plain and Indian manufacturing companies will have to re-examine their strategies to compete with Chinese firms in Indian markets as well as 3rd party markets. Taking a cue from some of the policy changes in the ASEAN economies, India will need to apply a customised approach for its own domestic economy. These have emphasised the need to exploit the comparative advantage of the domestic economy as compared to China. Box: How ASEAN restructured to Chinese growth Singapore In the Singapore case the policy responses focus on three aspects; namely, taking a free ride on the rapid growth of the Chinese economy; developing strategic industries in which it has competitive advantage over China, and, finally, constantly restructuring and upgrading its economy to be internationally competitive in response to the changing economic environment. The economy has and continues to restructure to adapt to the changing economic dynamism in Asia. By focusing on higher education and entrepreneurship, Singapore has devised a niche in high technology products, an industry where China is still an infant. While the Singapore case is not directly applicable to India, it’s the importance of elasticity of policy, which needs to be highlighted. Possibly a more applicable case is of Thailand which too has taken steps in adapting to the Chinese economic behemoth. Thailand The Thai strategy and policy responses are very much different from the island-economy of Singapore. First, Thailand has a reasonable large domestic market with a huge rural population. Second, it is endowed with natural resources and its technology level is still not sophisticated. Both these aspects make the Thai example a more suitable learning platform for India. In this respect, Thailand has tried to play a complementary role, first in meeting the increasing demand for raw materials and foodstuff from China and, second, in the Asian Production Networks, not only in the electronics industry but also in the motor vehicle market. Such complementarities have resulted in a rapid rise in regional intra-trade. In fact, while China has a trade surplus with the United States, it has trade deficits with almost all ASEAN countries, including Thailand. Drawn from – ‘Facing the Challenge of the Rising Chinese Economy: ASEAN’s Responses’, Yunhua Liu and BeoyKui N, Review of Development Economics, 14(3), 2010

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

Positive effect on FDI into India India’s deficit in infrastructure spending can be met, to some extent, by Chinese investors. With many opportunities in India, and overcoming security and political obstacles, Chinese investors have shown interest in certain Indian investment projects. In fact, nine Chinese companies, in joint ventures with Indian contractors are already implementing six highway projects worth Rs 2,478.32 crores in India. Three highway projects worth Rs 1,264.24 crores have already been completed23 . Most recently, India and China held a joint seminar in Yangzhou in the Jiangsu province in China. The seminar aimed to ‘evoke interest among Chinese companies to invest in India’24. The conference drew important businesses from both China and India, hoping to find an overlap of interests.

23

‘Chinese investment in Indian highways to rise 3-fold’; Economic Times, 24th Sep 2010

24

‘India, China business meet scouts Chinese investment in India’, PTI, 11th June 2011

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TAKSHASHILA POLICY BRIEF

SECTION 4: WHAT IS NEEDED FROM HERE ON? 4.1 Summing up China’s manufacturing competitiveness stems from (1) its low cost of capital and artificially suppressed input costs: power, water and land;(2) and in large measure, from its total factor productivity and the willingness of its labor force to work hard for the sake of the next generation. That workers have not been organized until now in China is an advantage in keeping wage costs down. Although wage costs are rising resulting from shortage of skilled labor in specific areas, there is still a vast reserve army of labor that would preserve China’s competitiveness for long time to come. Although Chart 14 does not include India and is based on data from the year 2008, it reveals the enormous ‘lead in competitiveness’ that China has over other advanced nations. It is hard to imagine India’s costs being closer to China’s. At best, it will be closer to the Asian average.

Chart 14 - China’s lead in competitiveness 44

DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

To its credit, India recognises the huge gap that exists between its ambition and potential on the one hand and the reality on the other. That is why it has come up with a National Manufacturing Policy (NMP) that aims to increase the Manufacturing share of GDP to 25%. The policy, recently approved by the Government of India, sets great store by the establishment of National Manufacturing and Investment Zones (NMIZ) to enable at least parts of the country leapfrog the constraints that hold back the sector. The hope is to use their successes to generate momentum for its implementation across the nation later. Perhaps, such an approach works at an earlier stage of economic development and more effectively for smaller nations. Further, the policy skirts the all-important question of labor market flexibility. Inflexible labor laws, enacted decades ago ostensibly with the aim of protecting workers from rapacious capitalists, have prevented employment generation. Capitalists have concluded for the most part that if firing workers was difficult, then it was best to avoid hiring them in the first place. They have also kept their labor forces below particular levels to avoid attracting the provisions of various labor laws. That has been the biggest deterrent against scale and growth of the Indian manufacturing sector dominated mostly by small and medium enterprises. Hence, most of the Indian workforce remains outside the protective umbrella that the plethora of labor laws has dreamt up for them! Talk about the road to hell being paved with good intentions! This is what India’s political and bureaucratic establishment have to show for all their noble development, egalitarian and social intentions. This mindset continues to this day, despite years of compelling empirical evidence from different sectors of the economy. Indian economic policy-making takes place in a ‘fact-free’ zone. Further, the NMP would end up exacerbating the constraints and inefficiencies under which the rest of the economy would be operating, outside the NMIZ, because the rest of the economy has to absorb the costs of providing these select zones of excellence with assured power, water, land at reasonable cost. The country’s finances – at the Federal and at the State level – are in no position to absorb these costs.

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TAKSHASHILA POLICY BRIEF

Hence, in the final analysis, the idea of a FTA with China has to be used as a thoughtexperiment or as a horror scenario to hasten all the crucial reforms and decisions that India has deferred or avoided taking, for fear of the damage that pursuing them would cause to the political future of the ruling parties. For the most part, these fears are imaginary. They can also be overcome through persuasion and communication. The Indian political class has shown itself to be either unwilling to or incapable of engaging in communication with the society on the policy imperatives. Consequently, it is reasonable to conclude that, at this stage, a free-trade agreement with China would largely confer one-sided benefits to China as has already been happening in the bilateral trade relations without the FTA. 4.2 The other steps A famous Indian proverb rings true of the economic ties between India and China - ‘for the friendship of two, the patience of one is required’. The time is not yet ripe for an India-China FTA though this discourse is vital in understanding where the two allies stand and how each of their futures could shape up. The last two decades have been dotted with Indian achievements but one can say without the slightest hesitation that India is far from its potential. Economic liberalisation has been piecemeal. What started with a scamper for liberalisation in the 1990a has been reduced to a clamber for growth. The Indian economy continues to grapple with half-baked reforms and a driven private sector unable to stretch its arms. There is a lot that needs to be done before India can achieve a competitiveness status commensurate with its human and resource capital. It currently stands behind some of the fastest growing economies in Asia (Table 11).

IMD

WEF

Singapore

3

3

Malaysia

16

26

China

19

27

Thailand

27

38

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

India

32

51

Indonesia

37

44

Vietnam

 

59

Source:  ‘IMD World Competitiveness Yearbook 2011’ and ‘World Economic Form: The Global Competitiveness Report 2010–2011’

Table 11: India’s competitiveness rankings Expedite the process of trade enabling India needs to become a more trade-friendly economy to trade by expediting the process of economic liberalisation. Currently it ranks far behind China and other Asian economies on its ability to enable trade (Table 12).

Overall Singapore 1 Hong Kong 2 Denmark 3 Sweden 4 Switzerland 5 US 19 Japan 25 China 48 Indonesia 68 South Africa 72 India 84 Brazil 87 Russia 114

Market Access 1 16 95 96 58 62 121 79 60 87 115 104 125

Border administration 1 6 3 2 10 19 16 48 67 53 68 80 109

Transport and communications infrastructure 7 5 8 9 10 11 14 43 85 65 81 66 48

Source: WEF Global Enabling Trade Report 2010

Table 12: Ranking of India’s trade friendliness

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Business environment 2 5 3 10 8 37 34 41 60 79 58 83 92

TAKSHASHILA POLICY BRIEF

Allow more private sector participation Private sector has been the engine of growth. The intended beneficiary of a trade agreement is the businesses. To ensure they are internationally competitive, the government needs to create the necessary business environment required for companies to thrive, innovate and expand. China does better than India on almost on counts of doing business (Table 13). India

China

Starting a Business

165

151

Dealing with construction permits

177

181

Registering property

94

38

Getting credit

32

65

Protecting investors

44

93

Paying taxes

164

114

Trading across borders

100

50

Enforcing contracts

182

15

Closing a business

134

68

Source: Doing Business 2011, World Bank

Table 13: Doing Business in India and China (World Bank rankings)

No more time for excuses India needs to focus on realising its immense growth potential by getting the government out of the way in many areas, including in cornering private savings to finance its ever-rising administrative and social expenditures. Social expenditure programmes are necessary in a growing country with a good number of poor people but they need to become empowerment rather than entitlement programmes. Further, in order to energise the nation, government must focus on two or three priority areas, achieve success and use the goodwill to tackle other areas. Key immediate priorities must be to unshackle education from government ownership and control, eliminate load-shedding and power shortages, ensure a transparent land acquisition mechanism

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DEMYSTIFYING INDIA-CHINA TRADE POSSIBILITIES

for industrial use and eliminate the prevalence of cash (rather than banking) in the property sector. Many reforms are interlinked; they affect vital political interests and funding for political parties. India needs a committed top-down leadership that is focused on the next generation rather than on next elections. Power, land and skilled and educated workforce would propel Indian manufacturing to the global stage within a decade. By realising its manufacturing potential and developing mature and competitive industries, India will be prepared to face competitive pressures from China and other prospective FTA partners. Without the aforesaid reforms and more, an FTA with a manufacturing behemoth like China may lead to a destruction of its domestic industrial architecture and probably have a detrimental effect on poverty through loss of workeroriented industries.

The Takshashila Institution is an independent think tank on strategic affairs contributing towards building the intellectual foundations of an India that has global interests. It aims to establish itself as one of the most credible voices in India’s public policy discourse, known for its unambiguous pursuit of the national interest, through consistent high-quality policy advisories. http://takshashila.org.in

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