The Hindu Business Line : Free trade agreements

India had signed free trade agreements with Sri Lanka, Thailand and Singapore in the recent past. But rupee appreciation and high customs duty seem to have nullified the benefits these agreements could bring India.

S. Majumder

India has been embroiled in a long and intense debate on whether FTA is a boon or bane. While some economists hope FTA to be a new and innovative model to integrate India into global trade, after the failure of WTO, the domestic entrepreneurs are up in arms against it. Besides losing the advantages of high tariff protection, the rupee appreciation has added to the woes of domestic enterprises and has put the FTA partner countries in an advantageous position.

The rupee has appreciated by about 11.5 per cent between March and December, 2007, on a month-on-month basis. This has concurrently impacted the tariff protection to the domestic enterprises.

A strong rupee has lowered the effective rate of custom duties and has benefited the FTA partner countries. Exporters of FTA partner countries enjoy tariff concession and over and above that rupee appreciation given more benefits to them.

Under FTA, the effective custom duties comprised countervailing duty and special duty. Only basic custom duty is exempted. Rupee appreciation has a cascading effect on countervailing and special duty since over 60 per cent of CIF value of import trade is quoted at the US dollar.

Further, the recent cut in CENVAT from 16 per cent to 14 per cent in the Budget has added to the windfall to the exporters from FTA countries to India. Now, FTA products enjoy an effective rate of customs duty of 18.99 per cent against the non-FTA product at 31.70 per cent at a peak rate of 10 per cent basic customs duty.

Rupee appreciation

With the rupee appreciation, the value of this effective custom duty slips by about 10 per cent, paving the way for more cheap imports of FTA products.

For example, if CIF value of a FTA product is $100, the effective customs duty will be $18.99 or Rs 760 (at the present exchange rate of $1 = Rs 40) after exemption of basic customs duty of 10 per cent.

Had the rupee not appreciated and remained at the March 2007 levels, the effective customs duty in rupee terms would have been Rs 855 (at Rs 45 per US dollar). This means the FTA product would have been costlier by 12.5 per cent had the rupee not appreciated.

So far India has entered bilateral FTAs with three countries – Sri Lanka, Thailand and Singapore. While the FTA with Sri Lanka did not raise much hue and cry, the Early Harvest (EH) with Thailand and the Comprehensive Economic Cooperation Agreement (CECA) with Singapore were much in the news.

Though the primary objective of FTA might have been fulfilled, that is, overall expansion of trade, the advantages of FTA accrued more to Thailand and Singapore than to India.

One of the major setbacks for India is that India’s trade balances with Thailand and Singapore have reversed due to the FTA. The trade balance has reversed with Thailand since 2005-06 and with Singapore since 2007-08.

A spurt in imports from these countries led to the adverse trade balance. Imports from Thailand increased at an annual average rate of 40 per cent since the operation of the EH programme against 7 to 10 per cent earlier and that of Singapore by 29 per cent annually in the post CECA period against about 23 to 25 percent annually earlier.

Even though 82 EH items constituted only 18 per cent of Thai exports to India, they were mainly responsible for reversing the trade balance. These included colour TVs, picture tubes and air-conditioners. During 2004 to 2006, the average annual growth in exports of these products from Thailand surged 71 per cent, 160 per cent and 90 per cent respectively.

Inverted duty structure

Similarly, exports of electronic goods from Singapore became the key product group to reverse the trade balance against India. Exports of these goods from Singapore surged 26.7 per cent in 2006-07, up from the 24.96 per cent growth posted in 2005-06.

India is also saddled with an inverted duty structure. While India is shackled by higher customs duty on raw material and parts, Thailand and Singapore enjoy low or nil duty on raw material and parts.

As a general principle, if a particular raw material, which is used as input for a finished FTA product, is not included in the FTA or free of duty, the finished product should not be included in the FTA.

In Thailand, customs duty on picture tube is nil. This led the Thai exporters to dump Colour TVs at a very competitive prices, taking the advantage of the FTA. Nearly 48 per cent of raw materials and parts imported into Thailand are below 10 per cent import tariff regime.

In fact, India’s main objective was to utilize the FTA to expandits services exports. In GDP services account for 45 per cent but, in terms of export, services are equivalent to 60 per cent of merchandise exports.

India exported services worth $76 billion in 2006-07, half of which were software services. India’s real objective for signing the FTA seems to have been waylaid.

More than three years have passed since the signing of the India-Singapore CECA, but nothing concrete in services exports has emerged. Both sides agreed to liberalise the visa regime on 127 categories of professionals. But the movement of Indian professionals has not yet gained momentum.

Neither has Singapore shown enough willingness to recognize the technical and professional degrees of second grade Indian institutions.

The India-Singapore CECA allows both countries to grant qualified full banking status to three banks each. Here too, not much headway has been made. So far only one Indian bank, State Bank of India, has been approved for qualified banking status.

Now an FTA with the Asean is in the offing. It took almost a year to reach a consensus on the negative list. However, during this period the rupee appreciation has softened the duty impact by over 10 per cent.

In this perspective, considering the upsurge in rupee (which is likely to continue in the near future) and without reforming the inverted duty structures, the advantages of FTA are debatable.

(The author is Adviser, Japan External Trade Organization (JETRO), New Delhi. The views are personal.)