The Hindu Business Line : SAFTA can do a NAFTA

FREE trade agreements (FTAs) are becoming common and India is not lagging behind either. Once a protagonist of protectionism and a staunch supporter of the World Trade Organisation (WTO), India is now looking at FTAs, especially with East Asia, as a new axis for development of trade and investment. Within a year the country has signed four FTAs — one bilateral (with Thailand) and three multilateral (one each with BIMSTEC, the Asean and SAFTA). Of these, SAFTA (South Asian Free Trade Agreement) has been relatively successful and is perhaps the only FTA which has served to reduce political asymmetry among the South Asian Association of Regional Cooperation (SAARC).

Two factors pushed India into accelerating its FTA drive. One, the breakdown of Soviet Union and the prolonged stagnation in the West, which forced India to look East-ward. But efforts to promote East Asia as a major trade partner failed as India was not part of any regional trade bloc. And, two, the emergence of China as a global economic and trading powerhouse and its keenness on FTAs, particularly with the Asean.

Though the FTAs that India has entered into are good news, there seems to an underlying feeling of suspicion. For instance, following the FTA with Thailand, the domestic auto component industry is jittery, as its Thai counterpart is better placed, thanks to the liberal domestic tariff system which has resulted in a lower cost structure. And with regard to the FTA with Singapore, which is to be inked, there are already trade-diversion fears, of Chinese assembled goods finding their way into the country via Singapore, which is no manufacturing centre. And because of the current political situation, there is scepticism about SAFTA as well.

Economic benefits apart, SAFTA would enrich political understanding among the members, something SAARC has found difficult to achieve. It is true that the immediate impact of SAFTA is blurring as the member-nations are endowed with similar assets — abundant labour and natural resources. But barring India, there is scarcity of technology and capital.

SAFTA members can reap economic benefits through enhanced cross-border trade. Thus far, because of high tariffs and cumbersome Customs procedures, much trade is taking place illegally — through smuggling, for instance. With better capital and technology, India would have a bigger role to play in SAFTA, just as the US in NAFTA (North American Free Trade Agreement).

India is the biggest exporter to Sri Lanka, accounting for 10-15 per cent of its imports, Bangladesh (35 per cent), Bhutan (over 80 per cent) as also Nepal. By contrast, the major export destinations of these countries are the US and Europe. It is surprising that despite this trade pattern, SAFTA has become reality.

One big constraint for exports of these countries to India is the high tariff, especially on textiles and garment. These countries enjoy concessional tariff in the US and Europe under the quota regime. But once quotas are lifted, in 2005, these countries will face severe competition from China in the American and European markets and India may emerge a big market, hitherto unviable to them because of the high tariff. Besides, with the rupee strengthening against the dollar, export earnings from India will increase. Therefore, it would not be right to infer that only India will gain from SAFTA.

How best SAFTA can be the used to foster closer economic ties among member-countries can be gleaned from NAFTA, where also there is sizeable disparity among the members — the US and Mexico, for instance. Unlike the EU, NAFTA was the first major FTA between developed and developing nations. Mexico's per capita GDP is only a seventh of the US'. At the start, the economic asymmetry between the countries roused concern over the likely success of NAFTA. But it has turned out to be a windfall for both the countries.

NAFTA emerged a strong platform for Mexico to boost exports and supplement its economy, which was wobbling on a large trade deficit. NAFTA helped in Mexico's export recovery through duty-free trade with the US. Over the past decade, Mexico's export to the US has risen four-fold. And to the surprise of many, Mexico turned its trade balance with the US in its favour in the post-NAFTA period.

How did Mexico succeed on the NAFTA platform, despite being the only developing nation in the trilateral FTA? Mexico became a cheap workshop for many US multinationals by cashing in on investment, labour and service issues yet to come under the WTO regime. These resulted in huge foreign direct investment (FDI) by US multinationals, which set up production units in Mexico and imported back the goods duty-free into the US, thus taking on the increasing competition from Asia.

A number of US firms established maquiladora (units set up with incentives from the government to make goods mainly for exports) operations along the US-Mexican border. Maquiladora accounts for 53 per cent of Mexico's total export. NAFTA has become the springboard for Mexico to export to the global market.

The issues relating to investment in NAFTA, which guaranteed national treatment and exemption from export obligations, domestic procurement and transfer of technology prompted the US to invest heavily in Mexico. The latter had to accept the FTA on these terms, as its rather rudimentary legal system was turning out to be a barrier in attracting FDI. Therefore, NAFTA helped Mexico spur not only investment but also investment-related exports to the world's biggest economy.

This shows that a developing nation in a multilateral FTA bloc can reap benefits and not have the fear of developed nations having the upper hand. But unlike NAFTA, the issues covered under SAFTA are not comprehensive; the scope is confined only to trade in goods. Cross-border trade among member-countries would get energised only if issues such as treatment of foreign investments, movement of labour and trade in services are included in SAFTA.

(The author is senior researcher in a New Delhi-based Japanese multinational firm.)