The Hindu Business Line : Why worry over the Indo-Thai FTA?

WITH the India-Thailand free trade agreement (FTA) to be launched on September 1, domestic industries, especially auto-parts and electronics, seem to be a worried lot. They feel that Thailand, with its lower manufacturing costs, lower Customs duty on inputs and idle capacity, would resort to dumping.

In the post-FTA period, Indian auto-parts and electronics sectors, which largely depend on Japanese assemblers in India, fear that these Japanese firms would shift to Thailand, seeking cheaper components and parts. And they allege that with nil Customs duty, domestic industries would be hit hard by Thai exports.

However, these fears should ease when the tax reforms proposed by Dr Vijay Kelkar are implemented. The Kelkar Task Force report, brought out after the Framework Agreement on the India-Thailand was signed, has recommended a drastic reduction in Customs tariff from 2005-06.

The major component of the Fiscal Responsibility and Budget Management Act, 2003 is the three-tier Custom duty structure, of 5, 8 and 10 per cent. The 5 per cent rate applies to raw materials, 8 per cent to intermediates and 10 per cent on finished goods. Consumer durables and motor vehicles are to be taxed at 20 per cent and 50 per cent, respectively.

Further, the Task Force cautions that unless these recommendations are implemented from 2005-06 it would be difficult for the Government to fulfil the target of zero revenue deficit by 2008-09.

The India-Thailand FTA talks of phased tariff reduction on 82 early harvest items (EHIs) — 50 per cent in 2004-05, 75 per cent in 2005-06 and 100 per cent from 2006-07 onwards. This means that at the peak rate of Custom tariff of 25 per cent on January 1, 2004, the FTA rate will be 12.5 per cent in 2004-05, 6.25 per cent in 2005-06 and nil in 2006-07 on the 82 EHIs.

Assuming that the Kelkar Task Force recommendations are implemented from 2005-06, the duty differential between the normal Custom tariff and the FTA will be 3.75 per cent in respect of finished goods (10 per cent minus 6.25 per cent) and 1.75 per cent for intermediate goods (8 per cent minus 6.25 per cent). However, from 2006-07, the duty difference will be 10 per cent and 8 per cent, respectively. The 82 EHIs are mainly finished and intermediate goods.

Thus, the duty differential will reduce substantially once the Kelkar recommendations are implemented. According to a study, if the peak rate of Custom duty remains at 25 per cent (the level when the Framework Agreement was signed), Indian auto-part makers would have suffered a cost disadvantage of 15-20 per cent vis-à-vis their Thai counterparts, mainly because of the adverse tax structure and infrastructure costs. With the new tax regime, much of the cost disadvantages are likely to be neutralised even when the FTA becomes fully operational.

From a long-term perspective, too, the impact of the FTA may not be adverse. The benefits of the FTA will largely accrue to Japanese auto firms in Thailand; their market share in Thailand is as high as 80 per cent in passenger cars, over 90 per cent in commercial vehicles and 99 per cent in motorcycles. In TV and air-conditioners, too, Japan leads.

By contrast, in India, Japan is languishing, thanks to stiff competition from Korea. The US has also targeted India as a major market in Asia. Till five years ago, Japan's share in India's passenger car market was over 70 per cent and Korea's less than 5 per cent. But now, Korea's share has jumped to 18 per cent and Japan's fallen to 55 per cent.

In electronic and home electrical appliances, Korea has again outsmarted Japan; its market share in colour TVs has surged to about 30 per cent against Japan's 20 per cent.

In air-conditioners, while Korea has captured nearly 40 of the market, Japan's share is only 10 per cent. It is unlikely that this growing presence of Koreans in the Indian market is reversible.

Korea, however, has not been able to entrench itself in Thailand. In automobiles, for instance, its presence there is minuscule. On the contrary, the gush of Korean investments into the Indian automobile and electronics sectors are likely to cushion domestic manufacturers against any Thai-Japanese threat in the long term.

In all probability, Japan would shrink its investment in components and parts in India and procure the same from Thailand. And this leads one to believe that Japanese brands, unable to compete in a highly price sensitive market such as India's, would exit. Can Japan revive its market merely through trading?

The thumb-rule of global trade expansion is investment-related trade — Korea's is a case in point. India's imports of electronic goods from South Korea has risen three-fold in the last two years, thanks to massive investments from Samsung and LG. No foreign investor can sustain in a host country merely by trading.

Hence, whatever gains that may accrue to Thailand and Japan in the immediate post-FTA period will not turn into a windfall in the long term. The anti-dumping clause is expected to be strictly enforced to radar pricing and value addition.

There are several positive aspects in the India-Thailand FTA. But these are being swamped by the clamour by a few industries. Take the case of plastics. A number of plastic intermediates have been included in the EHI, which are either not manufactured in India, or, if manufactured, not in sufficient numbers to meet the domestic demand.

For instance, polyacetals and polycarbonates in primary form are not manufactured in India, but with the spurt in the growth of automobiles and electronics, the demand for these plastic intermediates are surging in the domestic market. Hence, importing these have become inevitable.

In such cases, tax-free imports from Thailand will not only be beneficial for product manufacturers, but will also induce price competitiveness in the market.

Thus, the Indo-Thai FTA is not as harsh as it is being made out to be by a few industry segments. FTAs are a modern way to expand global trade, and many of them have been signed only since 1999.

The FTA with Sri Lanka in 2000 is evidence of India's success in trade expansion. Within four years, India's trade with Sri Lanka has more than doubled, with exports surging by over 108 per cent and imports by 187 per cent. The FTA has also become an FDI route in Sri Lanka.

It is true that the India-Thailand FTA will cause some hiccups for domestic industries, butthe slashing of Customs duties and growing investment by Korea would cushion any Thai-Japanese onslaught.

Trading alone cannot result in major gains. That is why the AFTA (Asean Free Trade Area) has not turned out to be much of a windfall to member-nations even after they reduced the tariff to 5 per cent since the beginning of last year.

In contrast, Thailand will provide the initial gateway for domestic industries to enter the Asean market. Considering the emphasis given in the Framework Agreement, both countries propose to liberalise trade in services, especially information technology, an area where the Thai Prime Minister has shown keen interest.

(The author is a senior researcher in a Japanese MNC in New Delhi.)