Is signing FTAs enough to ensure export growth?

India and Australia recently signed an Economic Cooperation and Trade Agreement. A similar pact is being negotiated with the UK. Both are high-income countries. Such pacts improve access rights for both citizens and organisations, such as visa entitlements and education and work opportunities, but are primarily intended to enhance the flow of goods and services.

While Indian services are globally competitive, will such agreements by themselves enable India’s merchandise exports to rise? The share of high-income countries in the Indian export basket has been consistently falling. The combined EU (including UK) and US share is now below 30%, as against 45% in 2000. Will we see a trend reversal now?

Bilateral/Regional Trade Agreements (RTAs) have become more prevalent since the 1990s. RTAs cover more than half of international trade and operate alongside global multilateral pacts under the WTO. The first 11 years (1995-2005) of the WTO were paralleled by a tripling of RTAs from 58 to 188. The pace increased thereafter. Currently, 455 RTAs are in force globally. This is the 14th RTA signed by India, which now shares preferential market access and economic cooperation with over 50 (mostly developing) countries.

The Indian experience with previous trade accords has been somewhat mixed. Exports to Sri Lanka jumped sharply post-accord, growing much faster than import growth. However, India’s trade deficit with ASEAN, South Korea and Japan widened post-RTAs as imports grew much faster than our exports. In fact, the growth rate of India’s exports to RTA partners over the past decade or so is similar to the trend growth to non-trade partners, both averaging about 13% y-o-y. Trade accords are negotiated with extreme care but somehow our companies, unlike those from Korea, Japan and the ASEAN countries, have not been able to leverage them to penetrate partner markets. Why?

Australia (population: 26 million) has a GDP of about US$1.4 trillion, with an average growth rate of 2.5% and annual exports and imports of $250 billion and $210 billion respectively. Our bilateral trade in goods and services is about $30 billion. India has a trade deficit in merchandise of about $8 billion but has a modest surplus in services trade.

The UK (population: 67 million) has a GDP of $3.37 trillion and average growth rate of about 1.5%. Its annual global export and import levels are $460 billion and $690 billion, respectively. Our bilateral trade in goods and services is about $24 billion, with a trade surplus in favour of India. The market sizes of the partner countries are thus deep, but our current penetration levels are quite low. We need to increase them.

Both the UK and Australia have relatively high per capita incomes and low annual growth rates. Their markets are deep and large, but not fast-growing. These trade pacts can therefore enhance bilateral trade only if Indian companies are able to take advantage of treaty terms to switch market preferences away from other countries’ products. Indian exporting companies will tell you the main problem they face are the ‘non-tariff barriers’, encountered even after the trade pacts.

Consumer tastes and preferences in high-income markets are focused on issues such as ‘quality’ and ‘ESG’ (environment, social and corporate governance) standards rather than simplistic ‘value for money’ competition. These standards are more stringent than that in the Indian market. There is intense price competition here. As such, several corporates have separate manufacturing lines specially for export markets and hence often lose out on volume shares in order to make effective consumer impression in high-income markets. While instances of Indian success stories exist, they are exceptions rather than the rule, which is why previous trade pacts with Japan, South Korea and the ASEAN witnessed muted export growth and increased trade deficits.

This problem is not encountered by Chinese or Southeast Asian companies as these countries have harmonised their internal standards to European levels. This harmonisation is not happening fast enough in India because of an apprehension that higher quality/ESG standards would make it unviable for our MSMEs. European MSME definitions go up to capital investment in ‘Plant and Machinery’ of around $50 million while ours is a maximum of $7 million.

It is important to understand the nuances. It is not that Indian exports are not growing. They are. Our annual exports recently crossed $400 billion. The challenge is to grow them faster by increasing our shares in the more profitable high-income markets. This requires that we make our MSME-driven manufacturing sector globally competitive. Removing obstacles such as the need to deal with multiple quality standards is one key measure that must be taken. Alongside, if we want our MSMEs to compete in high-income markets, they should be allowed to grow to sizes considered usual for those markets. Only then will we derive fuller mileage from trade pacts.