Why an India-China FTA makes “negative” sense!

 Steven Philip Warner | @TheDollarBiz

While India has largely remained an exporter of traditional raw materials, China has moved up the value chain in exports. An FTA between the two nations will only benefit China (much) more. (L - Inside the biggest CCTV, surveillance camera company, in China, April, 2010 in Shenzhen; R- Textile workers in a small factory in Old Delhi, February, 2008 in Delhi, India)

  It’s surprising how many stakeholders and policymakers in India are proclaiming an India-China Free Trade Agreement to be a matter of “macroeconomic exigency”. Given China’s dominance in the world of foreign trade in recent years, especially exports, this seems a measured idea from a distance. But closer observation proves that this elixir of a relationship, guaranteed to induce prosperity for India, is nothing but a sour “poison pill”. It is reasonable for the exporter-importer community to assume that the current batch of white-collared, educated professionals calling the shots in India’s foreign trade card game would be good at picking trade deals. But the very thought of playing a “blind” gamble (what else would you call an FTA with China?) fraught with untold risk would give even the grizzliest of Arctic ice-loving polar bears some distinct goosebumps. The only logic that one can fathom out for such an anxiety attack can be that it is our policymaking think tank’s brave shot at gathering some “homegrown-and-not-yet-toughened” muscle to stand up to the might of the two United States-led trans-regional trade pacts that are currently a work-in-progress (the Trans-Pacific Partnership and the Transatlantic Trade & Investment Partnership; that is, if they work out). [Combined, these two treaties will include more than a-third of world trade.] But such an effort can only tantamount to making some noise in the export-import market; whether it will actually work in India’s favour is a question to which most pundits cannot give an answer with proof! Taking decisions at a national scale, and when it comes to something as macro as India’s foreign trade, calls for more sensible and measured thoughts (with historical imperatives) than what even veteran expert money managers would take pride in. If you were to consider this overstatement as a vile act of dramatization, pray understand – you can’t agree with signing an accord on behalf of a nation and realise a decade later that failure was actually not an option.  We will quickly explore three reasons why the Indo-China foreign trade marriage – using the now much-discussed (proposed) platform of Regional Comprehensive Economic Partnership (RCEP) [that includes ASEAN countries besides six other nation with whom the ASEAN bloc has FTAs – India, China, Australia, New Zealand, Japan and South Korea] – is a mission that should be aborted. Reason #1: Morning shows the day Despite scholars having questioned the loopholes of Article XXIV the General Agreement on Tariffs and Trade (GATT), as incorporated into the WTO in 1994 (which allows WTO-member nations to form customs unions or FTAs, provided the members eliminate all internal barriers to trade inside the union and common external tariff / trade barriers are not increased on average) and Article V of GATS (which outlines conditions for WTO members to set up a PTA), India remains a believer in bilateralism. A decade-and-a-half since we got up in a hurry to sign FTAs (RTAs, PTAs, etc.), we are still to find reasonable numeric justification for the very birth of these harmonies. During the past ten years (post which most of these RTAs were signed by India), our annual exports to RTA partners have risen at a CAGR of just 12% – almost equal to the rate at which our exports to non-RTA nations have grown! If our past RTAs were signed as acts of generosity, they would have perhaps been better justified. Since FY2005, these RTAs have worked more to spoil the chart of trade deficit than beautify it. In the ten years leading to FY2014, imports from our bilateral trade partners (including the blocs) have actually increased by 12.3%. (Compare this to the lower 11.5% rise of import bill from non-FTA partners and you are taken by a bigger surprise.) To quickly explain how India’s experience with bilateral trade is not a happy one, let us consider the much ambitious trade pact with ASEAN bloc and with two Asian powers Japan and South Korea. In the past ten years, our trade deficit with these three geographies have increased close to 300% (deficit during FY2014 alone was $20 billion). If you solely consider the ASEAN bloc, during the past ten years, we have accumulated a trade deficit of over $56 billion – thanks to heightened imports and a sluggish outward trade with this bloc. Whether India should sign another FTA in a hurry should be determined by how the story has unfolded for India so far. That our annual trade deficit with 24 FTA partner nations has risen by 262% in the past decade, should be enough indication for the wise. Reason #2: Are we ready to kill brand India? Before crying wolf, it’s important that we bring to the fore two critical studies, which are amongst a few reports that talk about how India has remained primarily a “raw material exporter” while China has moved up the value chain to become a champion exporter of “finished goods”. As per a working paper by Prof. R. Chanda of IIM Bangalore, titled, ‘India-China FTA: Viability, Prospects and Challenges’, “More than 50% of China’s exports come from final processing and assembly of intermediate goods imported from its Asian neighbours. On the other hand, India’s exports are primarily raw material and labour oriented with items such as mineral fuels and precious stones dominating the export basket...from an Indian perspective, a narrow FTA covering only goods trade will not be beneficial to India. Our results indicate that even in a scenario where China completely opens up its markets, while India does not, India will continue to have a [trade] deficit.” From the ongoing discussions on CEPA and the manner in which our ASEAN and Mercusor accords have been administered, it is quite clear that our FTA that is being thought of with China will primarily, if not solely, include goods. That is definitely bad news for India’s foreign trade health. Another paper (published by ICRIER) by Przemyslaw Kowalski, an economist at OECD, titled, ‘China and India: A Tale of Two Trade Integration Approaches’ concludes that, “Deficiencies of the manufacturing sector are also reflected in the export performance [of India]. Despite the fact that India is relatively abundant in skilled labour and capital, its manufacturing exports are highly concentrated in low-technology goods and the share of high-technology manufactured goods in its total exports has barely changed since the mid-1990s and remains under 5%, as compared to 30% for China. India has not integrated into the global production networks of high technology products to the extent China did. The product composition of China’s merchandise trade has undergone a major change since the beginning of reforms with the large rise in the value of manufacturing exports and the significant increase over the years in imports of fuel, energy, and capital goods. Furthermore, a clear diversification is observed away from lower technology products such as footwear, toys, apparel and petroleum products towards ICT (Information and Communication Technology) sector products such as automatic data processing machines, transmission apparatus and parts and inputs into electronic products, amongst others. Both the growing specialisation and the going up the value chain are manifestations of the rising sophistication of China’s manufacturing sector.” The reports are literally sworn statements of the fact that China has moved far ahead in the race to create “Brand China”, one that is gradually getting recognised for quality around the world.  The cusp on its chart of popularity is still many years away. At present, the situation of Chinese-born brands is similar to that of the Japanese brands in the 1950s. [Then, Japanese brands were perceived as low quality and “made-for-the-masses” but they gradually started making headlines as high quality, high value-add and high-technology masterpieces.] We need to answer one question here: Why is it that despite trade deficits with ASEAN, Japan and South Korea rising past the roof since FY2004, our surplus with SAFTA has only grown in magnitude in the past decade? Secret: SAFTA has seven nations – Nepal, Afghanistan, Bhutan, Pakistan, Sri Lanka, Bangladesh, and Maldives – all of whom have a consumer group that appreciates volume and price more than quality or brand power! It is worth noting that in the most popular 2014 Milward Brown (and Kantar and Bloomberg) Ranking of world’s 100 most valuable brands, there are 10 Chinese brands. And Indian? No surprise there. ZERO! UNCTAD data proves that currently, India’s merchandise export structure is skewed towards petrol products, jewellery, furniture, chemical products and textiles and wearing apparel, quite resembling the basket of China’s exports about twenty five years back! It is very therefore clear that India in its present shape is not competitive enough in manufacturing of high technology and superior quality goods to the extent that even a skewed FTA – formulated to favour India’s competence and sectoral strengths – will fail to help improve India’s deficit. India has to wake up to the fact that an FTA with China will only mean mass assassination of brand India and all its stakeholders. It cannot forever remain a raw material supplier to China or to the world. And an FTA with the dragon nation will only encourage the complacent side of India’s exporters. How long do we want to continue supplying raw cotton and iron ore to China? Why not have an iPhone killer brand like Xiaomi that press in the American, English, Australian and Asian circuits are writing about. [Search “Xiaomi iPhone killer” on Google if you will. Of course, the Chinese are proud to see a headline like this: “iPhone 6 Plus vs Xiaomi Mi4”!] The need of the hour is to strengthen our manufacturing base and quality of production rather than waste time discussing FTAs that will get our raw material across the border with ease and kill the Indian spirit to create world beating brands. We recently heard a senior official from a certain industry association say thus (it was widely quoted across the media): “Why we are afraid of China? If we will enter into an FTA with China, it will benefit us. If Thailand can have an FTA with China, why not India? India should seriously look at this.” Here’s our calculated response: Comparing Thailand to India is, as they say, comparing oranges to apples. Much before Thailand shook hands with China (through the ASEAN accord), the country was running a trade surplus with China. [Compare that to the fact that China alone accounts for close to 30% of India’s global trade deficit, which stood at over $129 billion in 2013 as per UNCTAD.] Thailand then had little fear of a deficit growing cancerous. India is already in doubt. And what has happened to brand Thailand in the past decade since the agreement with China was initiated? Of course the surplus has stayed right where it should have. But even today, after having sponsored Everton Football Club for over a decade now, people wonder what the word “Chang” scribbled on the front of the Everton jersey implies! [F.Y.I., It is one of Thailand’s largest selling brands. But little known outside the tourist destination. Much unlike other beer brands associated with sports – like the Australian Victoria Bitter or even the Dutch Heineken or the Danish Carlsberg.] Does brand India desire to remain popular for only tourism and service outsourcing for another fifty years, just like Thailand? Simply asking China to give Indian exporters greater access to a couple of industries in China will not make India’s exports shine. You talk about the light at the end of the tunnel. It could be that of a train. The Chinese bullet train! As they say, there is always a choice. India too has. One, take the plunge and risk destroying whatever there is left of an Indian manufacturing and exports superpower dream. Two, don't mind a ticking clock and grow into a manufacturing giant, with an honest focus on quality and grow into an exporting nation (one for which exports doesn't just remain a function of surplus), and then meet the dragon eye to eye to discuss an FTA, with America and Europe going all green. Reason #3: Don’t! Because China wants it! It is not without wisdom that China has become the world’s largest exporter of merchandise in the past many year. $2.21 trillion worth of exports in Cy2013 is some proof. Compare that to India’s $314 billion in FY2014 and you’d prefer to change the topic while in a conversation with a Chinese diplomat. If we take a look at India’s export basket to China and vice versa, there are three main differences. First two as explained before – (a) value; and (b) product quality & nature. The third fact that is often missed by scholars that often indulge in superficial research is the diversified Chinese basket of offering. Of the $14.84 billion in exports to China during FY2014, just nine products from India (most highly exported by value; at the six-digit HS code level) accounted for over 50% of the export value. And these were products like cotton, iron ore, slag, ash, copper, petroleum oils, granite, etc. – none of which you can be proud of, as you are when you frequently hear the phrase “brain drainage” or “IITs”. Next, imagine China’s altar offering at the ports. There were 60 (most highly exported) commodities that made up for half of its exports to India ($51.04 billion in FY2014). And a proud Chinese won’t be wrong to claim that more than a quarter of these products can be categorised as ones that require some science to manufacture! What’s most interesting is that in the case of Chinese exports to India, there are 76 products (6-digit HS code) whose exports crossed the $100 million mark each. In the case of India’s exports, this figure stood at less than a third – just 25. In fact, at present, China exports 3,765 products to India (6-digit HS code) as compared to 2,064 items that it imports from India. The first argument we have here is that a bigger export basket of bestsellers will automatically mean that any FTA will imply China getting the clear upper hand. If you allow us to quantify by our observation then it’s a clear 3 to 10 times advantage for China. And if this happens, the current act of “dumping” will become legal. What happens to India’s domestic manufacturing industry then? More so, under the current state of affairs in India, it is clear that trade opening with China under RCEP, especially in electronics, high-tech goods, and “every” form of manufactured goods will only lead to more imports than exports. China produces almost everything under the Sun. Remember? [It even has a population larger than India’s!] The next argument is where this discussion started – of morning showing the day. China’s FTAs are proof that it knows how to keep the cake and eat it too. Currently, China has eleven FTAs, including those with ASEAN, Chile, Hong Kong, Macau, Pakistan, Peru, New Zealand, Thailand, Singapore, Taiwan, Costa Rica. It recorded a trade surplus of $370 billion in 2013 with the group of nations and ASEAN with whom it has signed FTAs (including a trade surplus of $8.5 billion with the ASEAN bloc) – a growth of more than $300 billion in the past decade! To give you a glaring instance of what can be expected from the India-China FTA, until CY2006, Indonesia had recorded a trade surplus with China. That very next year, the China-Indonesia FTA and Economic Integration Agreement (covering both Services and Goods categories) came into full force. The effect? Starting 2007, Indonesia has been running a bilateral trade deficit with China, amounting to over $11 billion as on January 1, 2014! Moral: There is no guessing the outcome if the China-India FTA goes through. FTAs that favour partners over the host and a fractured manufacturing infrastructure – either of these can never be the starting point if we are to usher into an era where India will be a trillion dollar merchandise-exporting nation. Before rushing onto seemingly greener pastures, Indian think tanks will do better to rethink and renegotiate their old FTAs. There is little doubt that India’s current trade accords suffer from lack of depth and have limited geographical coverage. India has to renegotiate its RTAs with Chile and Argentina that have only worsened India’s trade deficit over the years. It should find ways to win back lost ground by perhaps even extending areas under the purview of accords like ASEAN, Mercusor and even SAFTA beyond just goods. Three questions need to be asked: 1. If India indeed wants to judge the intentions of the Chinese as far as bilateral and supporting trade relationship is concerned, why can’t it try to encourage the Chinese Premier to convince his investors (government, we mean) to invest in India? 2. Why can’t we conduct an acid test with some product categories under the now in-force APTA agreement (starting 2006 that covers only goods), and where India is a signatory? Will signing an agreement under a brand new title make the Chinese kinder? 3. Why should Pakistan continue being the largest recipient of Chinese outbound investment in South-East Asia forever? [Despite huge security concerns, China pledged to invest more than $50 billion in building Pakistan’s infrastructure early this year – from roads to dams, factories to power plants. Perhaps this is a return gift to its largest arms buyer – as per the Stockholm International Peace Research Institute, Pakistan accounted for 47% of China's arms sale in CY2013.] Conclusion China is known for being a market infamous for using non-tariff barriers to prevent foreign exporters and companies from gaining access to its market for more reasons than one. It’s important our policymakers think well through the three reasons set above and focus on a Foreign Trade Policy worth cheering for. Day-dreaming about a coalition that will make China an “equal trade partner” with India can only make one smile momentarily. Only until one opens his eyes to reality. Of course, the other school of thought says that this FTA sounds brave for once, massages the Indian ego with the thought of being able to walk arms-in-arms alongside the clever Mandarin masters, and even looks good on paper. And it keeps everyone anxious for some reason – trade associations, exporters, customers, the Chinese (perhaps), statisticians, economists, and even the media. But what if the drawing walks out of the paper? Are we ready for the recoil? Conservative yes, but a practical suggestion to India at this juncture will be: “If you find yourself in a [deficit] hole, stop digging!”