India’s cautious embrace of trade

Like many post-colonial nations, India has historically had a sceptical attitude towards unfettered commerce.

Under India’s infamous License Raj system, firms required licenses for many types of imports. This system was prone to abuse and helped inculcate a strong and enduring ethos of self-reliance.

The prime ministership of Manmohan Singh – generally regarded as the architect of India’s post-1991 reform agenda – marked India’s first major experimentation with trade agreements. It was under his tenure that agreements were signed with Association of Southeast Asian Nations (ASEAN), Japan and Korea.

More impactful than any bilateral pact was Singh’s unilateral reduction in India’s tariffs. Average tariff rates were steeply reduced, reaching around 9% in 2014.

Current Prime Minister Narendra Modi has rightfully been credited with undertaking significant structural reforms. Early in his first term, Modi even flirted with grasping India’s thorniest of nettles, the difficulty in acquiring land for industrial development.

Given his willingness to undertake politically contentious reforms, it is perhaps instructive that Modi had little positive to say about free trade in his first term.

The prevailing narrative among the highest levels of Modi’s government was that agreements negotiated between 2004 and 2014 had exposed India’s manufacturing sector to unfair competition, resulting in rising trade deficits. Modi’s scepticism about free trade culminated in India’s eleventh-hour decision to walk from final negotiations on the Regional Comprehensive Economic Partnership (RCEP) in late 2019. RCEP encompasses ASEAN and its free trade partners, including China, Japan and Australia.

More than a couple of politically potent constituencies had reasons to applaud Modi’s decision. India’s agricultural sector, which still employs around 45% of the population, feared unchecked competition from Australian and New Zealand dairy farmers.

Manufacturers ranging from SMEs to much larger conglomerates feared a rush of low-cost goods, especially from China. Modi also faced staunch opposition from the BJP-affiliated Rashtriya Swayamsevak Sangh (RSS) Hindu nationalist organisation and its subsidiary agricultural and labour unions.

To protect companies participating in his flagship “Make in India” initiative, Modi raised import duties on more than 3,500 tariff lines. Standards have increasingly been used as a fig leaf to obscure blatant protectionism.

This makes the alacrity with which India has returned to the trade dealmaking table in recent years all the more surprising.

Since its rather unassuming economic partnership agreement with Mauritius in 2021, India has signed or finalised agreements, including with the United Arab Emirates, Australia, the United Kingdom, the European Free Trade Association, New Zealand, and most prominently, the United States and European Union.

India has not had a Damascene conversion to free trade. India has skilfully exploited its rising economic and geopolitical heft to negotiate exemptions for the most sensitive parts of its agricultural sector. The deal with the EU was clearly expedited by the exigency to offset the adverse economic effects of US tariffs.

Modi’s government nevertheless appears to have genuinely shifted its views on the role that trade openness can play in supporting India’s development aspirations – through enhanced export market access, cheaper inputs and helping to reverse shrinking net foreign investment.

On this front, New Delhi has also recently unilaterally reduced tariffs on capital goods and inputs, while tentatively opening the door to Chinese investment.

The EU deal is the most consequential of India’s bevy of trade agreements. Around 91% of India’s exports to the EU will benefit from the immediate elimination of duties, including in manufacturing sectors such as textiles, apparel, plastics and toys. European automakers who currently have very limited market share in India, are eyeing local production for both the domestic market and export.

But incremental trade liberalisation will only shift the dial so much. There is a range of structural factors that undermine India’s manufacturing competitiveness.

For one, Indian manufacturers continue to be hampered by an inverted tariff structure, where tariffs on inputs are often higher than tariffs on finished goods. Critical inputs like steel and textile fibres continue to lack competitive pricing.

This points to a fundamental dilemma facing Indian policymakers. Understandably, India wants to avoid the pitfalls facing countries such as Vietnam, which have become extremely successful at assembly-based manufacturing but have very limited local supply chains. India also fears being overwhelmed by Chinese overcapacity in sectors including steel and chemicals.

Others have argued that India would be better off prioritising assembly-based manufacturing before gradually mandating higher domestic sourcing. This policy would appear to be more consistent with the imperative to create jobs for India’s underemployed graduates.

India’s economy is diverse enough that there is always bound to be an exception to any rule. In smartphone exports, which have exploded in recent years, India has generally refrained from applying major tariffs on inputs.

Now that India’s smartphone sector is established, New Delhi is exploring re-tooling subsidies to promote exports and local content rather than just production.

Whether this template can be applied more broadly will depend in part on India’s political economy. It is notable that Apple, as well as South Korean and Chinese peers and their suppliers, face little domestic competition in India.

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Photo: Mymoon Moghul, CC BY-SA 3.0 <https://creativecommons.org/licenses/by-sa/3.0>, via Wikimedia Commons