Author: Dhiraj Nayyar, NITI Aayog
The Indian economy is experiencing rapid growth of between 7 and 8 per Cent a year. To sustain that growth rate and for India to achieve its development potential, it must open up its economy and have a strong export sector. It may not be easy, but given the global trade slowdown and the paralysis of multilateral trade negotiations, India’s best bet is to seize those opportunities for integration closest to home.
Thanks to its strength in the service sector, India’s trade to GDP ratio is around 25 per cent, close to that of China or Indonesia. But in terms of merchandise trade, India simply does not match up to the region’s other big players, accounting for just 1.7 per cent of global merchandise exports. In comparison, the United States accounts for 9 per cent, the European Union for 13.5 per cent and China for 14 per cent.
Unlike its East Asian neighbours, India is in a region characterised by remarkably little intraregional trade. Just 5 per cent of South Asian trade takes place within the region, compared to 25 per cent for ASEAN or 55 per cent for Asia as a whole.
What are the roadblocks to greater economic integration with India’s neighbours, dynamic East Asia and the global economy? And what can be done?
Some ingrained domestic opposition to openness can be explained by historical factors. Socialist development policies and import substitution industrialisation strategies are within living memory for many in India.
Then there are contemporary obstacles. India trades less than its East Asian neighbours in part because its manufacturing and agricultural sectors are relatively less competitive, and in part because of its big domestic market. The dynamics of liberalisation are also a factor — opening up to trade usually leads to a sharper rise in imports than exports in the short run.
What’s more, trade agreements tend to mainly affect goods, with less attention paid to services, India’s most competitive sector. Services are particularly vulnerable in international markets to non-tariff barriers like visas or complex regulatory requirements.
For India, the path towards economic integration begins at home. The implementation of a goods and services tax (GST), scheduled for April 2017, will create a single market within India. Yet as it stands, the GST requires critical reform. 40 per cent of India’s indirect taxes come from oil, tobacco and alcohol. These industries will remain outside the federal GST and in the hands of the country’s 29 states.
Since the early 1990s, India’s economy has risen on the strength of services while manufacturing has declined. This emphasis is now changing in policy debate. The government’s flagship Make in India initiative — a suite of proposed reforms aimed at boosting the competitiveness of Indian manufacturing — must follow through on the policy vision it offers. India needs a strong manufacturing sector because of the size of its low-skilled population and high demand for jobs. At present, manufacturing firms migrating out of China are more likely to set up shop in Southeast Asia than India.
Improving ease of doing business is a worthy policy priority that is receiving growing attention as part of the Make in India initiative. Making it quicker and easier to register a business, cutting red tape and simplifying the tax return process are areas flagged for reform. Following a public commitment by the prime minister, the Department of Industrial Policy and Promotion announced in late 2016 that it wants to see India reach the global top 50 in the World Bank’s ease of doing business index.
India’s infrastructure potential is all too often limited by bureaucratic bloat. Major ports are causing shippers frustration as smaller, private ports increase their efficiency and market share. Railways charge firms more in order to cross-subsidise fares for passengers, an arrangement which has long affected competitiveness. That means more goods are transported by road, the efficiency of which is marred by state-specific taxes and poor road quality. The good news is that the current government is approaching infrastructure upgrading with renewed focus.
One promising strategy is the use of ‘coastal employment zones’ in the style of the special economic zones in Shenzhen and Guangdong, China. By introducing flexible land and labour rules in limited areas, rather than to the country as a whole, these could provide a politically viable solution for overcoming the highly restrictive impact of these laws on business. Over the medium term, the zones are aimed at attracting large manufacturing firms that exit China as wages there rise.
But the strategy wouldn’t be easy to implement. Coastal land is hard to acquire, and unlike China, India is a federalist democracy. A policy that works in a special economic zone can’t be quickly rolled out across the country as was so successfully done in China.
When it comes to trade, China is still the elephant in India’s room. India’s trade deficit with China is substantial and rising — US$53 billion in 2015–16 compared to less than US$1 billion in 2000–01. China’s non-tariff barriers on sectors like entertainment, information technology, pharmaceuticals and meat hit India particularly hard in the areas where it’s most competitive.
On top of this, China’s investment in India is relatively small, especially for a large neighbour. India was the destination for just US$240 million of China’s outbound investment in 2013 — less than many of China’s smaller neighbours, like Kazakhstan ($1.34 billion), Vietnam (US$790 million), Myanmar (US$780 million) and Pakistan (US$270 million).
The SAARC countries — India, Afghanistan, Bangladesh, Bhutan, Nepal, Pakistan, the Maldives and Sri Lanka — form one of the least economically integrated regions in the world. This remains the case despite the South Asian Free Trade Area (SAFTA) having come into force in 2006.
SAFTA has been hobbled by political tensions between India and Pakistan, its two largest members. Pakistan refuses to grant India most-favoured nation status, though India granted it to Pakistan in 1996. Given recent trends, it’s unlikely that SAARC or SAFTA will be the foundation for greater economic integration for India.
India’s subregional arrangements are more promising for integration. The BBIN Initiative (Bangladesh, Bhutan, India and Nepal) provides a framework for these four countries to coordinate on trade, connectivity and management of resources. In 2015, BBIN members signed a motor vehicle agreement to allow vehicles carrying export goods to cross borders without having to transship the goods to a separate vehicle in the importing country. This is a fundamental condition for cross-border trade.
Another sub-regional arrangement, BIMSTEC — the Bay of Bengal Initiative for Multisectoral Technical and Economic Cooperation — has been getting renewed thrust in recent years as an economic bridge between South and Southeast Asia.
ASEAN presents improving prospects for Indian economic integration. The India–ASEAN free trade agreement, which came into effect in 2010, resulted in substantial two-way trade growth for India. Southeast Asia borders India’s least developed states, posing opportunities for the country’s relatively poorer east and northeast.
ASEAN remains India’s best option for integrating with ‘global value chains’ — the constantly expanding production networks that are at the heart of international trade in the 21st century and in which services play a crucial role.
ASEAN’s headline initiative, the Regional Comprehensive Economic Partnership (RCEP), is a comprehensive opportunity. India has warmed up to RCEP recently, dropping its insistence on a three-tier tariff concession structure, though it remains the most obstructionist member of the agreement. Navigating around the political distance with China will remain the key challenge for India’s trade negotiators.
Double-digit growth is only possible for India with a strong export sector. The pace of global trade growth is slowing, multilateral trade negotiations through the World Trade Organization are at a dead end and the Trans-Pacific Partnership is a thing of the past. If India moves too slowly on trade, it will miss the bus; if it moves too fast, it could suffer a domestic backlash.
Engaging more deeply with the rest of Asia — especially through ASEAN-led and subregional initiatives — is India’s best option.
Dhiraj Nayyar is Head of Economics, Finance and International Trade at NITI Aayog. Views are personal and do not reflect the views of NITI Aayog.
This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Towards Asian integration’.