Ajit Ranade: India should reinforce its strengths on the external economic front

Traditionally, India has preferred global multilateral arrangements such as the World Trade Organization (WTO) over bilateral or regional trade agreements.
Traditionally, India has preferred global multilateral arrangements such as the World Trade Organization (WTO) over bilateral or regional trade agreements.

Summary

  • Trade openness has served us well, but globalization with the WTO in bad shape is complex. Our free trade agreements (FTAs) must focus on job generation, negotiation skills should improve and we need to grab service export opportunities.

Trade openness is measured as the ratio of trade to GDP. India’s is close to 50%, as per World Bank data. It used to be 7% in 1970, about 15% in 1980 and 1990, and jumped to 26% in 2000 and 49% in 2010. This decadal upward shift shows India’s embrace of globalization, especially after 1991. It shows a decisive turn-away from the earlier export pessimism and trade scepticism, and India’s acceptance of trade as an enabler of economic growth. 

For a few years around 2010, the ratio inched up to 55%, before dropping, but has shown a steady rise in recent years. On this measure, India is ahead of China and the US, although one must not jump to any conclusion. The question of what an optimal ratio is and whether higher trade openness is always better is complex. For small economies extremely dependent on foreign trade flows, the ratio can exceed 100%. 

While India’s trade-to-GDP ratio is higher than Indonesia’s, Bangladesh’s and Sri Lanka’s, it is below Thailand’s 133% and Singapore’s 184%. The latter two’s high dependence on foreign trade also implies high vulnerability to global business cycles and recessionary winds. 

An optimal ratio for any country depends on its stage of development, the structural features of its economy, its resilience and stability, geopolitical considerations and increasingly its desire for strategic autonomy. With India’s large size, its optimal ratio cannot be too far from 40-50%, which represents a good combination of domestic orientation and harnessing of global markets.

Free trade is not just flows of goods and services, but is accompanied by flows of investment, know-how, management and skills. It undoubtedly enhances efficiency, but it can also be negative for certain non-competitive sectors and can wipe out jobs. It could also result in the ‘Dutch Disease,’ wherein the super success of one export sector strengthens the exchange rate and makes all other sectors uncompetitive. 

It can lead to worsening of income inequality as workers in one sector benefit more than others from globalization. The risk is higher if base conditions of education, infrastructure and innovation are not met, and there is premature exposure to harsh and possibly unfair foreign competition. Diversification of export sectors and destinations is thus vitally important for overall benefits. Also, a programme to compensate the losers of globalization (through skilling support etc).

Traditionally, India has preferred global multilateral arrangements such as the World Trade Organization (WTO) over bilateral or regional trade agreements. But the WTO is in a bad shape, even though it is trying to reinvent itself for relevance. The US, especially under President Donald Trump, has been party to undermining the WTO’s effectiveness. 

Its key dispute-resolution mechanism was left headless for far too long. The US has also tried to move the multilateral paradigm to plurilateral, with decisions to be taken by majority rather than consensus. Given the WTO’s perceived weaknesses, India has been signing bilateral and regional deals in the past two decades. New Delhi has signed 14 agreements with 26 countries in various formats. This has led to an overlap of multiple relationships with the same partners. 

For example, India has a bilateral with Thailand, but also a relationship based on India’s ASEAN free trade agreement (FTA). Similarly, India’s Comprehensive Economic Cooperation Agreement with Singapore coexists with the ASEAN FTA. While these overlaps can create a jumbled spaghetti, such issues can be resolved. India does not have any FTA with China and the US, two of its biggest trade partners, but is pursuing pacts with Australia, the UK and EU.

As we sign more treaties, here is a checklist. A trade agreement is no longer only about reducing tariffs and enhancing market access. It is also about harmonizing regulatory and policy standards, especially environmental and labour. We may need to sacrifice some policy autonomy to get a good deal signed. This also means assuring foreign investors of investment protection. 

Second, the treaties must be measured only by the metric of job creation and not export dollar earnings. For this reason, India is now much more willing to join global value chains, even if the value addition within the country is a small fraction. This focus is about jobs of the future, and not necessarily about protecting current jobs. 

Third, we should be ready to discuss tricky issues like government procurement, data sovereignty, decarbonization and labour standards. These can no longer be called non-trade issues, and hence our preparation for negotiations needs to be much stronger. We need new capabilities built for this.

India is that rare Asian country which runs a consistent trade deficit and has still received almost $1 trillion as foreign investment since 2000. India’s foreign exchange reserves of $650 billion did not accumulate on the back of a trade surplus, but the confidence of foreigners pouring in investments.

The growth of our service exports is nothing short of spectacular, having grown from $53 billion to $338 billion in two decades at twice the global rate. These have moved from just offshoring or ‘body shopping’ to occupying a much higher place in the value chain in the form of global capability centres (GCCs) in India. 

Soon, there will be 3,000 such GCC’s located in India. In such a scenario, our service exports could touch $1 trillion in less than a decade, so long as we strengthen the creation of domestic human capital, skills and infrastructure.

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