What Stops India From Being Asia’s Next Big Factory?

The US-China trade war is disrupting the functioning of global value chains (GVCs) that spread across East Asia, North America and West Europe.

Nearly two thirds of international trade is now happening through GVCs. Its potential spillover effects will likely transform the geography of GVCs, which in turn define the global trading system’s geo-economic architecture.

This is forcing a large number of Asian manufacturers to shift their production lines from East Asia to low cost economies such as Bangladesh, Cambodia, Sri Lanka that are relatively less fragile to a global trade war.

Many multinational corporations including Mitsubishi Electric, Hasbro, Micron Technology and Toshiba Machine are contemplating shifting their production centres to minimise the impact of the trade war between the US and China.

Now, a relevant question is: does the trade war offer a window of opportunity for India? The answer is probably yes. This is a unique opportunity for India to increase its exports and to capture greater space in GVCs. However, the potential gains from this opportunity hinge on India’s ability to align its trade, investment and infrastructure with operative principles of GVCs.

Also read: Delay in Mega Asian Trade Deal Comes as Boon to Modi Govt in Run-Up to 2019

This leads us to a bigger question – do India’s policies provide incentives for Asian manufacturers to relocate in India?

It’s clear that our trade and trade-related policy-makers need to undertake specific and substantial structural reforms over the next three to five years. If this is done, we can definitely emerge as the next factory of the world. The ripple effects of this cannot be overstated – it will emerge as a sustained contributor towards creating new job opportunities for our youth.

If we fail, India will have to deal with social unrest due to high unemployment of the increasing demographic dividend.

So, what needs to be done?

First, India is yet to liberalise its trade policy to make it coherent with the value chain led trade. India’s average applied tariff is higher than those in most other East Asia and Pacific economies. In 2016, India’s trade weighted average tariff was 7.5%, while in East Asia & Pacific economies, it was 3.6%. Higher tariffs hindering the imports of intermediate products create an impact at the very root of value addition through forward linkages.

Even with this disparity and its concomitant impact on the ability of Indian firms to operate within GVCs, the fact of the matter is India has recently increased its import duty on a number of products including telecom equipment, steel, automobile, textile products. An increase in import tariffs generates trade policy uncertainty. Moreover, such changes in tariffs may drive India out of regional production networks, which operate on efficient movement of intermediate products across borders.

Other than this, India’s trade policy is largely conducted at the aggregate level and its overall orientation is on conventional product or sector specific policies. Such policies often fail to capture nuances of comparative cost advantage at firm level that are vital for the participation in GVC-led trade. This is primarily happening due to the absence of trade-related firm-level data to understand the critical factors of their internationalisation.

Secondly, free trade agreements are important instruments to facilitate regional integration and connect with regional and global value chains. In the Asia-Pacific region, India has comprehensive free trade agreements with Japan, South Korea, Association of Southeast Asian Nations (ASEAN), Singapore and Malaysia. However, Indian firms are largely unable to use these FTAs to penetrate themselves into foreign markets. One of the major reasons is low utilisation of these FTAs.

This is evident from a survey by Japan External Trade Organization (JETRO) in 2017. The utilisation rate of India’s FTAs with ASEAN and Japan is more on imports than exports. The average utilisation rate for exports is 42% for ASEAN and Japan, while on imports it is 71% and 55% respectively. The higher usage of FTAs on imports indicates that Indian importers are making greater use of these FTAs and, therefore, greater market access for ASEAN and Japanese products in the Indian market.

The lower usage of FTAs in case of exports indicates that India’s FTAs do not provide incentives to importers in Japan and ASEAN to import under these FTAs. One of the reasons is wafer-thin margins between MFN (most-favoured-nation) tariffs which are same for all WTO (World Trade Organisation) members and preferential tariffs under these FTAs.

Also read: What does the New NAFTA Mean for Asia and Asian Firms?

Thirdly, participation in GVCs also hinges on the state of trade infrastructure and trade regulatory framework. Efficient export and import clearance is vital for well-lubricated value chains. India’s performance on the World Bank’s Trading Across Borders, 2018 has improved remarkably by taking a quantum leap from 146 to 80 out of 190 countries. Thus, it would be interesting to see how it impacts the cost and time of doing trade and facilitate the integration of Indian firms in GVCs.

However, it would be worthwhile if one analyses the current performance of India on trade facilitation in the context of the nature of traded products. Majority of India’s exports constitute cotton, diamonds, rice, yarn, garments, gem and jewellery, low-end engineering products, pharmaceuticals and petrochemicals. These products can be easily exported with less efficient trade infrastructure. Furthermore, more than 70% of India’s global trade takes place through Nhava Sheva Mumbai, Chennai and Mundra ports.

All of them are overburdened and working at 85% of their capacity whereas globally 70% is considered to be ideal. Therefore, reforms at the broader level might help India to improve its ranking on different global benchmarks but it is difficult to say that they would produce positive impact on business operations, where they are actually needed.

On the trade policy front, Indian policymakers should move away from sector-specific approach to GVC-oriented policies, which measure success in terms of efficiency and reduced transaction costs. There is also an urgent need to enhance the robustness of ‘trade policy analysis’ with a particular focus on firm level analysis. For this, special attention should be made to collect firm level trade-related data to enhance the effectiveness of trade policy.

Another necessary step is to conduct deeper examination of the impact of trade agreements on India’s firms and their integration into global value chains. A simple trade flows analysis will not lead to any substantive results.

On trade facilitation front, India should think about the setting-up of National Trade Platform (NTP) on the lines of Singapore’s NTP. This will serve as a one-stop platform for all kind of trade information and will electronically facilitate export-import related compliances. The NTP will help our exporters and importers to submit all information/documents online at one place and there will be no need to deal with customs, other regulatory bodies, banks and port authorities separately.

Pradeep S. Mehta and Surendar Singh work for CUTS International, a global research and advocacy group.