View: India needs RCEP to push much-needed domestic reforms

By Ajit Ranade

The Regional Comprehensive Economic Partnership (RCEP) grouping of 16 countries represents half the world population and two-fifth of GDP and trade. It’s also the fastest growing part of the world. Over the past four decades, the world’s economic centre of gravity has decisively shifted from west to east. That is why India embarked on the ‘Look East’ policy, which Prime Minister Narendra Modi upgraded to ‘Act East’.

It is a natural progression then to ‘Embrace East’ by signing up to RCEP. Alas, India chose not to sign, because of apprehension about the flood of Chinese imports, and perceived threat to small producers, agriculture, including dairy.

Hopefully, this is a temporary respite, and concerns will get sorted out by negotiators before the formal signing in March 2020. It is important that we don’t miss the RCEP bus, and don’t exit even before joining. Not signing up now would give us even less leverage on the terms of the treaty were we to join later. By engaging now, we can ensure that most of the tariff reduction commitments are backloaded and become fully operational almost 25 years later. Surely, that’s a long enough period for domestic industry to become competitive enough to withstand the pressure of imports.

Most of our competitive disadvantage stems not from tariff or non-tariff barriers in destination countries, but from lack of domestic reforms. Our producers face higher cost of energy and electricity, credit and capital, and logistics. Until recently, even our corporate tax rates were out of sync with East Asia. Thankfully, that’s been corrected.

The indirect tax regime is still too burdensome and needs to reduce. Goods and services tax (GST) covers only about one-third of GDP, with multiplicity of rates leading to serious issues like large proportion of unusable input tax credits. Just ask the telecom, metals or synthetic textiles sector. The unutilised tax credits are deadweight and reduce our competitiveness.

Many parts of industry still suffer from inverted duty structures, in which the raw material is subject to higher import duty, and the finished product can come in at zero duty. The current special economic zones (SEZ) framework is such that an Indian entrepreneur located, say, in Aurangabad SEZ faces a much higher duty barrier while selling to the domestic market than a producer from Thailand. Surely, that discourages investment here in favour of India’s free trade agreement (FTA) partner countries. The cure is not to un-sign the FTA with Thailand, but rather fix the domestic anomaly. Our exports and domestic industry also suffer from an overvalued exchange rate.

More Than Nudge Theory

The domestic reform agenda can get a huge fillip and urgency with the signing of RCEP. The crisis-induced 1991 reforms under International Monetary Fund conditionalities, or signing up to the World Trade Organisation (WTO) in 1995, despite countrywide protests, are examples of how domestic reforms need external alibi. Indeed, India was forced to give up the quantitative restrictions on imports in 1999, thanks to losing a case in WTO.

Similarly, just last month, India lost another case in the WTO on a complaint by the US. This means our export incentive schemes like the Merchandise Exports from India Scheme (MEIS) and Export Promotion Capital Goods (EPCG) have to be dismantled since they have been ruled to be illegal. Did we not know this? Or were we just buying time for domestic industry to stand up without illegal subsidy props?

Indeed, informally, commerce ministry officials had warned industry that the export subsidy schemes would soon be wound up. The idea is not to introduce yet another subsidy scheme, but to become globally competitive.

In signing up to RCEP, the following points need reiterating.

First, no country has been able to achieve high manufacturing growth without commensurate growth in exports. Hence, a successful export strategy and performance is required for us to reach the $5 trillion target sooner than later. Exports are hampered much more by domestic handicaps than by anything else.

For instance, the coal cess of Rs 400 a tonne represents an increase of 15-20% cost in energy, which is not in GST and hence no input tax credit is available.

Same is true for electricity duty on captive power and mining royalty. No wonder domestic production of metals like steel or aluminium is stymied against cheaper Chinese imports that don’t have the cost disadvantage.

In textiles and clothing, since we don’t have a cluster approach of fibreto-fashion in one place, we have a fragmentation leading to logistics costs.

Lack of scale is due to a variety of constraints like cost of capital and inflexible labour laws.

Second, RCEP allows us tariff quota restrictions. So, we can restrict quantity that can come duty-free. Amul should be assured that New Zealand dairy is not going to flood the country.

Jump Over the Great Wall

Third, we must recognise that the Chinese economy is being rebalanced from exports to domestic, from investment to consumption, from industry to services, and from old to new economy. China hosted the world’s first import expo, pledging to import nearly $12 trillion worth of goods and services in the next five years. Are we not looking to tap into that market? Apart from software and para-medical services, the biggest opportunity lies in tourism, which needs domestic reforms alone to flourish. Why is our attitude only defensive when it comes to FTAs?

Fourth, let’s not ignore the employment, value addition and export potential of joining global value chains. This opportunity is lost if we don’t join RCEP.

Fifth, the sector most likely to gain from trade liberalisation is agriculture. The person who supported joining WTO when all parties were opposed was Sharad Joshi, the leader of Shetkari Sanghatana. It is by deregulating agriculture exports that farmers’ income will rise substantially.

Finally, spare a thought for the silent mass of billion consumers who benefit from cheaper and quality imports due to trade liberalisation. They are not as vociferous as the producer lobby, but beneficiary nonetheless.

The writer is an economist