Explained: Why Staying Out Of The RCEP Is In India’s Best Interests

After elaborate deliberations, the Narendra Modi government chose to step away from the Regional Comprehensive Economic Partnership (RCEP), a free trade agreement amongst countries in the ASEAN (Association of Southeast Asian Nations) bloc, and China, Japan, South Korea, Australia, and New Zealand.

Had India stayed in the RCEP, the agreement would have catered to 3.4 billion people, almost half of the world’s population and would have constituted 40 per cent of the global gross domestic product (GDP).

India’s call to stay out of the RCEP is a testament to the decisive leadership under the Modi regime.

The move will have significant benefits for India’s farmers, the dairy sector, and other local industries, guarding them against the likes of China who would have otherwise used the RCEP to dump their cheap products in the Indian market. The move will also benefit the service sector.

A Weak History

The decision to walk out of the RCEP stems from the weak history India has had with free trade agreements under the UPA (United Progressive Alliance) regime before 2014.

India signed a free trade agreement (FTA) with countries in the ASEAN bloc and South Korea in 2010. Separate FTAs were also signed with Malaysia and Japan in 2011.

The first UPA regime under Dr Manmohan Singh had also explored the possibility of an FTA with China in 2007, a move that would have devastated the local industries.

However, these FTAs did little to cater to India’s interests. Between 2004 and 2014, India’s trade deficit with RCEP nations increased eleven times, from $7 billion in 2004 to around $78 billion in 2014. India’s trade deficit with China alone is more than $50 billion.

While one may attribute the deficit to India’s low level of exports, a problem Modi government has been trying to tackle through programs like ‘Make in India’, the truth remains that domestic industries have suffered hugely due to cheap imports and dumping practices of China.

Even with the ASEAN bloc countries, the FTA has been unjust to Indian interests.

While India eliminated tariffs on 74 per cent of tariff lines (codes for items/products), there was significant trade distortion as Indonesia eliminated tariffs only on 50 per cent tariff lines and Vietnam on 69 per cent. Similar practices by other nations led to India suffering under these FTAs.

The story remains the same with South Korea. India signed the Comprehensive Economic Partnership Agreement (CEPA) with South Korea in 2009.

While under CEPA, South Korea’s exports to India almost doubled between 2009 and 2019 from $8.5 billion to $16.7 billion. However, India’s exports have shown weak growth, going from $3.42 billion in 2009 to a mere $4.71 billion in 2018-19.

Put simply, India’s export sector has failed to tap the South Korean market. Steel, where 100 per cent tariff reductions were made available to India under the CEPA, the exports have remained stagnant at $339 million in 2017-18 from $330 million in 2010-11.

Similar imbalance with other countries of the RCEP has led to severe trade distortion and flooding of the Indian market with cheap Chinese products.

While it may benefit the consumer due to low prices, it eliminates the possibility, in the long run, of the emergence of the local industries, thus having a depreciating impact on employment, innovation, and capacity building.

What Made India Stay Away From The RCEP

A number of unresolved issues resulted in India choosing to stay away from the RCEP.

One, there was the threat of circumvention of Rules of Origin due to ‘tariff differential’.

Put simply, countries within the RCEP could take advantage of the tariff differential given to another country in tariff lines (classification codes of goods or products) not offered to it. Thus, China could, for instance, use the tariffs offered to Vietnam, to dump its products in the Indian market.

Two, India wanted a change in the base rate of customs duty from 2014 to 2019. Assuming RCEP was signed now, it wouldn’t become operational till 2022.

However, if a change in the base rate was not done, custom duties from 2014 would be applied in 2022, negating the change in the base rate due to current market forces and consumer dynamics.

For instance, local Indian industries that have witnessed strong emergence post-2014 under the ‘Make in India’ programme would have suffered due to the application of customs duties that do not take into account the contemporary market realities.

Yet another point is that while the change in the base rate would have surely helped Indian industries, it would have been beneficial for all members of the RCEP too.

Three, there was the request to enable tariff lines for Auto Trigger Safeguard Mechanism (ATSM) with a review clause at a periodicity of three years.

This would have ensured safeguards against import surges and dumping practices that countries like China engage in. Again, enabling tariff lines for ATSM would have been helpful for all the RCEP members.

Four, India wanted the exclusion of the Most Favoured Nation (MFN) obligation, stated within the investment chapter of the RCEP.

An MFN, though commercial in nature, is usually coupled with diplomatic and strategic interests, and thus, cannot be handed over to countries with which India shares a border or a geopolitical dispute.

Within the RCEP, allowing an MFN status to all members would not have been beneficial for India at all.

Five, there was also the issue of carving out sensitive sectors from the ratchet obligations under the investment clause of the RCEP.

For instance, if India were to give any benefits to France or the United States for a defence programme, the same benefits would have had to be given to all RCEP members, including China.

The same would have applied for other sectors too. Given how the allocation of some of these benefits stem from geopolitical interests, this clause within the RCEP was strongly against India’s interests and capacity building in the long run.

What’s Next For India?

Already, India is embarking on several measures to undo the ills of the previous FTAs and to further secure local interests.

One, the import of agarbatti, a significant import, has been moved to the ‘restricted category’ from the ‘free category’.

This will be helpful in securing the local industries. Also, a safeguard duty of 5 per cent has been imposed on palm oil imports to secure local interests and help farmers.

Two, to help the local cashew planters, MSP of Cashew Kernel Broken has been raised to Rs 680/kg from Rs 288/kg.

For Cashew Kernel Whole, it has been raised to Rs 720/kg from Rs 400/kg. Import of peas and pulses has also been restricted. In FY 2019-20, import of only 4 lakh MT (metric tonne) of Toor and 3 lakh MT of Moong and Urad would be allowed.

Three, a Steel Imports Monitoring System (SIMS) has been launched to monitor the import of steel. Stakeholders in the steel industry will have all the information pertaining to steel imports, and thus, required policy intervention and planning would be possible.

Four, to tackle the shortage of maize (feed grade) for poultry and dairy farming, customs duty has been lowered to 15 per cent from the earlier 50 per cent for the import of 5 lakh MT of maize. This will be a booster for the local poultry and dairy industry.

Five, and lastly, several other steps are being taken. For instance, the government has restricted imports of the national flag that violated the flag code. There are other measures also in the pipeline to secure the interests of local farmers and fishermen.

Moreover, options for elaborate FTAs are being explored with the European Union, United Kingdom (keeping Brexit in mind), and the United States.

In retrospect, the biggest issue facing India entering the RCEP was China.

While China’s reliance over its exports has decreased in the last few years, the recent trade war, the slowing economy, and the challenge to sustain its employment numbers may have inspired China to embark on another decade of driving cheap exports and flooding the markets of India, ASEAN, Australia, South Korea, and Japan.

Thus, while India has taken the path to secure its local interests, it remains to be seen how China will use the clauses within the RCEP to treat the other 14 member nations across the 2020s.

Going by precedence, the free trade agreement may come at a hefty cost for these 14 member nations.