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INDIA LOOK AHEAD: Have a free trade agreement in services

Financial Express, India

21 October 2004


Have a free trade agreement in services

The Indian industry needs to adjust to external competition


Economists will agree that the first best solution is to have a multilateral framework which designs and enforces trade policy rules that are transparent, fair, and take into account the stages of development of its members. Such a framework is Pareto Optimal and increases world welfare. However, since Cancun, most countries in the world resorted to a less optimum route of intensifying free trade agreements (FTA) with other countries. Even India embarked upon various forms of FTAs. It has agreements or near agreements with Sri Lanka, Thailand, Asean and Singapore. FTAs with GCC, Mercosur and South Africa are in the pipeline. These are all FTAs with emphasis on goods, and some include services. A more substantial FTA is called a Comprehensive Economic Cooperation Agreement (CECA), such as the one with Singapore.

It is too early to measure the impact of FTAs on the Indian economy. But they have provided a clear signal to the industry that the days of high tariffs may be over, and they need to adjust to external competition without protection. Hopefully, each FTA has been designed in a way that one is sure that it is of benefit to India. Unfortunately, one is not aware of the analytical underpinning behind such agreements that calculate the net overall benefit to India and the costs borne by certain industries. My personal belief is that a full-fledged FTA with over 20% average tariff level is not likely to benefit India. Moreover, most empirical studies show that a South-South Preferential Trading Arrangement may not have a favourable outcome for both countries. All Indian FTAs are with other developing countries. A better way for India might be to pursue an FTA on services with a developed country. Such an agreement will not be trade distorting, will be based on India’s dynamic comparative advantage, and will avoid the prickly problems of rules of origin and transaction costs associated with customs clearance, and transport and port logistics. India may be a pioneer in this and set a trend as there is no FTA exclusively on services.

Why should we narrow down FTAs to services? Besides the advantages cited above, the services sector is becoming the backbone of the Indian economy, and to a considerable extent has accounted for our rapid growth since the 1990s. The services sector grew at an average annual rate of 9%, contributing to nearly 60% of the overall growth rate of the economy. The growth of exports of services has been close to 20% per annum in the 1990s, making India a recognised global leader. Most of the exports were confined to information technology (IT) and business process outsourcing (BPO), but other sectors such as healthcare, education, financial services, retail, tourism, and entertainment possess tremendous potential which could be unleashed if some of these are exposed to outside demand and competition. In IT and BPO, India has already created awe in the global economy, and it has featured prominently as an issue in the run-up to the US Presidential elections.

Another reason is that the WTO is not able to move fast on services especially on Mode 1 (Cross-border supply) and Mode 4 (Presence of natural persons), the two modes of interest to India. An FTA in services between India and the US will spur the EU, China and others to sign FTA in services with India and the US. In effect then, we will have achieved liberalisation of services de facto in a multilateral framework. But will the US and EU allow temporary reallocation of labour given the problems we are encountering with H1-B visa? The aim should be to carve out of restrictive immigration regimes greater scope for service delivery. We need to lobby along with the multinationals that also want to relocate their personnel abroad. But we should insist on the temporary nature of such immigration. With regard to Mode 1, India must seek to pre-empt potential protectionism by locking in the current open international trade regime. Then what are we waiting for to begin discussions on FTA with the US? We clearly have the upper hand. The US might, for a change, be defensive. This should be our first agenda after the November US elections.

The author is principal advisor, CII and former economic advisor, commerce ministry. These are his personal views