UPA may have left another can of worms in Anand Sharma’s Free Trade Agreements

One of the most serious long-term damages done by any ministry under the UPA was commerce under Anand Sharma. Over the last 10 years, the UPA government signed FTAs (free trade agreements) with Japan, Korea and - the largest one - with Asean. Egged on by a lobby of multinational companies, Sharma made it a goal to push India towards FTAs.

FTAs are a favourite with economists who studied economics in the 1960s and 1970s and who are ruling the roost today. There logic for free trade is like free anything - more is better. According to them, untrammelled free trade is good for the economy and the country. To support this hypothesis, the work of an 18th century broker, financial speculator and economist – David Ricardo – in the area of comparative advantage is cited.

Ricardo’s theory was enunciated when three T’s were not visible - transnational corporations (TNCs), transfer pricing and tax incentives. Now, exponents of FTAs are TNCs who look for areas with the lowest taxation and subsidies to export and import to other countries. FTAs need to take this into account if they have to drive growth and employment. The focus of a country should not be just on boosting trade, but trade that benefits industries or companies in a country and which will help boost employment.

Take the largest FTA – the India Asean Free Trade Agreement (FTA) - signed in Bangkok on 13 August 2009, and which came into effect from 1 January 2010 with Malaysia, Thailand and Singapore. It will be finalised with countries like Indonesia by 2016. This FTA covers a market of 1.8 billion people and will slash tariffs for over 4,000 product lines, creating one of the largest markets in the world. Currently, the FTA is limited to trade in goods only.

The India-Asean FTA affects the automobile sector, one of the largest employment generators. Industry lobbying body Ficci claimed that the FTA will have a neutral effect on the Indian auto sector. The government accepted this logic though Thailand and Indonesia are big export hubs for automobiles. Almost every Japanese and Korean firm and their ancillary units had set up operations in these countries. In 2012,Thailand became the seventh largest car exporter in the world and for auto components too. According to an analysis done by Aranca, a global research and analytics firm, imports from Thailand have increased by a staggering 969 percent post this FTA. This is because Toyota, Honda and others have their manufacturing plants set up in Thailand. Free trade provides these companies an incentive to import from Thailand to India.

Thailand is witnessing rapid growth in its auto industry and one of the reasons is the low corporate tax rate of 20 percent - much below that in India. This is the tax arbitrage in trade that TNCs thrive upon. It would thus make sense for them to book profits in Thailand rather than in India. Moreover, Thailand also offers a tax holiday of up to eight years with no cap for certain sectors where it wants to promote manufacturing. Any firm sitting on eight years of tax holiday will generate cash reserves for sustained competitiveness.

Imports from Thailand have been growing at a CAGR (compounded annual growth rate) of 46 percent after 2009-10, while exports are growing at a CAGR of 36 per cent. The growth rates are more for imports but India has a marginal surplus in exports of auto and auto components.

Thailand’s three biggest manufacturers are Toyota, Isuzu and Honda. Ford joined the trio in 2012. Behind the auto industry is a bigger ancillary industry. Ancillaries are bigger job generators as companies in this sector are smaller in size and automation is low compared to the main automobile plants. Thailand exports components worth $5 billion - more than the other members of Asean combined.

Thailand is an automobile export hub and Indonesia is not far behind. Recently, Toyota committed $1.3 billion worth of investments to Indonesia due to new incentives for hybrid cars. It is difficult for India to match these tax incentives. Indian component makers are also attracted by Thailand and Indonesia’s tax incentives.

Indonesia is part of the India-Asean FTA, and it offers even more attractive tax incentives for corporates compared to Thailand. The OECD calls Indonesian incentives as ’excessive’ and a cheese full of holes. With companies wanting to remain in these holes to avoid paying any tax whatsoever. The Indian government has to see how these tax incentives affect us and whether it will erode India's competitiveness within the FTA.

The FTA with Indonesia is not operational yet. There are already two schools of thought in the government about the benefits of the FTAs. India needs to consider the distorted competitiveness of Indonesia into account before making it operational.

There are other sectors and FTAs which also needs a relook. Of which, more later.