To double exports under Govt. FTP-26, India needs to join FTAs like RCEP

Without FTAs, Indian cannot hope to increase its exports from $450 billion to $1 trillion as Modi hopes.

Asia takes in about 50% of India’s annual merchant exports, and accounts for 60% of our imports.  In all, more than 55% of our total trade with the globe goes to Asia. India is very Asian.

The 15 RCEP countries in Asia account for 37% of our global exports, and 42% of our global imports.  In all about 40% of our global trade is with RCEP countries. It results in an annual deficit of about $100 billion. We should seek to lower this deficit.

For perspective, the US accounts for 20% of our exports and 8% of our imports. Our trade with the US is only about 10% of our global trade. US gives us a trade surplus of $22 billion annually, which we don’t appreciate enough.

RCEP countries constitute 30% of the global population [not including India], have a combined GDP of $26.2 trillion, which is again 30% of the global output.  It is both the world’s largest trading block, as well as the fastest growing region of the globe.

Why is India not in the RCEP pact?

In November, 2019, Modi went to Beijing for an RCEP summit where India was all set to sign the trade pact.  But at the last minute, Modi discovered a Gandhian talisman that did not permit India to join.

The Talisman says:

“Recall the face of the poorest and the weakest man [woman] whom you may have seen, and ask yourself, if the step you contemplate is going to be of any use to him [her].”

Unless you think Ambani or Adani represent the faces of the poorest men in India, Modi’s argument not to join RCEP is open to question.  Exports are labor intensive. They create jobs.  Exports are what keeps us alive and solvent as an economy.  In India, it is the poor who export, mostly their labor, and the rich who import, mostly goodies or Gold. But Modi’s decision locked Indian exports out of 30% of the global market. It is hard to see how that helps the poor.

Basically, RCEP was designed to eliminate 90% of the tariffs in the 15 member trading block, and to bring about a convergence in the economies of member countries, and thus stimulate growth and employment.

In a trade block, firms can locate at any site in the block where  their costs are the lowest. Lowest tariff market access to all member countries is guaranteed from any location.

Lower costs enhance productivity within the block. Markets are larger than before. Economies of scale kick in. Employment across countries converges.  Firms and consumers are exposed to new technologies. Commercial contracts and practices are uniform.

The benefits of joining a trade block, especially one in which India would be the second largest player, but with the fastest growing economy by far, [China having plateaued], should be obvious. It would have been an excellent strategy to make India the growth engine of the globe.

What then made Modi baulk at a done deal?

There two major downsides from an FTA.

Firstly your local players, the Ambanis and Adanis, have to compete with the Jack Ma and Liu Chuanzhi of the world, and that’s not an easy thing to contemplate. Second, there is a steep learning curve you face in order to export your products, build brands, and create markets in other member countries.

Local entrepreneurs can no longer shelter behind tariff walls from competition. The single biggest hurdle to India’s joining RCEP was not that India’s dairy industry would be wiped out by New Zealand - that was just a scare story - but that rent seeking tycoons would not be able to use use their leverage with Govt. to tilt the playing field in their favor.

India’s business elites lack the confidence to tackle overseas markets, especially difficult ones like Asia, where language is a barrier. Yet they have the software services model, where our tech firms have built large, and durable franchises, in US, Europe and Asia.

The brick and mortar firms, run by tycoons with old money, have never learned to compete with the best, and are therefore reluctant to launch into exports.  It is not an accident that most of them are in capital intensive, rentier businesses. Tycoon owned firms are large importers. They can sustain their profits only if an obliging client Govt. in Delhi protects their oligopolies and fiefs.

The fundamental aim of Modi’s economic strategy is to protect local tycoons from external and internal competition, in order to enable them to grow bigger.

So be it demonetization, GST, digitization of payment system, along with Aadhar enabled surveillance; all measures were designed to force commerce, and consumers, to migrate from the informal to the formal sector, where tycoons dominate the playing field. This has forced commerce and economic activity to move from the informal to the organized sector, sending corporate profits, and stock markets, zooming.

Squeezing the informal sector has sent tiny firms out of business, adding to the ranks of unemployed, and the poor.  New job creation is virtually zero, as the informal sector learns to deal with GST codes, digital payments, and find new capital.  Meanwhile many of the unemployed are being pushed into Malthusian poverty traps.

With exports stagnant, and private sector investment still on a holiday, despite soaring profits, both growth and employment opportunities have shrunk.

What Modi has grasped of late is that a shrinking gross domestic savings rate of 30%, given an ICOR of 5, can only generate a growth of 5% to 6%, that is simply not enough to create the required number of jobs in the economy.

Modi has thus embraced the mantra of export led growth, by announcing a new Foreign Trade Policy, FTP-21-26, which seeks to double exports from $450 billion presently, [including services exports], to $ 1 trillion, over next five years.

So far so good.  But how can this happen?

Some of the building blocks required to launch into an export led growth have already been put in place by Modi.  Corporate tax rates are now globally competitive.  Labour laws are much more flexible.  Digitization of tax collection has vastly improved economic intelligence and compliance. A huge corporate cash pile is available for new investments, provided Govt. can assemble a credible plan of action.

But to unleash export led growth, some more steps are imperative.

Firstly, to export another $550 billion worth of goods and services, you need to invest $2.5 trillion in the domestic economy, over and above the existing savings, that amount to $60 billion annually.

How are you going to find $550 billion of FDI per annum in the next 5 years?  Or even $250 billion over ten years?

Secondly, why would anyone give you this FDI, and set up a plant to make, say EVs, when you can’t export the car you make in India, to any other country in the world?

We are not even a MFN trading partner of the US under WTO.  We are not in the RCEP, that would enable the new firm to export EVs, without duties, to China, or Australia or Indonesia.  Or even Bangladesh.  We don’t have a trade deal with EU. Who will give us this scale of FDI we need, just for the pleasure of selling to Indians?  Modern firms need access to global markets to be competitive.

So if you want FDI, especially at the scale you need to double exports, the first order of business is expand your market, and that means going to trade blocks post-haste.  Of the blocks that we could join quickly, RCEP makes the best economic and strategic sense.

Next we need to lower the barrier to entry into the the Indian economy like China did in the 1980s.  We have to drop the asking price of the non-tradable part of our economy by devaluing the INR.

Why does an FDI investor come in to invest in your country?  She comes in to access the lower costs of your non-traded economy.  [The tradable part can be accessed through trade]. But this has a price set by the exchange rate.  If that price is too high, you will not get the required FDI.

So you have to drop the value of INR, and sustain it there, for a period of 3 to 5 years, by pegging the lower rate to a Dollar plus Yuan combination.  [The 90/91 reforms were not as effective as they could have been because we failed to put a durable and visible peg in place.] This allows you to suck in the required FDI for new investments because of lower effective selling price. And the peg helps firms to align with the new cost & trade structure.

For best results, we should combine this with a strategy of concentration of investments, at select export promotion regions, to offer lower costs to firms in the long run.

Next join the RCEP. The beauty of preparing to join the RCEP is that it automatically repairs your trade dispute with the US, and paves the way to craft an FTA with EU.

As competition grows global, you need global scale and global access to markets.  No significant FDI is going to come your way simply to serve local markets.  Nor do you want that sort of FDI because you want exports.  So when you have to sell your wares, lower the price.  There is no shame in it.

Thirdly, you do need to protect your local players for sometime to help them negotiate the learning curve.  The best way to do that is by lowering the external value of the INR as we discussed, and pegging it for a while till the firms can adjust.  This also helps eliminate tariff barriers and export subsidies, a pre-requisite for joining FTAs like RCEP. So tycoons can have their cake and eat it too.

Recognizing the need for an export led growth is very welcome. Modi can combine it with some of the reforms already in place to give FDI a humongous push.

To bag the required FDI, in order to make doubling of exports possible, a currency realignment to access the FTAs is imperative.  There is no way we will get any significant FDI that leaves an export-dependent-firm out of the RCEP.  Single country markets, even as large as India’s, no longer enthuse global firms.

You are either in RCEP, or you are out, as in global outcast.