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Asia-PacificDecember 5 2005

The ramifications of a Sino-Indian FTA

In reality, free trade agreements rarely go the whole nine yards – they are at best liberal trade agreements.
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This year millions of Indians lit up their homes to celebrate the festival of Diwali, but their neighbours in China had another reason to smile. The Indian market was flooded with Chinese-made garland string lights, among thousands of other products, but the Indians weren’t complaining. In most nations the over-dependence on Chinese products is becoming a matter of grave concern as economies labour under a huge trade deficit with China. But India at the moment seems fairly relaxed as it has a trade surplus with China, a feat that cannot be matched by many other countries in the world.

The bilateral trade between India and China has skyrocketed and is expected to reach close to $20bn by the end of the year, a target that was set for 2008. Compare this with bilateral trade of $2bn in 2000. This equates to almost a 10-fold increase in a span of five years and an increase of 80% alone from 2003 to 2004.

India and China also recently signed an agreement to set up a joint economic committee that will conduct a feasibility study to agree on a free trade agreement (FTA) by 2010. One can only imagine what an FTA would do to bilateral trade, but even if it grew at a conservative 50% over the next seven years, it will cross the $400bn mark, not far off the UK’s trade with the 25 EU member states.

The implications of free trade

Proponents of the FTA put forth an argument that creating such conditions improves productivity, brings down prices, increases quality and generates immense wealth.

That is what will likely happen if the two most populous nations on earth go on to sign an FTA, something that would be quite unprecedented. The Indian consumer will benefit immensely from wider choices, lower prices and improved quality goods flooding its markets. The profitability of Chinese industry would increase as it would procure raw material from India at relatively lower costs. In addition to increasing employment and wealth generation on both sides, the FTA would create extremely tough and competitive conditions for other nations that trade with India and China.

But in reality FTAs rarely go the whole nine yards. They are, at best, liberal trade agreements. FTAs are predicated on transparency and trust – and these are traits that seem to be missing between the two nations.

While the general relations between the two seem to be moving in a positive direction, the countries compete fiercely on the world stage to secure energy and fight for the same foreign direct investment. Indian industry also finds China is not a safe haven for safeguarding its intellectual property rights.

Indian exports

A closer look at the underlying structures in Sino-Indian economic relationships does do India a favour and that is to debunk a myth: that India is only strong in the services sector. It has achieved a $1.75bn trading surplus with China not on the back of exporting services but by exporting traditional goods from the mining and manufacturing economies. India’s top exports to China include ore, slag, ash, iron, chemicals, precious stones, metals and cotton. But it also exposes the fundamental weakness that the top export item constitutes 57% of India’s total exports to China. So it has a long way to go before it can add other items to the portfolio.

On the other hand, China’s exports to India, which include value-added goods such as electrical machinery, minerals, silk and other fabrics, have a more equal distribution varying from 15%-22% of exports.

The bad news does not stop here. Contrary to the general belief that investments follow trade, cross-border investments between India and China are only a fraction of the trading levels. It is estimated that Indian investments in China are $200m and Chinese investments roughly 10% of that, signifying a lack of confidence between the two trading partners.

So even if an FTA between India and China was to materialise in the near future, it would not deliver the utopian world that it promises. But there is no doubt that it would boost bilateral trade, as well as provide ample opportunities for other nations to strike gold.

Sanmit Ahuja is head of India Affairs at Commonwealth Business Council and an adviser to the private and public sector.

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