Even though India and the European Union (EU) are celebrating 60 years of bilateralism, it was only in 2007 during Prime Minister Manmohan Singh’s first tenure that a Strategic Partnership between the two parties was signed, which after six years of engagements broke down due to unresolved issues. This hiatus was finally broken in May 2021, when India and the EU decided to resume from where they had left off towards an ambitious, comprehensive and a win-win trade deal for both. They also reached an understanding to pursue market access issues, implement globalization and protect investments. The talks were formally resumed in June 2022 with the first round held in Delhi, the second round held in September 2022 in Brussels, and are to be followed by the third round in Delhi in November 2022. European Union as a region is India’s third largest trade partner after the US and China with trade volumes evaluating at $116.36 billion in 20210-22. In addition to protecting investments, both parties are keen to make a headway in accessibility in regards to digital commerce, agricultural products and geographical indicators (GI)(1). If the EU gets access to the vast and untapped Indian market, India in turn is hoping to enter a level-playing field on an equal footing with countries like Bangladesh and Vietnam that have received privileged status in the EU market.(2) The First Round covered 18 policy areas of FTA in addition to 7 sessions on investment protection and GIs. The Second Round focused on Indian responses to the EU’s proposals and India’s textual counterproposals.(3) While understanding each party’s sensitivities on trade in goods and divergences on rules of origin was the highlight of Round 2, it is quite improbable to date the inking of the trade deal between the two with certainty due to EU’s 27-member countries’ complexities.
There are up north of 6000 European companies present in India across various sectors, which are responsible for providing 1.7 million jobs, excluding 5 million that are indirectly provided. If tapping the markets is considered to be a rationale behind the trade talks, from EU’s point of view, the objectives are very many, viz. sound, transparent, open, non-discriminatory, and predictable regulatory and business environment for European companies trading with or investing in India. This is inclusive of protecting investments and intellectual property. The EU’s share in foreign investment stock in India reached €87.3 billion in 2020, up from €63.7 billion in 2017, making the EU a leading foreign investor in India. This is significant, but way below EU foreign investment stocks in China at €201.2 billion and Brazil at €263.4 billion. The reason for this lag is what the EU considers India’s restrictive trade regime and regulatory environment. For example, TBT (Technical Barriers to Trade)(4), which serve legitimate public policy objectives are often treated contentiously by Indian exporters, as any imposition of TBTs can lead to a significant relocation of resources from high-productivity to low-productivity firms. This coupled with limited administrative and technical capability potentially threatens the adoption of regulatory standards that have gained international currency. Then, you have the SPS (Sanitary and Phytosanitary Measures)(5), which is found to be ineffective in India’s case, primarily because SPS Measures provide a space for protectionist purposes under the guise of legitimate concerns. But, India is persevering to prove that its ease of doing business has improved, and in an age of deglobalization and economic decoupling, it wants to have a strategic partnership with the EU rather than merely focusing on an economic one, and an FTA in this regard would only help strengthen and forge newer ties and partnerships.
Coming on the heels of India-UAE CEPA (Comprehensive Economic Partnership Agreement), which is broad in scope, but shallow at the same time, there is a sudden spurt in signing FTAs. It must be noted that in a number of India’s trade agreements, Indian trade deficits have increased after the signing of the FTAs as the demand for imported commodities increased with complete elimination of tariff and non-tariff barriers.(6)(7) The “Early Harvest”(8) trade pact with Australia in April was interim and narrow in scope, but with the India-EU negotiations on, the scope of this FTA is supposed to be ambitious and broad with specific emphasis on trade and sustainable development. Importantly, the investment protection agreement was made distinct from FTA due to regulatory framework within the EU.(9)
India has long exercised caution against FTAs, either because of its over-indulging conclusions on the success/failure rates of FTA utilization, market penetration, or integration with regional and global networks, and crucially trade deficits. All of this is supposedly to change with its new found penchant for signing on to FTAs.
Beginning in the 1990s, and on through the decade, economic liberalization helped India integrate into the global fold. There were divergences in academic scholarship between how such an integration would help India’s trade schemata in the short as well long run, when it comes to fully subscribing to the international market order. The skeptics(10) argued that any FTA India were to become part of in the wake of economic liberalization might not make sense in the short-term, but would definitely help the country in its strategic ends, if India were to become a hub for services’ exports. The not-so skeptics(11) argued that liberalization followed unilaterally should get its due acknowledgement in India’s integration with the World Market, especially in its Look East Policy. The Look East Policy has been upgraded to Act East Policy, and with it, the driver for a deep integration was liberalization(12), or more appropriately financial liberalization, until CoViD-19 hit and brakes were applied and course changed towards ‘protectionism’ by the Government’s ‘Atmanirbharta’.
The process of financial liberalization directly influences the level of interest rates and indirectly, the structure of capital costs, marginal efficiency of investment and levels of aggregate savings, investments and employment. The three major objectives of financial liberalization are,
– opens qualitative and quantitative financial flows
– liberalizes terms governing outflows of forex
– transforms financial structures
If we look at the financial landscape on either side of the Global Financial Crisis of 2008-09, India had done relatively better with its tight capital controls and small extent of its external linkages. This on the one hand had slowed down investment, while on the other locked in restrictions in most traditional industries. However, reforms were once again introduced during the current political dispensation of the BJP-led NDA regime when foreign investment permissions were relaxed. According to Arvind Panagariya(13), foreign invested enterprises may be wholly owned in some policy priority areas, including marketing food products, high-tech and capital-intensive activities in transportation, coffee, rubber, medical manufacturing, e-commerce, to name a few. Despite such reforms, the results on the ground are barely translatable, as India’s domestic financial development is still caught up in a lag, with the public sector banks accounting for a significant majority of the loans. In other words, India’s financial system remains in a hybrid mode with market forces permitted, but continuing state ownership and intervention geared towards priority sector requirements on the one hand, and in curbing the unleashing of market forces on the other constrict both of these. While the corporate bond market remains highly regulated and small in size, the equity markets are open and well regulated, it is the debt market with extensive capital controls(14) that govern the flows foreign funds.
Financial liberalization involves developing equity markets. With banks entering this arena, any turbulence in equity markets could have ripple effects on the performance parameters of banks. Secondarily, FII (Foreign Institutional Investors) investments constitute a large share of equity capital of a financial entity. An FII pull-out, even if caused by developments outside the country can have rippling implications on the financial health. Thirdly, FII outflows can depreciate the currency, and in a special case (thankfully India hasn’t faced it yet) cause a currency crisis.
Even if Financial Liberalization leads to growth, it can also force the state to adopt a deflationary position to appease financial interests, which are contrary to deficit-financing, as deficit financing can lead to a liquidity overhang(15) in the system further leading to inflationary pressures(16). This complex is a sign of interventionism on the part of the state and thus is contrary to the market dynamics. At the same time, curbing deficit contracts public expenditure, and this adversely impacts capital formation. This leads to declining growth and employment, and further contracts social sector expenditures. The moonshot of this declension is privatizing public assets. The cycle is vicious, as global finance seeks to delegitimize state and legitimize the market.
India’s FDI (Foreign Direct Investment) flows are heavily distorted by phantom capital flows, where special purpose entities and other conduits are used for tax optimization and to obscure the origin of capital, thus facilitating speculative forays in the market. It is essential to clean up these phantom flows. Mauritius, a tax haven followed by the EU and the US are the largest investors in India. UK is the 3rd largest non-tax haven investor with an inward FDI stock into India as large as the US and the EU. But, post-Brexit, the EU stands to lose almost half of its inward FDI stock to India. Looking at India’s outward investment, Mauritius and Singapore are the leading destinations whereas stocks in the EU fluctuate and remain relatively low. Another credo of financial liberalization that could be stamped is to exempt listed equities from long-term capital gains taxation regime, as this would facilitate investment in equities. Only short-term capital gains are taxable as of now.
Modi’s Make in India to make manufacturing account for 25% of GDP decelerated due to a series of setbacks in the domestic credit market. By the end of the first term, it was clear that market-driven global integration had not delivered on the economic or strategic front leading to annulling a series of bilateral investment treaties. To add to the woes, the downward trend in customs duties since 1991 liberalization was reversed. Even India’s stepping out of RCEP that had simplified rules of origin and enough transition periods for Indian industry to adapt was deemed irrational. Atmanirbhar policy in the wake of CoViD-19 pandemic has been touted as a move away from market-driven liberalization to a more strategic approach with selective increases in industrial tariffs, liberalization of FDI in both goods and services, and PLIs (Performance-Linked Incentives) aimed at restoring key manufacturing processes.
Post-1991, India signed a large number of Bilateral Investment Treaties (BITs), including 21 with the EU members, of which only with Latvia and Lithuania are still in force. Since 2015, India has annulled a high number of these BITs. The reason being a number of high-level investor state dispute settlement cases against India. In recent times, India has signed on FTAs, but have agreed in-prior principle to providing MFN status and national treatment to foreign investment, thus limiting the use of performance requirements and dispute settlement mechanisms.
With this adumbrated look at India’s Financial Liberalization policies, let us briefly point out how would this impact the current and ongoing negotiations between India and the EU. EU Agreements are mostly two-dimensional – they have width and they have depth. In other words, they cover issues going beyond issues in liberalization of trade in goods and services and investments. Indian Agreements have shown an increasing inclination towards the dimension of width, but are a far cry from depth. In other words, EU Agreements are bounded by commitments, whereas Indian Agreements are at best, “best-endeavors”(17).
Advancing non-trade policy objectives is a core part of EU’s foreign policy. One of the cornerstones of EU’s Trade Agreements is Trade and Sustainable Development (the negotiating parameters) culminating into provisions related to environment and labor standards. An example of the EU-South Korea FTA(18) is apt here, for the agreement widens the scope to measures affecting trade-related aspects on environment and labor. If these standards are violated, the EU can legitimately ask the other party to comply with the standards, as had happened in case of South Korea which was asked to improve, rather than improvise on its standards in 2019. Such factors were then introduced in the text of the subsequently inked EU-Vietnam trade agreement. Contrast this with the example of India-Korea Trade Agreement, who in general agree on Sustainable Development, but the text of the deal misses any chapter on commitments.(19)
Commitments needs to be complied with, and an ombudsman is essentially tasked with the responsibility. In case of FTAs that the EU signs on to, there are two such compliance mechanisms in place, viz. DAG (Domestic Advisory Group), and PoE (Panel of Experts). The former is an informal mechanism, while the latter is a formal one in nature. Domestic advisory groups should be advisory, consultative, institutionalized and competent to cover all provisions of FTAs. The EESC (European Economic and Social Committee) considers that the participation of civil society in all FTAs is an indispensable element in the strategic ambitions of the external policies of the EU. The DAG, which is more of an informal mechanism is represented from the two parties in a deal, while the Panel of Experts is constructed in accordance with the formal, third-party dispute settlement mechanism. In case of any dispute or non-compliance, the PoE is invoked and the decision of the same is binding and requiring the contracting parties to effectuate a change or changes to their domestic regulations. The case of EU-Korea mentioned above is related to precisely such an invocation of the PoE. The PoE admonished Korea to ratify three ILO (International Labor Organization) Conventions and also had to amend its trade union and labor relations.
How would these different takes pan out between the EU and India remains to be seen considering there are differences in multilateral and regulatory and domestic positions on these aspects. Multilaterally, two main conventions of the ILO, viz. C087 and C098 – Right to Convention and Right to Collective Bargaining are not ratified by India have not been ratified by India, and such a miss might become a point of contention to the inking of the treaty. Regulatory-wise, compliance is the responsibility of enterprises, and in India, where a large majority is informal sector, compliance costs could be onerous. If the trade deal is then said to go through, adherence to labor and environmental compliances could very well strike out a massive sector of the economy from getting integrated in the deal.
If these are fiduciary challenges (in financial and trade terms), then there are challenges on an environmental front. Firstly, India’s environmental laws have gone through a series of notifications that critics believe are substantially diluted to foster India’s growth. Secondly, you have the EU’s Carbon Border Adjustment Mechanism (CBAM) to prevent carbon leakage within the geographical territories of the EU and by moving carbon-intensive production where standards are lax. India looks unfavorably at this schema for its protectionist, discriminatory and contrarian evaluations to international laws and agreements.
Unless these challenges are consensually agreed to be addressed, any trade deal, with how much ever liberal economic policies in place will have serious impediments to clear. Maybe, this is one of the reasons why critics of FTA between India and the EU call the deal, which is yet to materialize as a deal of unequals. As of now, for the EU, India remains a partial hedge against the risks emanating from the trade architectures along the pacific rim. It remains to be seen if additional layers are added on to this hedge.
Lastly, with India now chairing the G20 for a year, there is likely to be a political temptation to conclude an early harvest agreement with the EU, but it would be compromising on the principles of a comprehensive agreement that may take longer than is expected.
(1) A GI is generally a produced, agricultural or natural product that is specific to a geographical origin. In trade parlance, GIs carry a guarantee of quality and originality.
(2) India is specifically anticipating growth in industries like leather, textiles, processed foods etc. to create a parity in exports, which Bangladesh and Vietnam enjoy.
(3) The EU tabled a chapter on trade and sustainable development, anti-fraud and mutual administrative assistance, which the Indian side was supposed to provide detailed explanations and clarifications on. Such an exchange then, would provide grounds for the negotiators to enter into actual negotiations in Round 3.
(4) A progressive decline in tariffs has brought non-tariff measures (NTMs) under greater scrutiny as one of the major barriers to trade flows between countries. The increase in NTMs has been primarily driven by a surge in regulatory measures like technical barriers to trade (TBT) and sanitary and phytosanitary measures. Theoretically, the imposition of a TBT can affect a firm in various ways: first, it can directly raise production costs. In particular, TBTs can be associated with either an increase in variable costs (eg. labelling requirements) or fixed costs (eg. new production processes) of production or both. Second, the existence of different standards in different markets could entail individual fixed compliance costs for separate markets, which could severely limit exporters’ production capacity and the number of markets. Overall, by increasing the variable or fixed costs of production, TBTs are likely to affect aggregate exports, which in the Indian case is very true to the markets maintaining these measures. Chakraborty, P., & Singh, R. (2020). Technical Barriers to Trade and the Performance of Indian Exporters. ERIA Discussion Paper Series, No. 393, 1–30. Retrieved December 1, 2022, from https://www.eria.org/uploads/media/discussion-papers/FY21/Technical-Barriers-to-Trade-and-the-Performance-of-Indian-Exporters.pdf.
(5) The Agreement on the Application of Sanitary and Phytosanitary Measures (SPSA) was negotiated with a view to setting in place an array of multilateral rules that would, on the one hand, recognize the legitimate right of WTO Members to adopt sanitary and phytosanitary measures necessary to protect human, animal, or plant life or health, and on the other, enshrine certain checks and balances to cope with the possibility of thee measures emerging as non-tariff barriers (NBTs). Das, K. (2008). Coping with SPS challenges in India: WTO and beyond. Journal of International Economic Law, 11(4), 971–1019. https://doi.org/10.1093/jiel/jgn033
(6) The case of import of Malaysian Palm Oil is appropriate here.
(7) In order to understand the mathematical and econometric frameworks to assess the impacts of FTAs on the commodity value-chain, see Ghosh, N., Konar, A., & Pathak , S. (2015, October). India’s FTAs with East and SE Asia – Impact of India-Malaysia CECA on the Edible Oil Value Chain. Observer Research Organization Occasional Paper. Retrieved December 5, 2022, from https://www.orfonline.org/wp-content/uploads/2015/12/Oc-Paper_73.pdf
(8) An early harvest agreement is aimed at liberalizing tariffs on the trade of certain goods between two countries or trading blocs before a comprehensive agreement. It is primarily a confidence building measure.
(9) While an FTA can be approved by the European Parliament, investment promotion pacts are to be ratified by parliaments of member countries.
(10) Pal, P. P., & Dasgupta, M. (2008). Does a Free Trade Agreement with ASEAN Make Sense? Economic and Political Weekly, 43(46), 8–41.
(11) Asher, M. G., & Sen, R. (2008). India-East Asian Integration: A Win-Win for Asia. Economic and Political Weekly, 40(36), 3–9.
(12) Liberalisation is a loosely used terminology often tailor-made to suit contexts. But, in general, it refers to the relief of state restrictions with areas of social, political, and economic policies. Liberalisation in economic policy focuses on the reduction of government laws and restrictions in place to encourage greater participation by private entities. In India, liberalization began with the 1991 economic reforms, and were primarily aimed at – annulling the then-existing license raj; lowering of interest rates and tariffs; stripping the public sector’s monopoly from various segments of the economy; and sanctioning of foreign investment in different industries. Trade liberalization, on the other hand is the removal or reduction of restrictions or barriers on the free exchange of goods between nations, These barriers include tariffs, such as duties and surcharges, and non-tariff barriers, such as licensing rules and quotas. For a in-depth treatment on Trade Liberalisation, see Wacziarg, R. (Ed.). (2018). Trade liberalization. 2 vol. set. Edward Elgar.
(13) Panagariya, A. (2016, May 18). Two years of reform: Substantial progress has been made towards restoring economic momentum. Much remains to be done. The Indian Express. New Delhi. Retrieved December 5, 2022, from indianexpress. com/article/opinion/columns/pm-narendra-modi-2-years-of-modi- govt-bjp-two-year-anniversary-pradhan-mantri-krishi-sinchai- yojana-2804219/.
(14) In a related concept, India during the heydays of unfolding its liberalization policies acted prudentially in liberalizing its capital account. A capital account deficit is showing that more money is flowing out of the economy along with increase in its ownership of foreign assets and vice versa in case of surplus. The Balance of Payments contains the current account (which provides a summary of the trade in goods and services) in addition to the capital account which records all capital transactions.
(15) Excess liquidity in the system, and has the potential to send short-term interest rates crashing down.
(16) Chandrashekhar, C. P., & Pal, P. P. (2006). Financial Liberalization in India: An Assessment of its Nature and Outcomes. Economic and Political Weekly, 41(11), 1–25.
(17) Best Endeavours are an onerous obligation requiring a party to take “all those steps in their power which are capable of producing the desired results” although it is by no means an absolute obligation and the concept of reasonableness still applies. One expression of this is that “best endeavours” requires “all that reasonable persons reasonably could do in the circumstances”. In contrast to “Best Endeavors”, you also have Rational Endeavors, which are the obligations that depend upon the circumstances of the party subject to it and they would not be required to sacrifice their own commercial interests.
(18) European Union , Official Journal of the European Union (2011). Retrieved December 5, 2022, from https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:22011A0514(01).
(19) Ministry of Commerce, GoI, India – Korea CEPA (2009). Retrieved December 5, 2022, from https://commerce.gov.in/wp-content/uploads/2020/05/INDIA-KOREA-CEPA-2009.pdf.