New FTA playbook: India reworks trade policy to de-risk from China

The evolution of India’s trade policy under Prime Minister Narendra Modi can be divided clearly into two periods: the one before the Covid-19 pandemic and the one after. While critics initially labelled the administration’s early moves as a hint at protectionism, careful observation suggests a more nuanced reality. India’s trade stance has been primarily defined by an effort to navigate the systemic risks posed by Chinese economic dominance while simultaneously upgrading domestic industrial competency. By dividing the Modi era trade policy into pre- and post-pandemic phases, one can map a clear trajectory: from identifying trade dependencies to actively de-risking those dependencies through a compartmentalised approach to bilateral trade deals, supply chain linkages and aggressive industrial policy.

Before the pandemic in 2019, India hit an 11-year high in both categories of Most Favoured Nation (MFN) trade-weighted average tariff and MFN simple average tariff at 8.8% and 15.5%, respectively, and 2319 items saw a rise in tariffs from India. It was also the same year when India pulled out of the Regional Comprehensive Economic Partnership (RCEP) at the last moment. Anyone looking at these data points at the time in isolation would have come to the obvious conclusion that India under Modi was again taking a protectionist turn. Some even said that it was a setback to India’s Act East Policy, which emphasises deep engagement with the geography to its East. However, patterns of the long Modi tenure suggest that trade is not an ideological subject for the current administration. Its treatment of trade has been specific and pragmatic to avoid repeating the same mistakes.

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The government has consistently maintained that India has gotten raw deals during free trade agreements (FTAs) with Japan, South Korea and the Association of Southeast Asian Nations (ASEAN) under the UPA government, as those countries didn’t provide fair market access to India in areas of its competence, imposed strong non-tariff barriers to Indian exports, and there were no precautions related to rules of origin issues through which a chunk of Chinese goods was funnelled into India even as India continues to have an increasing trade deficit with China. In fact, when Modi took a very bold diplomatic call to get out of RCEP in late 2019, Amit Shah, while explaining the government's rationale, called out China by saying it was done to protect Indian “industries from any adverse effects that Chinese interests could have caused", as the deal could have opened “the floodgates for Chinese goods to enter India”. So one could say by and large that the approach to trade under the first term of Modi was shaped by the concerns over China.

These concerns further rose during the pandemic as Beijing tried to leverage the COVID-led supply chain disruptions to play wolf warrior diplomacy via its trade leverage against the world. Moreover, India has been very vulnerable and subject to various kinds of import restrictions from Beijing due to its high dependence on China for materials like active pharmaceutical ingredients to make medicines, rare earth magnets and critical minerals that are key for semiconductors, electric vehicles, solar panels and other high-tech industries, and tunnel boring machines, among others. With India, things became worse with Chinese aggression at the Galwan Valley on the Indian border, where both Indian and Chinese soldiers died in a clash. In addition to a large mobilisation of troops across the Chinese border, India also took economic measures against China as a response by banning several big Chinese apps, including TikTok; decoupling its telecom infrastructure from Chinese equipment led by Huawei; limiting Chinese participation in public procurements; and limiting Chinese investments into India through Press Note 3, including in key strategic sectors.

Covid-19 Pandemic

Covid emerged as a key opportunity for India on the trade front to widen and deepen its supply chains. Since 2021, beginning with Mauritius, India has entered into FTAs with eight economies, viz, Mauritius, the United Arab Emirates (UAE), Australia, the the European Free Trade Association (EFTA), the European Union (EU), the United Kingdom (UK), Oman and New Zealand, and is in talks for new ones with other economies like Canada, the Gulf Cooperation Council (GCC) bloc and Israel, in addition to being in negotiations to revise its existing FTAs with Japan, South Korea and ASEAN to make them fairer.

Compared to previous FTAs during the UPA era, new FTAs under Modi are very different. They do not seem to follow the principle of the post-Cold War EU-led model, where a comprehensive set of trade, investment treaties, intellectual property (IP) protection, geographical indications (GI) recognition, environmental and labour rights, among others, is negotiated as a single package deal. India compartmentalises some of these variables and negotiates them separately without holding one hostage to the other. That is how all the FTAs since the pandemic have been done. It is important to note that India has pursued this approach first with smaller economies like Mauritius, the UAE, Australia and others before signing similar deals with big economies like the UK and the EU; the EU one is the largest of all, as it is the second largest economy with a nominal GDP size of around $23 trillion at dollar market exchange rates. For instance, despite finalising the FTA, separate negotiations between India and the EU on an Investment Protection Agreement and an Agreement on GIs are still ongoing. Even in a deal as big as the EU, India has focused on ensuring protections related to rules of origin provisions and securing reciprocal benefits in terms of services trade opportunities and the labour-intensive sectors, among others. India has been excluding sensitive areas like major agricultural crops and dairy from these deals.

While in an ideal scenario, negotiating all of these together helps deepen economic partnerships in a true sense, it has been seen that India still doesn't seem confident in the competitiveness of some sectors, in addition to likely domestic political costs in areas like agriculture and dairy. So, India has been trying to carefully navigate the path of free trade as an emerging economy with several productivity challenges. This is where the Modi government looks less ideological and more pragmatic, as these FTAs show openness to free trade while avoiding an all-in-one model of a free trade ideologue by securing politically viable deals that can be effectively implemented.

Adjusting to Trump 2.0

In the immediate few years post-pandemic, Indian FTA pursuits had the main motivation of at least derisking, if not decoupling, from China as the main motivation to diversify market linkages by finding new markets, especially in areas where Indian exports can be competitive. But the new threat of the tariff regime under Trump 2.0 has added another motivation to India, which some believe was also the reason for the quick completion of the FTA with the EU. While such a threat to global trading norms existed even under Trump 1.0, the scope and scale of that was way lower relative to whatever is happening under the current Trump administration.

However, China leveraged its dominance over key supply chains to coerce various economies in response to Trump’s trade policies over the last year. But the Chinese response shall not be seen in isolation, as there is a risk of justifying it if one doesn’t recall its predatory trade practices over the years, which have already been highlighted earlier. Despite being cognisant of it, India has shown some signs of relaxing its economic posture against Beijing as New Delhi seeks more opportunities for business partnerships and investments across the world. India recently relaxed Press Note 3 to allow some Chinese investments in non-strategic sectors to balance the risks from Trump's trade threats. It realises that ignoring the second-largest national economy (in nominal dollar size) is difficult in these challenging times.

Domestic Reforms in Aid of FTAs

All these FTA efforts by India since the pandemic have been happening in parallel to domestic economic reforms so that domestic markets are prepared to take benefits in time. The Modi government has focused on industrial policies in several sectors through the Production Linked Incentives (PLI) scheme, with big success in key sectors like electronics and the solar industry. PLI has also been later complemented with design-linked incentives for semiconductors. It has also been on a constant reform spree by restructuring the GST regime, Insolvency and Bankruptcy Code makeover, Rajiv Gauba committee-led deregulatory reforms, modern maritime and shipbuilding laws aided by substantial funding, new labour reforms, and several other reforms, including those at the state level. Further, the government has been consistently maintaining a heightened level of capex spending across energy infra, industrial infra, connectivity — highways, railways, airports, seaports, urban public transport like metros, etc. — and other forms of infra.

To realise the full potential of its FTAs, India should also formulate its new model BIT soon so that it can sign investment treaties with all the major economies to give confidence and protection to foreign investors. However, there already seems to be an issue with how to approach BITs with some of these nations. For instance, while the Modi government is conducting BIT negotiations with several economies, the one with the UK has been put on hold, as India does not want to include taxation and Most Favoured Nation (MFN) status under the treaty, and New Delhi wants to maintain its sovereign fiscal powers over taxation and believes MFN is a trade concept that has nothing to do with BITs, which are legitimate concerns to have.

Further, with more success and confidence, India should only try to finish as many FTAs as possible and deepen the scale and scope of FTAs. Moreover, if one looks carefully, most of the recent FTAs have been with nations to its West, barring Australia and New Zealand, In this regard, it should put special emphasis on finalising revision or upgradation of its current FTAs with Japan, South Korea and ASEAN so that it can deepen its engagement with the East, thereby strengthening its Act East Policy. To this effect, New Delhi shall also look to join something like CP-TPP a few years down the line to set the Indo-Pacific trade agenda, given that most of the CP-TPP members are already in an FTA with India and are its larger strategic partners. This will also help balance China geoeconomically in the Indo-Pacific and show the path to non-China/non-US nations on how to forge a trade future without being overly dependent on either bloc.

(Aditya Laxman Jakki is currently associated as Policy & Media Lead at Bharat Pacific, Indian Society of Artificial Intelligence and Law. Views expressed in the above piece are personal and solely those of the author. They do not necessarily reflect Firstpost’s views.)