Assessing the Likely Impact of PTAs and FTA between the PRC and India

Several studies are available on estimating the effects of regional trading blocs on intra-regional trade.⁷ Raipuria and Mehta (1990), Naqvi and Samad (1992), Srinivasan (1994), and Srinivasan and Canonero (1993a and 1993b) made some noticeable attempts in this context. Raipuria and Mehta (1990) outlined the framework of an approach (Inter-country Link Model System) for analyzing the impact of trade cooperation in the region, along with a review of 21 models for analyzing bilateral trade. Bhattacharya (2004) studied the impact of a PTA between Bangladesh and India using the Gravity Model.

A number of different specifications of the Gravity Model have been used in the literature, depending mostly on the objective of the study, and the type of sample data. In most existing studies, the bilateral trade flows have been explained by variables like GNP (proxy for size of countries), GNP per capita (proxy for degree of development), and trade restrictive variables such as tariff and nontariff barriers, distance, adjacency, linguistic links, etc.

In this analysis, the impact of PTAs is measured under some hypothetical scenarios, i.e., the proportionate change in exports and imports of the PRC and India in dollar terms. A comparative static analysis of tariff reductions has been undertaken under different scenarios and its resultant effects on the increase in imports and exports of both the PRC and India. The objective of this analysis is to see costs and benefits (measured in terms of higher rates of growth of exports and imports) due to different PTAs and FTA to India and the PRC and trade potentials between these two countries. Four hypothetical scenarios in this study are as follows:

(i) 25% across the board tariff cuts by the PRC and India;
(ii) 50% across the board tariff cuts by these two countries;
(iii) 75% across the board tariff cuts by the same countries;
(iv) 100% tariff cuts, i.e., free trade between the PRC and India.

The results of the simulations obtained are only indicative because these are estimated values based on hypothetical scenarios under the proposed India-PRC economic integration by liberalizing economies through FTAs. However, these simulations do not consider the removal of nontariff barriers.

The analysis is based on elasticities estimated by Srinivasan and Canonero (S-C) using panel data. Frankel's estimation procedure is adopted in this model. The results of the simulations are not valid to any particular year. These are indicative due to reductions in tariffs under different hypothetical scenarios. Both tariffs and trade data used in this analysis are taken from TRAINS CD-ROM compiled by the United Nations Conference on Trade and Development. Trade and tariffs data are taken for 2004. In the case of both countries, simple mean tariffs rather than weighted tariffs were taken. The PRC's tariffs data were taken from World Development Indicators 2006 while India's tariffs data were taken from the customs tariff manual 2004–2005.

The analysis is based on the Gravity Model developed by Frankel, et al. (1993 and 1997) and extensively used by Safadi and Yeats (1993) in their analysis to estimate the likely impact of the formation of the North American Free Trade Area (NAFTA) on South Asia by considering other potential trading arrangements. Following the above methodology, S-C estimated the effects of PTAs in South Asian countries. In this study, the model adopted by S-C (1993, 1994, and 1997) was used, as follows:

Log BTI _{c, d, t} = a₀ + a₁ log (GNP_{c, t} * GNP_{d, t}) + a₂ log ( PCGNP_{c, t} * PCGNP_{d, t}) + a₃ D_{c, d} + a₄ log ( 1 + TR_{c, d}) + a₅ log ( 1 + TR_{d, c}) + a₆ log REXRT_{c, d, t} + e_{c, d, t,}

and, e_{c, d, t} = u_c + v_d + w_t + η_{c, d, t,}

where,

BTI_{c, d, t} = Bilateral trade of commodity "I" between country "c" and country "d" at time "t."
GNP_{c, t} (or GNP_{d, t}) = Gross National Product of country "c" ( or "d" ) at time t
PCGNP_{c, t} (or,PCGNP_{d, t}) = Per capita Gross National Product of country "c" on country "d."
D_{c, d} = Distance between relevant centers of "c" on country "d."
TR_{c, d} = Tariff rate imposed by country "c" on country "d."
TR_{d, c} = Tariff rate imposed by country "d" on country "c."
REXRT_{c, d, t} = Real Effective Exchange Rate between countries "c" and "d," at time "t."
u, v = country-specific effects
w = temporal effects
η = random effects

The essence of the Gravity Model is that the bilateral trade flow is positively related to the size of the two countries and inversely related to the distance between them. This follows the concept of physical science, where gravity force is directly proportional to the mass of two bodies and inversely proportional to the distance between them. ⁸

The higher the initial tariff level on trade between partners, the greater the final effect of reduction and elimination of tariffs. The result of the reduction in tariffs would be reflected in the increasing estimated values of a4 and a5. However, tariff is only one among many factors that determine the impact of PTA on trade. It is to be noted, however, that the tariff Tp represents tariffs imposed by the PRC on its imports from India, whereas Ti represents tariffs imposed by India on its imports from the PRC. Since tariffs Ti are higher than Tp, the higher the coefficient of Ti in absolute values, the greater the impact of preferential arrangement. Secondly, since a4 and a5 are elasticities indicating the proportionate response of bilateral trade to changes in tariffs, the initial tariff levels as well as initial trade level are relevant in determining the absolute changes in trade in both the PRC and India following a PTA.

S-C used the cross-country data (of 21 trading countries/partners) overtime (i.e., 1968–91) to estimate the above gravity equation for nine commodity groups. The commodity groups were selected keeping in view the trade of South Asian countries. Further, the variance-component regression model was adopted to capture the spatial impact of individual countries (u and v) and time period (t).

The S-C elasticites are given in Table 5 [ PDF 19.3KB | 1 pages ]. Coefficient a₅ is relevant in estimating gains from India's exports to the PRC at different levels of desegregation as well as total exports, whereas coefficient a4 is considered in estimating increase in India's imports from the PRC due to PTAs and FTA. The elasticities used in these simulations are much higher than expected. The reason is that these are not price elasticities but tariff elasticities showing the increase in demand due to reduced preferential tariffs. In case of trade between the PRC and India, the role of a price mechanism is not very important because the bilateral trade between these two countries is too small compared to their total trade to affect the price structure of these countries. Therefore, an increase in demand with respect to change in prices is not considered as it is almost meaningless in this region. In this case, the tariff rate is the most appropriate indicator to estimate the increase in trade due to reduction in tariff rather than on price. Elasticities (1+TR) are higher basically due to distance factor. It is also a priori true that price elasticity is inversely related to distance. If the distance is less, obviously elasticity is high.

While estimating the likely increase in India's imports from PRC in terms of value, a Variance Component Model is used. The entire commodities at 8-digit level are grouped into nine major groups. S-C undertook this exercise by using panel data. The groups and corresponding elasticities are shown in Table 5 [ PDF 19.3KB | 1 pages ].

Given the estimated parametric value of a4 and a5 from the fitted regression equations (of the nine commodity groups), and changes in tariff rates under different alternative scenarios, the percentage increase in import from d to c (i.e., from the PRC to India) and percentage increase in exports from c to d (i.e., India to the PRC) is estimated. The methodology is:

[ exp { ^a log ((1+TR_{c, d})₁ / ( 1+ TR_{c, d})₀ ) + ½ σ 2 } -1 ] * 100,

and increase of import of c from d (i.e., from the PRC to India)

[exp { ^a₅ log ((1+TR_{d, c})₁ / (1+TR_{d, c})₀ ) + ½ ^σ2 } – 1 ] * 100

where, ^σ² = σ²

The results of the simulations obtained are only hypothetical and indicative because these are estimated assuming four scenarios of preferential tariff concessions. However, these simulations measure only gains from trade creation and do not consider gains from trade that may emerge from the liberalization of nontariff barriers, such as welfare improvement.

Since the PRC and India are yet to sign an FTA and neither have decided on the broad framework about how it should go, the gains and losses of bilateral trade due to a duty free arrangement cannot be estimated. Despite this, in a given situation, one can simulate the likely increase in bilateral exports and imports due to an FTA as well as the probable impact of PTAs and FTA. While simulating the impact of PTAs and FTA, the tariff data of the PRC at a disaggregated level or at least for broad categories of products whose impacts are being simulated, cannot be obtained. The PRC's tariff information was taken from the World Development Indicators 2006, where tariff has three categories. Simple mean tariffs for all commodities, primary goods, and manufactured goods are used rather than weighted mean tariffs. Latest tariff data available for the PRC are for 2004. India's tariff data were taken from the Customs Tariff Manual of 2004–2005. For India, disaggregated level data at the 8-digit harmonized system (HS)⁹ categories have been aggregated to 20 major categories of items for simulation purposes. Both India's exports to and imports from the PRC are taken from Monthly Statistics from Foreign Trade of India.

In this simulation exercise, four kinds of hypothetical scenarios are considered, such as both way tariff reduction of 25%, 50%, 75%, and 100% (completely duty free). Simulation results are very much consistent with a priori idea that the country whose tariffs are low will gain much and the country whose tariffs are high will gain much less. PRC's simple average mean tariff was 9.8% during 2004, whereas India's simple average mean tariff was 29.3%, i.e., 199% higher than India's mean tariffs. Such huge difference in tariff structure is reflected in the simulation results. If both the PRC and India go for PTAs and FTA, the likely increase in bilateral exports and imports are shown in Tables 6 and 7.

Table 6 [ PDF 10.9KB | 1 pages ] shows a likely increase in India's exports to the PRC if PRC's existing tariffs are reduced by 25%, 50%, 75%, and 100% (i.e., duty free). It shows the simulation results of different PTAs and FTA. If the PRC reduces existing tariffs by 25%, India's total exports to the PRC will increase by $610.22 million. If the extent of reduction is 50%, India's total exports to the PRC will increase by $1,220.45 million, which will be $1,850.67 million if the extent of reduction is 75% of the mean tariff. If the trade is completely duty free, India's total exports to the PRC will increase by $2,440.90 million or 45.67% of India's total exports to the PRC. This simulation is based on India's exports during 2004. The same table also shows the simulation results in percentage terms. The percentage increase of India's exports to PRC's market will be 11.42, 22.83, 34.25, and 45.67 under different scenarios mentioned above. As mentioned in Table 3, iron ore; primary and semifinished iron and steel; plastic and linoleum products; processed minerals; inorganic/organic/agro chemicals; other ores and minerals; and drugs, pharmaceuticals, and fine chemicals are the seven major product groups in India's total export basket to the PRC. Simulations are undertaken for 20 major product groups/categories to estimate the likely impact of different PTAs and FTA on their exports to the PRC. The results show that export of these seven product groups will increase substantially but the percentage increase will remain the same as other product groups (Table 6). Although India's major export item to the PRC was iron ore during 2004, it is not sure whether India's supply will be fully elastic and responsive to price decline. The table also shows that in these seven major product groups, increase in exports will be 57.6% due to FTA compared to 45.67% of total exports. Even the rate of increase in exports is much higher in case of different PTAs. Major beneficiaries of PRC's PTAs and FTA are different types of ores and minerals, iron and steel, different items of iron and steel, and different items of drugs and pharmaceutical products in which India has more comparative advantage. Both value and percentage increase of India's major export items to PRC's market are shown in Table 7.

Table 7 [ PDF 10.7KB | 1 pages ] shows the simulation results of likely increase in India's imports from the PRC due to PTAs and FTA. It is important to note that any kind of bilateral preferential tariffs and FTA will not make India gain much at this stage unless there is substantial change in investment regime, first to make India more competitive with the PRC and second, India can gain provided it lowers its tariffs and make them at par with the PRC. India's tariff data were taken from the Customs Tariff Manual of 2004–2005. Tariff data of HS categories at 8-digit level were aggregated into average of product categories being simulated. During 2004–2005, India's average tariff on all commodities based on the World Development Indicators 2006 was 28.3. Other tariff information was taken from the Customs Tariff Manual. Table 7 shows that if India reduces 25% of its existing tariffs, its imports from the PRC will increase by 27.59%; in value terms the increase will be of $1,865.37 million compared to the base value of $6,760.42 million in 2004– 2005.

If both the PRC and India decide to reduce tariffs by 50% on all commodities of their respective countries, India's imports from the PRC will increase by 55.19% (value terms at $3,730.74 million), whereas India's exports to the PRC will increase by 22.83%. If both countries reduce bilateral tariffs by 75%, India's imports from the PRC will increase by 82.78%, whereas its exports to the latter's market will increase by only 34.25%. Finally, if both countries agreed to an FTA, maximum gains will accrue to the PRC because of its lower tariffs. If there is free trade between the PRC and India, the simulation results show that India's export to the PRC will increase by only 45.67%, whereas India's imports from the PRC will increase by 110.37%. This is precisely the reason why Indian businessmen have expressed strong reservation to bilateral FTA unless there is a level playing field. Although governments of both sides have not spelled out their plan for either PTAs or FTAs, it is more sensible to think that an FTA will be implemented in a phased manner rather than in one go. It may follow the model of the Indo-Sri Lanka Bilateral FTA, where India has removed tariffs on all its imports from Sri Lanka from 2004 with a small negative list, which has been pruned over the years. On the other hand, Sri Lanka will remove tariffs on all its imports from India by 31 December 2008, after India removed tariffs on all its imports from Sri Lanka. Since Sri Lanka's negative list is relatively large, it has given commitment to prune it progressively over the years.

Simulation results show the likely increase in India's exports to and imports from the PRC due to PTAs and FTA. The percentage is notional in the sense that increases in the value of exports and imports depend on the base values of both way trade. As stated earlier, during 2004–2005, India registered an export growth of 80.87% to the Chinese market, whereas its import growth was only 67.00%, which was much less than exports. Actual growth of trade will be more because of trade creation and trade diversion. Taking experience from the trade among counties of the South Asian Association for Regional Cooperation (SAARC) (Bhatacharya and Mehta, 2000), it is expected that if India and the PRC decide to go for free trade—apart from the items presently traded—a host of other new items, which were not traded earlier is expected to be traded between them. The percentage increase due to the different PTAs alone does not determine the shape of future trade between these two countries. Trade depends on many other factors other than tariffs. In the simulation, only a reduction of tariffs under cetrisperibus assumption is considered. Due to an FTA between the PRC and India, a likely increase in India's imports from the PRC will be highest in the following items/products categories: manufacture of metals; professional instruments and optical goods; metaliferrous ores and metal scrap; man-made filament and spun yarn; raw silk (highest increase i.e., 48% in case of an FTA); iron and steel; inorganic chemicals; etc. The entire picture of the likely increase in India's imports from the PRC due to the PTAs and FTA is shown in Table 7.

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Comment(s)

There are [2] comment(s) for this entry. Post a comment.

1. S.N.Singh
   (posted 17 May 2007 / 06:34:01 PM)
   
   I reviewed the paper thoroughly and based on the hypothetical model, we cannot access the actual scenario of trade among countries. Several hidden and more effective factors should also be brought into consideration.
   
   Thanks
   Singh S.N
2. Geethanjali Nataraj
   (posted 23 February 2007 / 05:38:04 PM)
   
   I have gone through the article. I think the data on India's trade with China can be easily updated by another year to 2005-06. The ministry of commerce, government of India has posted data up to 2005-06 in its data base. Secondly, the source of most of the tables is also mentioned as CMIE. I am not sure whether it is a good idea to use CMIE database. It is generally considered to be unreliable . To depict trade between two countries, it would be advisable to use international trade sources say for instance COMTRADE.
   Thanks
   geethanjali.