RTA Issues of Interest to India

A. India’s stand

India is a marginal player in the global trade scenario. Its share in global trade is below one percent. India is also not a part of any RTA that has substantial influence on world trade. As a part of the integration process with the world, signing of the Bangkok Agreement (signed by Bangladesh, India, Republic of Korea, Lao People’s Democratic Republic, Philippines, and Thailand) in 1975 was the first initiative. The agreement failed to go a long way in achieving its objective of trade expansion. Recent developments like proposals of accession of the People’s Republic of China to the Bangkok Agreement have given rise to new expectations. India’s second initiative on this front is the SAARC free trade agreement (SAFTA) with Bangladesh, Bhutan, Maldives, Nepal, and Pakistan which came into full effect in 2006. Due to political tension between India and Pakistan and also for reasons like the very limited export basket Bangladesh, Maldives and Nepal have to offer to the comparatively larger economies like India, Pakistan, and Sri Lanka, India has not achieved much from this regional arrangement. India is also a part of Bangladesh, India, Myanmar, Sri Lanka, Thailand Economic Cooperation (BIMST-EC), with the other member countries being Bangladesh, Myanmar, Sri Lanka, and Thailand. India also entered into a bilateral free trade agreement with Sri Lanka in 2000 and more recently with Thailand in 2004 and negotiated a comprehensive economic cooperation agreement (CECA) with Singapore and ASEAN in 2005.¹² Total SAFTA¹³ and BIMST-EC trade constitute about 1.5 percent and 2–3 percent of total world trade, respectively. This implies that about 96 percent of India’s trade is outside the preferential zone. More than half of this 96 percent is with countries that are part of one or more RTAs. For instance, NAFTA and EU constitute 50 percent of India’s exports, 10 percent goes to ASEAN, and another 10 percent to Japan and South Asia. Therefore on the whole, 70 percent of India’s trade is with countries that are part of strong and well established RTAs. So, with India being part of only SAFTA, the Bangkok Agreement, and BIMST-EC, the country needs to take a strong view on whether its interest would lie in seeking tighter discipline in WTO on RTAs.

Within the GATT and the WTO, the examination of specific RTAs has been plagued by disagreement about the interpretation of certain elements of the rules relating to RTAs as well as by certain procedural aspects. In practice, the Committee on Regional Trading Agreements (CRTA) of the WTO has also not been able to resolve many of the systemic issues. The WTO Secretariat has prepared a synoptic paper on procedural and systemic issues (document TN/RL/W/8/Rev.1), which summarizes on a factual basis the discussion that has already taken place on RTAs and highlights the issues.

On the goods side, probably the most important single issue relates to the interpretation of the term “substantially all the trade,” which relates to the requirement that “duties and other restrictive regulations of commerce … are eliminated on substantially all the trade between the constituent territories” as defined in GATT Article XXIV:8. This is particularly relevant for those agreements where the coverage of agriculture is currently limited, for example, many of the RTAs formed by European countries. A few RTAs have eliminated all duties on agricultural goods, but in general agricultural trade, even on a preferential basis, remains subject to exceptions. Average agricultural preferential tariffs remain high and concessions on agricultural products granted by RTA partners tend to be parsimonious in nature. The debate on “substantially all the trade” has centered on two possible interpretations, which are not mutually exclusive. The first, a quantitative approach, favors the definition of a statistical benchmark, such as a certain percentage of trade between the parties. The second, a qualitative approach, would require that no sector (or at least no major sector) be excluded from intra-RTA trade liberalization. For India too, agriculture is a sensitive sector. But whether India would like to grant concessions on agricultural products will depend much on the partner country’s export basket and India’s export competitiveness. But perhaps it is logical for India to go with the second option, i.e., a qualitative approach and where necessary use of the positive list approach in granting concessions on agricultural products, as is done in the majority of RTAs.

Another issue deals with “the general incidence of duties,” which are not on the whole to be higher or more restrictive against third parties upon the formation of a customs union (Article XXIV: 5). This issue has been largely clarified with the 1994 Understanding, which specifies that the evaluation of the general incidence of the duties and other regulations of commerce applicable before and after the formation of the customs union shall be based upon an overall assessment of weighted average tariff rates, for which the applied rates shall be used. If it were desired to ensure that even static trade diversion were avoided, this could be also achieved by requiring that the MFN rates also be reduced to a level that would prevent or minimize trade diversion. In relation to “other regulations of commerce (ORCs)” (Article XXIV: 5) and “other restrictive regulations of commerce (ORRCs)” (Article XXIV: 8), the systemic debate also runs up against the issue of the definition and measurement of nontariff barriers. The only exceptions concern quantitative restrictions that satisfy GATT provisions (e.g., agriculture, balance of payments, and health or safety considerations). “Regulations of commerce” is an expression that has been used in the GATT legal texts only in connection with RTAs. No definition of the term is provided. Some Members have argued that what is important is not whether some specific measures fall under the umbrella of ORRCs, but rather if their application among RTA parties leads to a restriction on the trade of third parties. The question that concerns India is whether safeguards and anti-dumping measures are considered as ORCCs. Moreover, should consideration of ORCs and ORCCs be different in fully implemented RTAs and interim agreements? SAFTA has encouraged tariff concessions, but significant non-tariff trade barriers remain in place. Anti-dumping investigations continue to be a major barrier to trade in the South Asian sub region. Also, in terms of measurement of non-tariff barriers, it needs to be clarified, for example, what methodology should be used to aggregate commitments on domestic supports and export subsidies.

There are no explicit WTO disciplines on the use of preferential rules of origin. The rules of origin can multiply distortions as overlapping FTAs have begun to form. Origin rules should be justified to prevent products from non-parties to an RTA gaining preferential access to the market through the party, which maintains the lowest external import restriction (i.e., to avoid “trade deflection”). There are different interpretations on whether or not RTA origin rules constitute ORCs. There have been arguments for and against. However, most member countries of the WTO believe that RTA rules of origin definitely constitute an ORC. Most countries in the world agree that a case by case examination of the preferential rules of origin in RTAs is needed. That would clearly indicate whether these rules had restrictive effects on the trade vis-à-vis third parties.

The meaning of certain aspects of Article V of the GATS has also been raised. The basic provision is that an “economic integration agreement,” the term used in the GATS for an RTA covering trade in services, should have “substantial sectoral coverage,” understood in terms of the number of defined sectors used in GATS schedules of commitments, volume of trade affected, and modes of supply. This coverage is to be achieved through the elimination of existing discriminatory measures and the prohibition of new or more discriminatory measures. For the purposes of evaluation, account may be taken of the contribution of such an RTA to a wider process of economic integration or trade liberalization among the Members. Some flexibility is allowed for such agreements involving developing countries. Many countries including India agree that unavailability of detailed trade data in services makes it difficult to arrive at a percentage-type test for quantitatively measuring “substantially all discrimination.”

One important issue deals with RTAs established under the Enabling Clause, i.e., RTAs in the area of trade in goods between developing countries. As Laird (1999) writes, an RTA formed under the Enabling Clause need not cover substantially all the trade; does not require duty elimination; has no fixed timetable for implementation; and is not subject to periodic reporting requirements. The only main obligations of parties to such an RTA are to notify the agreement or its modification to the WTO Committee on Trade and Development, to furnish information deemed appropriate, and afford the opportunity for prompt consultations with respect to any difficulty or matter that may arise. India is unlikely to oppose this point and would not like to touch the enabling clause while flagging other issues in the negotiating group.

Another point that would be of concern to many developing economies including India is the unclear issues related to transition periods. Could RTA parties apply a longer (exceeding 10 years) transition period to some products? When it is said that any interim agreement shall include a plan for the formation of a customs union or an FTA, it is not clarified as to what should constitute a “reasonable length of time.” When should interim agreements fulfill the requirements spelled out in paragraphs 5 and 8 of Article XXIV? As noted by Laird (1999), the developed countries tend to have wider trade coverage and generally apply their commitments over a stricter time frame than their partners. There is no explicit provision for such asymmetrical application of the WTO rules, although this would seem consistent with the principle of special and differential treatment for developing countries.

Developing countries have also voiced their concern with other countries on the issue for elaborating disciplines aimed at ensuring that third parties are compensated for the possible negative effects brought by the creation or enlargement of an RTA. Finally, regarding the notification requirements (para 7), it has been observed by India that clarification with respect to contents of notification is required. Ambiguous notification requirements do not obligate members to provide substantial information. Therefore sufficient information should be provided by the RTA members to build up a strong database to help all members.

Since India is not a member of any RTA that has a strong influence on world trade, India will stand to lose because of trade diverting effects of any RTAs and the new formations where it is not involved. The Indian textile sector, for instance, has been badly affected because the US gives preferential treatment and duty free access to textile products from Mexico under NAFTA. The question of what should be India’s general stand on RTAs is difficult to arrive at. For this India will have to look at whether or not RTAs promote global welfare, i.e., it has to analyze the extent of trade diversion due to RTAs and its impact on Indian exports. However, all India’s present agreements with the regional partners have opened the markets for Indian goods in the countries concerned. All these agreements constitute unilateral tariff reduction except the India-Sri Lanka FTA. India’s overall trade balance with SAFTA is positive. The share of India’s exports in South Asian countries has increased from 2.73 to 6.2% over the period 1990 to 2006¹⁴ . Hence its existing and recent initiatives in regional/ bilateral trade liberalization may help to divert some trade of the countries concerned from their other trading partners in favor of India given their supply capabilities, and therefore may be beneficial to India.

B. Other problem issues in RTAs involving countries at various stages of development

Some of the other problematic issues in respect of RTAs are (i) use of tariff peaks¹⁵ by developed countries, (ii) equivalence notion under the Sanitary and Phytosanitary Measures (SPS) Agreement not being extended on an MFN basis, (iii) rules of origin problem, and (iv) non-reciprocal tariff concessions. Some of these issues are also quite important as far as the trade diversion aspect of RTAs is concerned. These issues are dealt with here briefly one by one.

(i) Use of tariff peaks by developed countries

After the implementation of the Uruguay Round, and the consequent tariffication of non-tariff protection in agriculture, dispersion in tariff rates did not fall substantially, and even increased in some instances. Especially in the case of agriculture, protection was lowered mostly on the items already characterized by relatively low barriers, while the tariffication procedures did little to reduce protection on highly protected goods such as dairy, meat, and sugar. Overall, the phenomenon of tariff peaks seems to have been aggravated.

Although the average tariff rates in the industrialized countries are low, they have high peak tariffs for certain products, some of which are of export interest to many developing countries. In certain Quad markets (EU and Japan, especially) MFN tariff peaks in some processed agriculture and food categories can be so high as to displace completely exports from developing countries in the absence of any preferential regime. As can be seen from Table 2, in Canada and the United States, tariff peaks are concentrated in textiles and clothing; in the EU and Japan, they are concentrated in agriculture and food products.

Preferences granted by the Quad are of a cascading nature: countries with FTAs get the best treatment, followed by least developed countries (LDCs) and other developing countries. The US grants preferences to the members of the Andean Pact, Caribbean Community, and to Mexico under NAFTA. Two different groups of LDC countries are constructed in the EU case: LDCs that are not African, Caribbean, and Pacific group members, and LDCs that are. For Canada, the developing countries are grouped into several categories: those benefiting from LDC, GSP (Generalized System of Preferences), and Mexico and Chile, which benefit from FTA status. Finally, for Japan, developing countries are divided into GSP beneficiaries and LDC beneficiaries. On average, the preferential schemes are quite generous, but are much less generous for tariff peak products. Preference margins on tariff peak items for GSP beneficiaries are only 9 percent in Canada, 18 percent in Japan, and 23 percent in the US¹⁶. For LDCs the margins fall to 25 percent in Canada, and 30 percent in the US and Japan. The EU by contrast has a 50 percent margin for GSP beneficiaries and 70 percent margin for LDCs in tariff peak items. It is said that tariff peaks in Japan affect about US$500 million in LDC exports to the world and those in the EU affect about US$800 million.

Indian exports such as textiles and garments as well as agricultural commodities can be greatly affected by the prevalence of tariff peaks. Market access for these products could be facilitated by our ability to secure reduction in these tariffs in the industrialized countries through future tariff negotiations in the WTO framework. The phasing out by all countries of tariff peaks and escalation (tariffs rising with the degree of processing of imports) is critical to the development dimension of the current round of multilateral trade negotiations, and could best be achieved through formula approaches that ensure deep across-the-board reductions. Hence the issue of tariff peaks and tariff escalation should be addressed very carefully, since this holds back export-led growth and leads to greater trade diversification in countries that are not members of any significant RTA and the developing countries in general. Moreover, the higher the MFN rates of a developed country, the greater the leverage strength it will enjoy in terms of asking for special privilege from the developing countries, particularly in any of the North-South RTA formations.

Table 3. Distribution of Tariff Peaks by Product Groups in Quad Countries [ PDF 13.2KB | 1 pages ]

(ii) Equivalence Clause under SPS Agreement not being extended on an MFN basis

The SPS Agreement encourages the use of equivalence and mutual recognition agreements in Article 4. According to that article as well as the decision by the SPS Committee, two SPS measures are said to be equivalent to one another when they are not identical but they yield the same level of sanitary and phytosanitary protection.

Developed country representatives noted that equivalence, although a useful principle in theory was in practice difficult to deal with even for large developed countries¹⁷. Formal equivalence agreements are rare even between developed countries. The reason for this is that negotiations are very demanding in terms of resources and time. At the same time, ad hoc acceptance of the equivalence of specific products, or of the equivalence of certain technical aspects related to SPS measures, are common. The acceptance often takes place without any formal agreements.

The Agreement between the EC and the United States on sanitary measures is aimed at facilitating trade in live animals and animal products between the two parties, by establishing a mechanism for the recognition of equivalence of sanitary measures. The procedure to reach recognition of equivalency is, however, rather complicated and consists of several steps. Basically, the importing country has to explain the objective of the sanitary measure for which recognition of equivalency is sought and identify its appropriate level of sanitary protection. The exporting country has to demonstrate that its sanitary measure achieves the importing country's appropriate level of sanitary protection. On the basis of the evidence provided by the exporting country, the importing country decides whether the foreign measure achieves its appropriate level of sanitary protection and, therefore, can be regarded as equivalent. The recognition of the equivalence is not easy to achieve and usually implies the fulfillment of several requirements. However, for developing countries, this option is worth pursuing since it would greatly facilitate market access for their products.

While the WTO Agreement on Technical Barriers to Trade (TBT) and the Agreement on Sanitary and Phytosanitary Measures (SPS) recognize that countries have the right to introduce measures necessary to protect human, animal and plant life, however, these measures are not to be applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination among the WTO Members. Developing countries have frequently complained about the lack of implementation of Article 4 regarding equivalence particularly on an MFN basis. They state that importing countries often require “sameness” instead of “equivalence,” the former implying that the measures must be identical not only in outcome but also in formulation¹⁸. Moreover, an RTA may enact a regime of positive integration through rules of mutual recognition. The NAFTA Treaty, for instance, provides for the mutual recognition of SPS measures if the exporting country’s regulations achieve the importing country’s appropriate level of protection. The burden of proof is on the exporter. The final decision about equivalency stays with the authorities of the importing country, who take decisions on a case by case basis. With the help of such mutual recognition agreements, regional agreements would effectively increase barriers to imports from third countries, thereby leading to trade diversion.

The question remains of whether the SPS Agreement, including the international standards and guidelines, is a sufficiently strong instrument to ensure that developing countries can in practice derive benefits from the use of the principle of equivalence, as well as one that promotes multilateralism. The core of the problem is the lack of trust on the part of developed countries regarding the capacities of the food safety systems of developing countries. More work by international organizations on clear guidelines on the establishment of equivalence agreements could be very helpful and could help distinguish between “equivalence” as defined by the SPS Agreement and “sameness.” Developing countries must take part in the international setting of guidelines on how to achieve equivalence in these areas so as not to be left out. In fact, a number of developing countries have requested more information about how and under what circumstances equivalence can and should be implemented through mutual recognition agreements. India has asked the developed countries to notify the WTO of any equivalence agreements they enter into between themselves so that developing countries can study them and negotiate similar agreements with the developed countries.

(iii) Rules of origin problem

Preferential rules of origin (ROO) are of crucial importance in the functioning of any FTA in administrating a number of trade issues and in avoiding trade deflection. ROO in general serve as important elements in the administration of a range of other trade regulations, including duty drawback provisions; antidumping (AD) provisions; countervailing duty and safeguard proceedings; quantitative restrictions; and prohibited imports. Each of these trade regulations involves distinguishing domestic from foreign goods, or distinguishing among foreign goods. A study made by Bhattacharyya and Das Gupta (2000) on triangular trade among the People’s Republic of China (PRC), India, and Nepal clearly showed that in the absence of any value addition norm in respect of manufacturing products according to the Indo-Nepal Trade and Transit Treaty, there was large scale trade diversion via Nepal from the PRC to India. However, despite the importance of ROO, their design can result in their development as a trade protectionist tool hence leading to trade diversion. Krishna and Krueger (1995) demonstrate how rules of origin can act as “hidden protectionism” and induce a switch in demand in free trade partners from low-cost external inputs to higher-cost partner inputs to ensure that final products actually receive duty free access.

ROO is also a major problem in an RTA and acts as a barrier to trade when particularly developed and developing countries are involved. In the EU, the ROO criterion is very complex and is discriminatory. Also, satisfying the certification requirements of the ROO of the EU is often too costly. The benefit conferred by the preferential schemes in certain cases becomes marginal in comparison with the administrative workload and cost to plan the product mix to comply with the preferential ROO. This often leads to instances where firms, although they meet the necessary conditions for origin, decide that it is simpler and cheaper to pay the MFN tariff rates. The different rates of value added criteria reflect the discretionary protectionist interests in formulating the ROO in the EU. This has a negative impact on many developing countries, which are engaged with the EU in preferential RTAs, and their exports bundle is concentrated in such sensitive products as textiles and apparel. For example, a study found that about 75% of EC-EFTA trade benefited from the preferential trade regime, while the use of tariff preferences under other schemes such as the GSP was low, mainly as a result of the restrictive ROO. According to Brenton et al. (2002), information on the implementation of the EU’s preferential scheme of access for developing countries shows that only one third of EU imports from developing countries that were eligible for preferences actually entered the EU market with reduced duties. This primarily reflects the treatment of textiles and clothing products, which accounted for over 70 percent of EU imports from countries covered by the GSP but where the utilization rate (the ratio of imports receiving preferences to eligible imports) was only 31 percent.

In some RTAs, ROO can be subject to a “cumulation” procedure. According to this procedure, ROO are broader in their geographical coverage required for a certain product to confer origin. In other words, ROO of a certain product in a given exporting country confer to the required ROO set by the RTA if they are partly allocated in that exporting country on the condition that the rest of the requirements to fulfill the required ROO be done in other countries that are agreed upon from the members of the RTA. This procedure relaxes the restrictiveness of the ROO and reduces their negative impact on production distortions and trade and investment diversion. However, some experts argue that cumulation is likely to have negative consequences on the developmental efforts of developing countries engaged with developed partners in RTAs.

In NAFTA, the change in tariff heading (CTH)¹⁹ supplemented by value added criteria are the main rules applied in determining ROO. Compared to the European Economic Area (EEA) Agreement, NAFTA places a greater reliance on CTH and less use on value added criteria, which is applied more intensively in the case of sensitive sectors as textiles and automobiles. Regarding automobiles, there is an initial regional value-added requirement of about 55%. In the textiles sector, the value added required is so high resulting in a very restrictive ROO in this area. Here the ROO for textiles and apparel are “triple transformation,” implying that all the materials used in producing the goods are made in North America. In other cases, ROOs are based on the material inputs used. The reason why NAFTA does not follow the EEA system is the fear on the part of the US of the low cost Mexican automobile assembly industry, which could result in the import of components from a non-NAFTA country for further processing in Mexico to produce a final product of “Mexican” origin.

ASEAN rules of origin allow up to 60% of non-members’ originating input²⁰ incorporated in the ASEAN products entitled to the Common Effective Preferential Tariff (CEPT)²¹ under AFTA. Also ASEAN applies a cumulative ASEAN original input for CEPT products, so that in practice the net cumulative regional content may be lower than 40% and the eligibility for ASEAN-origin is still valid²².

In SAFTA, the ROO distinguish between goods that are “wholly produced or obtained” and goods that are not “wholly produced or obtained” in an exporting SAPTA country. In order to encourage regional value addition, the agreement also includes a cumulative rule of origin, which initially said that goods processed in more than one member country can be eligible for concessions provided that the value added in SAPTA countries was at least 60 percent of the free on board (FOB) value. The ROO local content provision has been a contentious issue and was subject to continuous scrutiny by members who realized that the effectiveness of SAPTA was limited, in part due to low value addition in many of their most competitive exports. After much resistance particularly from India, the local content requirement was reduced to 40 percent for the non-LDC members (India, Pakistan, Sri Lanka) and to 30 percent for the four LDC members (Bangladesh, Nepal, Bhutan, Maldives), and the cumulative rules of origin were reduced to 50 percent.

Thus, given the prevalence of PTAs, the question of rules of origin is of particular policy relevance. It is essential that clear-cut principles and criteria for determining the origin of goods be adopted. Rules of origin will vary among the FTAs depending on the underlying sensitivity to intraregional competition and on member countries’ strategic goals and the level of development.

(iv) Non-reciprocal tariff concessions

One of the important problem areas is the non-reciprocal tariff concessions exchanged in an RTA. For instance, SAFTA distinguishes between members according to their level of development. The agreement provides “special and favorable treatment” for the LDCs by the non-LDCs, including deeper and wider tariff preferences. Also, tariff and other concessions accorded by a non-LDC to another non-LDC are extended unconditionally to all member countries. However, concessions extended by a non-LDC to an LDC are automatically applied only to other LDC members.

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1. Dr. Jayanta K. Nanda
   (posted 04 July 2007 / 08:44:57 AM)
   
   Not only for India, but for global trade in the near future.
   
   -www.jknanda.com