Effects of a preferential trade agreement between India and the Eurasian Economic Union

_ Yuri Kofner, junior economist, MIWI – Institute for Market Integration and Economic Policy. Munich, 18 December 2020.

In anticipation of the next Supreme Eurasian Economic Council of the Eurasian Economic Union (EAEU)[1], the new Member of the Board, the Minister of Trade of the Eurasian Economic Commission (EEC) Andrei Slepnev, announced that negotiations on the establishment of a free trade area (FTA) with India “have entered the active phase” and may be completed in 2021.

Indeed, the creation of a free trade area with the world’s third economy – India’s GDP has a purchasing power parity of over USD 10 trillion (IMF data) – will be a great success in the Union’s foreign economic policy and will significantly bring closer the implementation of the international  North-South transport corridor project[2], as well as the concept of a “Greater Eurasian Partnership”, proposed by Vladimir Putin and Nursultan Nazarbayev.[3]

Stylized facts about India-EAEU merchandise trade relations

In addition to the current lack of trade preferences, the main obstacle to increasing mutual trade between India and the EAEU is geography, or rather the significant distance for transporting goods by sea. For example, maritime cargo shipments from the port of St. Petersburg to the port of Mumbai need to cover 14 thousand km and take an average of 48 days.

In this regard, it is not surprising that the EAEU accounts for only 1.2 percent of Indian exports and 1.4 percent of the country’s imports (calculated by the author based on WITS Comtrade data). According to the Observatory of Economic Complexity, the main trading partners of India are the United States, the European Union, the United Arab Emirates, and China. Similarly, India occupies only 1.8 percent of the geographic structure of the EAEU’s exports and 1.2 percent of its imports. The main trading partners of the Eurasian Union are the European Union, China, Turkey, Korea, the USA, and the EAEU itself.

On average, between 2009 and 2018, Indian exports to the Eurasian Union amounted to USD 5.5 billion each year, from the Union to India – USD 3.2 billion annually (calculated by the author based on data from WITS Comtrade). However, the relatively limited volumes of Indian-Eurasian trade have significant growth potential. Thus, during the study period, total exports from India to the EAEU grew by an average of 9.6 percent annually, from the EAEU to India – by almost 12 percent annually. Moreover, in 2017, compared with 2016, Eurasian exports to the subcontinent grew by as much as 75%.

In general, the commodity structure of exports from the Republic of India to the countries of the Eurasian integration bloc is more diversified than vice versa: their Herfindahl-Hirschman index is 0.09 and 0.17, respectively. The lower the index, the more diversified the export structure. The main positions of Indian exports to the Union are basic pharmaceuticals (19.3 percent), finished foods (12.4 percent), chemicals (almost 10 percent), machinery and equipment (8.3 percent), textiles, and ready-made clothes (9.4 percent). Eurasian exports to India also generally have a lower degree of added value: the main EAEU exports to India are fertilizers (almost 29 percent), petroleum and oil products (26.3 percent), chemicals (15.4 percent), coal (8.4 percent), and non-ferrous metals (7.4 percent) (calculated by the author based on data from WITS Comtrade).

Effects of a potential free trade agreement between India and the EAEU

In order to assess the potential effects of the implementation of a free trade agreement between the Republic of India and the Eurasian Economic Union, the author used a partial equilibrium model developed by (Francois et al. 2002).

For the simulation, the author used the following input data: 1. Bilateral data on trade in goods for 2018 for four parties (EAEU, India, South Korea and the “rest of the world”), taken from the (WITS UN Comtrade) databases using the 2012 GTAP classification. Wherever possible, the author preferred CIF data from the importer. 2. Ad valorem equivalents of non-tariff barriers (AVE-NTB) for the EAEU were taken from (Knobel et al. 2019), for India, South Korea and the “rest of the world” from (Niu et al. 2018). 3. The average ad valorem MFN applied import tariffs for 2018 for all parties were taken from the (WTO World Tariff Profiles 2019). 4. Import elasticities were taken from (Ghodsi et al. 2016). The elasticity of export supply and substitution were taken as constant values ​​in all regions.

The scenario of the implementation of the free trade area is defined as the complete zeroing of mutual import tariffs between India and the EAEU. It is worth noting that, according to the WTO, the average tariff protection in the Republic of India is two and a half times higher than in the Eurasian Union: 17.1 percent in overall, 13.6 percent for non-agricultural goods and as much as 38.8 percent for agricultural products. For comparison, the simple average MFN tariff applied of the EAEU is 6.8 percent in total, for agricultural products – 11 percent, for other goods – 6.1 percent.

Due to time restrictions, the author estimated the effects of liberalization not for total trade, but only for the main above-mentioned commodity positions. They occupy 61.2 percent of Indian exports to the EAEU and 87.6 percent of Eurasian exports to India. In this regard, it would be more correct to speak about the effects of not an FTA, but of a “preferential trade agreement”. In fact, the interim agreement on the EAEU FTA with Iran is also a preferential trade agreement, since it covers only 55 percent of the goods nomenclature.

Simulation results

By implementing a preferential trade agreement for the above-mentioned main product groups between India and the EAEU, the total export of these product groups from the Republic of India to the member states of the Eurasian Economic Union would increase by 43 percent or almost USD 1 billion (0.04 percent of GDP), from the EAEU to India by almost 59 percent, i.e. by almost USD 4.6 billion (0.24 percent of GDP), which is logical, as the reduction in Indian import duties on goods from the EAEU would be more significant.

The gross welfare effect (producer surplus + consumer surplus) of India would be USD 852.1 million, of the Eurasian Union – USD 423.5 million. As a result, from the conclusion of such a preferential trade agreement, India’s GDP would be 0.03 percent higher annually, that of the EAEU – by 0.02 percent higher each year. Conventionally, every Indian would be 70 US cents richer, each EAEU citizen – USD 2.3.

Out of the studied product groups, in absolute terms, exports of finished food products (USD 600 million), basic pharma and chemical products (USD 180 million), textiles and clothing (USD 104 million) from India to the EAEU countries would increase the most. On the contrary, from the EAEU to India, in absolute terms, shipments of minerals and fertilizers (USD 3.2 billion), petroleum and oil products (USD 760 million), chemical products (USD 361 million), non-ferrous metals (USD 193 million) would grow most.

Mutual trade liberalization would lead to an intensification of competition between Indian and the Eurasian producers. However, the simulation results show that only producers of finished food products from countries of the Eurasian Economic Union could incur losses due to greater competition. In all of the other industrial sectors studied, on both sides, the effect (producer surplus) is either negligibly or significantly positive.

It is interesting how the results obtained by the author compare with the results of another econometric modeling, mentioned in 2018 by the then Chairman of the EEC Board Tigran Sargsyan in an interview with the Economic Times. According to the result of this simulation, which, however, covered the liberalization of total trade, the trade turnover between the parties could grow up to 30-40 percent of the current level depending on the depth of tariff liberalization (for comparison, the author’s results: from 40 to 60 percent). The total GDP growth of the EAEU countries can reach about USD 1.4 billion in the short term and USD 2.7 billion in the long term (0.14 percent of GDP), and for India – as much as 3 percent (for comparison, the author’s results are much lower: 0.02 percent for the EAEU and 0.03 percent for India annually).

For another comparison, the author used the gravity model developed by (Decreux et al. 2016). According to this model, the total export potential of India to the EAEU given a mutual trade regime liberalization may amount to USD 2.7 billion. The following Indian goods possess the greatest export potential in the Eurasian market: medicines, rice, diamonds and jewelry, cars and spare parts, insecticides, tea and coffee. The export potential of the member states of the Eurasian integration bloc on the Indian market could amount to USD 3.3 billion. The following Eurasian goods possess the greatest export potential in the Indian market: fertilizers, diamonds, wheat, non-ferrous metals.

Tab. 1. Effects of merchandise trade liberalization between India and the EAEU

Export from IND to EAEU Export from EAEU to IND Annual GDP increase IND Annual GDP increase EAEU
Preferential trade agreement, partial equilibrium model (Kofner 2019) 43 percent

 

USD 1 billion

59 percent

 

USD 4,6 billion

0.03 percent (welfare effect)

 

0.04 percent (export increase)

0.02 percent (welfare effect)

 

0.24 percent (export increase)

Free trade agreement, gravity model (EEC 2018) 40 to 60 percent

 

3 percent 0.14 percent
Export potential, gravity model (Kofner 2019) 100 percent

 

USD 2.7 billion

119 percent

 

USD 3.3 billion

0.1 percent (export increase) 0.17 percent (export increase)

Source: Compiled by the author.

Recommendations

The analysis shows that inking a preferential or free trade agreement between India and the EAEU would beneficial and appropriate for both parties. Yet, for a more significant increase in mutual trade flows, it would be important to pursue three more goals.

First, as mentioned above, long shipment distances significantly increase the cost of mutual trade between India and the Eurasian Economic Union. In this regard, it would be important to strengthen the transport and logistics infrastructure between them under the North-South International Transport Corridor (“Spice Route”) project. This ought to be done not only through improving “hard” infrastructure, i.e. by investing in port infrastructure, railway lines, transshipment and storage centers, and so on. But also, from the point of view of improving “soft” infrastructure along the route, by which the harmonization of the necessary cargo documents and the related regulatory environment is meant. The situation is already somewhat facilitated by the entry into force in 2019 of the interim free trade agreement between Iran and the EAEU, which, for example, has a separate article on ensuring better transit conditions (Article 2.8).

Secondly, within the framework of a potential India-EAEU free trade agreement, it would advisable to prescribe mutual obligations on reducing non-tariff barriers (NTBs), i.e. technical regulations and standards, sanitary-phytosanitary and veterinary measures, quotas, excise taxes, licenses, etc. It is them, together with the difficulties of transportation, that most of all increase the costs and complicate mutual trade between the parties. According to estimates by (Niu et al. 2018), the weighted average ad valorem equivalent of India’s NTBs amount to 74 percent. Interestingly, most additional barriers, such as excise taxes on imports, are set up not by the federal government in New Delhi, but by the provinces themselves. The EAEU’s NTBs are also significant and increase importing costs by 37 percent on average (according to Knobel et al 2019). Thus, it would be precisely the mutual reduction of non-tariff barriers between India and the EAEU that would promise a much more significant increase in mutual trade and welfare effects.

Thirdly, the parties might consider the possibility of concluding additional agreements on the free movement of capital (on foreign direct investment), free trade in services and the free flow of digital data (i.e., on digital cooperation), especially considering the fact that the latter two are becoming increasingly more important for value creation in global value chains (GVCs). However, since the Eurasian Economic Commission does not have the authority to conduct negotiations in these key areas, New Delhi and the capitals of the EAEU member states could add “vertical” bilateral agreements (for example, along the lines of India-Armenia, India-Belarus, India-Kazakhstan, etc. e.) on investments, services and on digital cooperation under the framework of the “horizontal” structure of the free trade agreement currently under discussion between India and the EAEU. The EEC and the member states of the Union already have their first experience in this area: in October 2019, they signed a free trade agreement together with a “Framework Agreement on Comprehensive Economic Cooperation” with the Republic of Singapore, under which Armenia and Singapore signed a bilateral “Agreement on trade in services and investments”.

Notes:

[1] The Eurasian Economic Union (EAEU) is a trade and economic bloc, akin to the EU, aimed at creating a customs union and common single market for the free movement of goods, services, peoples, capital and “digits”, as well as a common (supranational) or coordinated (intergovernmental) economic policy in many areas. It was founded in 2015 and currently consists out of five post-Soviet states – Armenia, Belarus, Kazakhstan, Kyrgyzstan, and the Russian Federation. In 2018, the EAEU’s GDP by PPP amounted to USD 4.7 trillion, i.e. half of India’s economy.

[2] It is also called the Indo-Iranian “Spice Route” in comparison with the Chinese “Silk Road” project.

[3] In 2016, Vladimir Putin and Nursultan Nazarbayev co-proposed to move towards a “Greater Eurasian Partnership” – a nexus of potentially overlapping free trade areas, transport corridors and integration initiatives in the wider Eurasian space and involving the EAEU, the CIS countries, China, India, Iran, and other interested countries and integration blocs of the continent (especially the EU).

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