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RCEP deal creates giant new FTA in Asia Pacific as India stands aside

06 November 2019 Rajiv Biswas

A deal has been reached among 15 Asia-Pacific nations to conclude the Regional Comprehensive Economic Partnership (RCEP) agreement after years of negotiations. The RCEP deal, which is expected to be signed by governments in February 2020, provides a further boost to trade liberalization in the Asia-Pacific region at a time when Asia-Pacific trade has been hit by trade disputes between some of the world's largest economies, notably the US-China trade war.

Asia-Pacific economies have suffered considerable negative contagion effects from the US-China trade war, as the wider Asian manufacturing supply chain has been hit by the impact of high tariff barriers on US-China trade flows. Consequently, the RCEP deal provides a positive initiative that will help to boost trade and investment flows among the 15 nations that have agreed to the RCEP deal, which comprise the 10 nations of ASEAN, plus China, Japan, South Korea, Australia and New Zealand.

However, the decision by India not to join the RCEP deal will reduce the scale of the free trade area significantly, since India is already a USD 3 trillion economy that is equal in size to the 10 ASEAN member states combined. India's decision not to join the RCEP deal reflects considerable domestic concerns amongst political parties as well as industry groups in India about the potential economic shock to Indian industries from dismantling tariff barriers for trade with the other RCEP member nations. In particular, India had been concerned about the potential impact of largely removing tariff barriers for trade with China, as India feared that many domestic industry sectors would not be able to compete effectively with Chinese manufactures in a wide range of industry sectors.

India's manufacturing sector has been facing considerable challenges in 2019, with the Indian auto industry facing a severe crisis due to slumping vehicle sales. Consequently, Indian industry has heightened concerns about the potential negative impact of an RCEP deal on their own domestic market shares.

Unlike ASEAN, India does not have a bilateral FTA in place with China, and the Indian government decided that the overall economic and political costs of dismantling bilateral trade barriers with China would far outweigh the economic benefits, which were assessed to be relatively modest in size relative to the economic costs.

India has had a large and chronic trade deficit with China for many years. India's bilateral trade deficit with China was USD 58 billion in 2018, notably due to a large imbalance in trade in manufactures. Consequently, the Indian government feared that removing tariff barriers for Chinese imports would further erode India's domestic manufacturing market share at a time when the Indian government is trying to accelerate the development of India's manufacturing sector through the "Make in India 2025" policy, which is championed by Prime Minister Modi.

India also runs a trade deficit with Australia, but the size is relatively moderate compared with India's trade deficit with China. As Australia is a strategic source of supply for Indian imports of key commodities such as LNG and metallurgical coal, the trade relationship with Australia provides critical raw materials for Indian industry and does not compete significantly with India's manufacturing industry.

Although India decided that it is not able to join the RCEP agreement in the first wave, there may be the possibility for India to negotiate a later entry date into RCEP to allow a longer transition period for Indian industry to adapt to the new trade rules. Many other RCEP member nations are keen to have India as a member of RCEP, particularly since India, which is now the world's fifth largest economy, would substantially increase the long-term trade and investment benefits of the RCEP agreement.

Posted 06 November 2019 by Rajiv Biswas, Executive Director and Asia-Pacific Chief Economist, IHS Markit

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