‘Having the political will to implement pro-business policies could improve lives for Asians’ | Photo Credit: KR Deepak
On January 31, 2023, South Asia must now re-think regional trade across Asia after the International Monetary Fund (IMF) warned that global trade would decline from 5.4% in 2022 to 2.4% in 2023. The forecast is optimistic with multiple risks such as an escalation in the Russia-Ukraine war, disconnection from global supply chains and handling of variants of the COVID-19 virus.
A recent paper published in “South Asia’s Path to Resilient Growth”, an IMF book, argues that a strong foundation exists for South Asia trade with a dynamic East Asia: Since the 1990s, South Asia-East Asia trade has gained momentum, which is reflected in the realignment of India’s trade towards East Asia through its ‘Look East’ and ‘Act East’ policies, the adoption of reforms in South Asia and China’s involvement in Asia. Also linked to offshore global supply chains. Total merchandise trade between South Asia and East Asia (in dollar terms) grew at a rate of about 10% annually between 1990 and 2018, to $332 billion in 2018, and may reach nearly $500 billion going forward. A handful of free trade agreements (FTAs) linking the economies of South Asia with those of East Asia could grow to 30 by 2030.
Furthermore, regional trade in Asia is recovering following the COVID-19 pandemic and has opened opportunities for South Asia to participate in global value chains and services trade.
Steps starting with tax reform calibration
What needs to be done then?
First, regional trade integration across Asia can be encouraged by gradually reducing barriers to trade in goods and services. Import duties and obscure non-tariff measures have been rampant in many South Asian economies since the 2008 global financial crisis – and have never been reversed. To overcome this, South Asia’s trade opening must be calibrated with tax reforms as trade taxes account for a large portion of government revenue in some economies. Adjustment financing is also necessary for reallocated sectors of production and retraining of workers to boost profits from trade and reduce income inequality.
Second, to improve the performance of Special Economic Zones (SEZs) and invest in service SEZs to facilitate industrial clustering and exports. In South Asia, more than 600 SEZs are operational in Kochi (India), Gwadar (Pakistan), Mirsarai (Bangladesh) and Hambantota (Sri Lanka). However, these SEZs have a variable record in terms of exports and promotion of jobs and domestic ties. Competitive fiscal incentives matter only at the margin in multinationals’ local decisions, and long tax holidays deprive economies of significant tax revenue. Improving SEZ processes and outcomes in South Asia requires ensuring macroeconomic and political stability, adopting good practice regulatory policies for investors, providing reliable electricity and 5G broadband cellular technology, and upgrading the skills of workers.
Third, pursue comprehensive FTAs that eventually lead to the Regional Comprehensive Economic Partnership (RCEP) to provide a regional rules-based trade to insure against growing protectionism. While South Asia is a late entrant to FTAs compared to East Asia, it has started with the Japan-India FTA, the Sri Lanka-Singapore FTA and the Pakistan-Indonesia FTA.
RCEP Membership
But the devil is in the detail. South Asian economies need to improve tariff preference utilization by better preparing businesses to navigate complex rules of origin in FTAs and to include issues related to global supply chains in future FTAs. Though India opted out of RCEP negotiations in November 2019, the door is still open for it to join the agreement. India has also concluded FTAs with UAE and Australia in 2022. The confidence gained from these could help prepare for future RCEP membership by carrying out structural reforms to promote trade competition in supply chains and greater regulatory harmonization with East Asia.
If India joins the RCEP, the rest of South Asia may be encouraged to join for fear of being left out and suffering from the effects of trade diversion.
Fourth, a reinvested trade-focused Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) could facilitate stronger trade ties and support the interests of smaller members. Inaction in the South Asian Association for Regional Cooperation (SAARC) means India is pushing BIMSTEC to promote South Asia and Southeast Asia cooperation. Its secretariat needs better resources to restart BIMSTEC, conclude the long-standing BIMSTEC FTA, build trade capacity in smaller economies and dialogue partner status to encourage open regionalism in Asia Give.
While extensive South Asia-East Asia trade may be desirable, the advent of increasingly complex geopolitics may rule it out for the time being. Accordingly, a narrow geographic coverage between South Asia and Southeast Asia may be a building block for eventual trade integration across Asia. To reduce a backlash against regionalisation, large economies should provide trade benefits to smaller economies.
Slow global trade means that it makes economic sense to trade more within Asia. Having the political will to enact pro-business policies could improve lives for Asians. India is the largest economy in South Asia and its G20 presidency can be a good platform to initiate these changes.
Ganesan Vighnaraja is Professorial Fellow in Economics and Business, Gateway House, Mumbai and Senior Research Associate at ODI Global in London. Views expressed are personal