Trade Analysis

FTA Signed With An Eye On FDI

Published: April 14, 2023

The government has been working hard to sign Free Trade Agreements (FTAs), Comprehensive Economic Cooperation Agreements (CECAs), and Comprehensive Economic Partnership Agreements (CEPAs) with several of its main trading partners during the past few years.

With the recent signing of CEPAs with the UAE and Mauritius, India’s economic ties to these nations reached a new level. Deals with the UK, EU, and Canada are now being negotiated. The potential advantages such agreements can provide in terms of greater FDI flows between the signatories has frequently gone unnoticed.

Infrastructure, human capital, market size, resource endowments, tax policy, and regulatory environment are just a few of the variables that affect FDI inflows. Further to these elements, recent research have highlighted the FDI-improving outcomes of FTAs. These studies have demonstrated the presence of numerous pathways by which FTAs can boost FDI flows.

The flow of intermediate or finished goods between parent companies in the source country and overseas subsidiaries operating in the FDI-host country is primarily made easier by the reduction of trade barriers between the nations.

The clauses in the agreements that loosen limitations on capital transfers between parent companies and their affiliates operating in the partner nation may also result in an increase in FDI flows. Nonetheless, the effects of FTAs can differ depending on the type of FDI, or whether the FDI is horizontal or vertical. When a company invests vertically in a foreign business that operates in the same industry and may or may not have the same supply chain.

Contrarily, horizontal FDI refers to investments made by a corporation in a foreign business engaged in the same industry. An example of vertical FDI is an Indian pharmaceutical producer investing in foreign firms that provide it with raw materials, such as active pharmaceutical ingredients (API). Whereas the opening of outlets by an Indian manufacturer of clothing and textiles in the US can be considered horizontal FDI. Businesses engage in vertical FDI to take advantage of the cheap and plentiful production inputs offered in diverse nations.

Contrarily, horizontal FDI results in the duplication of already-existing production facilities abroad. Research have revealed that FTAs typically have a favourable effect on vertical FDI as the It becomes more affordable to trade intermediate goods with FTA participants and import finished items into these nations’ own countries. Since that Global Value Chains currently dominate international trade, the evidence of a favourable influence on vertical FDI gains significance (GVC).

The OECD estimates that GVCs are involved in 70% of current international trade. Not all nations will experience an increase in FDI flows as a result of signing FTAs, as locational advantages are also important in luring FDI. If the parties are at different stages of development, empirical data suggests a complementary link between FTA and investments.

For instance, a study of South Korean FTAs indicated that FTAs have a favourable impact on FDI entering and leaving countries as well as FDI going in. having more money than Korea. Vietnam has been recruiting FDI in manufacturing and utilising the China-plus-one approach successfully. In addition to its geographic advantage, studies show that FTAs with its partner nations have contributed to the increased FDI flows.

It must be emphasised once more that signing FTAs does not inevitably result in more FDI as a number of other criteria, including location, tax laws, market size, etc., play a crucial influence.

In addition to boosting FDI flows, signing FTAs and CEPAs will be a boost for India’s international trade. The India-UAE CEPA, for instance, is extensive and addresses a number of topics, including commerce, investment, healthcare, and IPR.

Trade occurs

Eight months after the contract was signed, The growth in bilateral trade between India and the UAE was 27.5%. Bi-directional FDI flows have accelerated; from April and December 2022, inward FDI flows will total roughly $3 billion, up from $843 million during the same period in the previous year.

Over $930 million in FDI was sent abroad to the UAE in the first nine months of FY23, which represents an increase over the previous year’s data. A careful examination of the prospective partner nations with which India seeks to enter into agreements reveals that they are rich reservoirs of investment, technology, and intellectual property in addition to offering a larger market for Indian exports.

Over the past ten years, Indian businesses have increased their outbound FDI in both developed and developing nations. Taking part in By getting simpler access to cutting-edge technology, raw materials, technological know-how, etc., such agreements may aid them in achieving their objectives to be a part of the global community.

With the China-plus-one strategy gaining popularity among many MNEs as a backdrop, India must aim to use its strength to include clauses in CEPAs that make it easier for companies to establish subsidiaries in India and vice versa, particularly in the manufacturing sector.

A one-size-fits-all approach may not be effective for the successful implementation of the Production Linked Incentive (PLI) scheme, hence efforts must be made to harmonise PLI provisions with those of CEPAs. For the seamless integration of the Indian economy with the international trade and investment networks, policy reforms aiming at enhancing the business environment should be regularly pursued.

Krishnan is an academic. Gopalakrishnan is a fellow and the former Head of Trade and Commerce at the NITI Aayog. Padmaja M. is a scholar and an assistant professor at NIT Trichy.

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