Negotiations on a Free Trade Agreement between India and the EU

New realism in India’s trade policy

When Prime Minister Narendra Modi and the Bharatiya Janata Party (BJP) came to power in 2014, there were high hopes for further economic reforms and an even greater integration of India into the global economy. However, New Delhi initially erected new import barriers, selectively increased critical tariff lines – for example for shoes, clothing, and mobile phones – and terminated existing investment pro­­tec tion agreements in 2016 and 2017. This also led to multilateral and bilateral conflicts.

Multilaterally, India’s reluctance to com­promise has on several occasions hindered progress in negotiations at the World Trade Organization (WTO), for example on the capping of agricultural subsidies. Further­more, no other country has been subject to WTO dispute settlement proceedings as frequently as India, with the exception of the trading powerhouses the EU, the United States, and China. In 2019, India withdrew from negotiations shortly before the signing of the Regional Comprehensive Economic Partnership (RCEP) free trade agreement. In the 2000s, India agreed to various bilateral free trade agreements, for example with Korea, Japan, and the regional economic organisations ASEAN and Mercosur. How­ever, these agreements contained practically no substantial tariff reductions or opening of the import market and therefore did not result in any significant trade expansion. The Modi government did not conclude any new bilateral trade agreements until 2021.

At the national level, New Delhi provided specific incentives for investment and pro­duction in key industries through government programmes such as “Make in India”, “Skill in India”, and “Digital India” using subsidies, tax rebates, and targeted import protections. In addition, the Modi government took additional pro-business meas­ures, including public investment in infra­structure, corporate tax cuts, price liberali­sation, the removal of investment restric­tions, and the implementation of a national value-added tax. As a result, India improved its ranking in the World Bank’s Ease-of-Doing-Business Index from 142nd (2014) to 63rd (2019). In May 2020, during the Corona pandemic, Prime Minister Modi announced a new economic policy (“Atman­irbhar Bharat”). He thus emphasised national autonomy even more strongly, but without reviving the former import substitution policy. Instead, Modi is focussing on privatising unprofitable state-owned enterprises and providing targeted support for domestic companies.

Modi wants India to become a developed economy by the time it celebrates 100 years of independence in 2047. To achieve this goal, however, the country would have to generate annual economic growth rates averaging 7 per cent over 20 years. To do so, the country would have to exploit its com­parative advantage of low labour costs in the international division of labour to a much greater extent, expand the domestic manufacturing sector, and thus create jobs for the large number of low-skilled workers. Given India’s low savings rates and lack of fiscal leeway, exports are the only plausible growth driver. Measured by its potential, India would in principle be well-positioned to sell a rapidly growing industrial produc­tion output on world markets, if necessary by displacing other Asian suppliers.

However, there are many discrepancies between the country’s lofty ambitions and actual economic developments. Since lib­er­alisation in 1991, the country has achieved considerable development successes in the information technology and pharmaceutical sectors. In aggregate economic terms, how­ever, India’s industrialisation has stag­nated. The manufacturing sector’s share of India’s gross domestic product remains deceptively low at 14 per cent (2021). The number of employees in the manufacturing sector has even fallen by a good 20 million. With an industrial capacity utilisation rate below 70 per cent, investment has re­mained weak despite the improved eco­nomic en­viron­ment under Modi.

Internationally, India under Modi has manoeuvred itself into a difficult situation with its mercantilist trade policy. Apart from the limited number of highly com­petitive companies in the IT and pharmaceutical sectors, the international competitiveness of India’s manufacturing sector is not in the best shape. Trade in goods with foreign countries registers high deficits every year. In addition, the Corona crisis has revealed dependencies and vulnerabil­ities in the import inputs from China. The border incident on the Galwan River in the summer of 2020 – in which 20 Indian and at least four Chinese soldiers were killed – has noticeably soured bilateral relations in general and has negatively affected trade relations. Despite the already high tariff protection and a number of other protective and boycott measures directed against China, the trade deficit with China widened further in the first nine months of 2022.

Since India is neither a member of the RCEP free trade area nor of the Comprehen­sive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), it is sidelined in the Indo-Pacific in terms of foreign trade. Thus, India’s exports have to overcome the customs and import hurdles of countries in the RCEP and the CPTPP. At the same time, India’s manufacturing production is bur­dened by comparatively higher costs, as the imported inputs from RCEP and CPTPP countries are subject to tariffs. In any case, the generally applied tariff rate (the “most-favoured-nation applied tariff”) in India for others is on average significantly higher than elsewhere in the region, namely 14.9 per cent in the manufacturing sector and almost 40 per cent in the agricultural sector (2021). As a result, the country is only inte­grated to a limited extent into the Asian value chains and is at a disadvantage when it comes to competing for new industrial investments.

With a new generation of free trade agree­ments, India wants to find a way out of its self-inflicted isolation, secure and diver­sify supply sources, open up new export markets, and attract new capital and tech­nology. An important political motive is to reduce its economic and technological de­pendence on China. In the face of increased economic and political pressure, India is now clearly willing to negotiate seriously on sensitive issues such as sustainability, public procurement, and digital trade. In 2021, the country concluded a free trade agreement with Mauritius, and in 2022 one with the United Arab Emirates (UAE). In the same year, it agreed on a fast-track interim “Early Harvest” agreement with Australia to pave the way for a com­prehensive free trade agreement. India is also negotiating free trade agreements with the Gulf Coopera­tion Council, the United Kingdom, Israel, and Canada. India is also a partner in the US Indo-Pacific Economic Framework Initia­tive (IPEF). However, the negotiations with the EU, which will be launched in June 2022, are likely to be the most important.

Untapped potential in economic relations

The EU and India – the world’s third- and fifth-largest economies – are already im­por­tant trade and economic partners. With a foreign trade volume of 88 billion euros (2021), India is Europe’s tenth most impor­tant trading partner and its fourth most important one in Asia. Europe’s economic importance for India is even greater: Europe is the third most important trading partner and the second most important sales mar­ket, after the United States. Among the EU member states, Germany leads with a share of 21.4 per cent (2021), followed by Belgium, France, Italy, and the Netherlands. The largely balanced European-Indian trade covers the entire range of the manufactur­ing economy.

In contrast, agricultural trade and India’s energy and raw material exports to Europe play a subordinate role. Politically, how­ever, they can be highly relevant. Agricultural supply chains, for example, are often linked to differing preferences between producer and consumer countries in terms of sustainability, for example on the ques­tion of what level of animal welfare should apply in agriculture. In addition, protective measures in this sector can upset global food supplies, such as India’s recent bans on agricultural exports as a response to increasing global agricultural prices due to Russia’s invasion of Ukraine.

In recent years, the services trade has developed far more dynamically than the trade in goods and is concentrated on the areas of transport, information, commu­nication, and business services. However, with a volume of almost 40 billion euros (2021), it is still significantly below the level of trade in goods. In terms of direct invest­ment, the EU is one of the most important foreign investors in India, along with Mau­ritius, Singapore, the United States, and the United Kingdom.

Political relations between India and the EU have further intensified in recent years. A strategic partnership was agreed in 2004. The Roadmap 2025, adopted in 2020, sets out the plan for the expansion of relations. In 2022, the EU and India agreed on a joint trade and technology council. In geopolitical terms, the two sides have come closer in recent years with regard to China and see themselves as politically indispensable part­ners. However, the erosion of democracy, freedom of opinion and expression, and the rule of law in India since 2014 has fuelled doubts in Europe as to whether the country can really be a “like-minded” partner.

Despite the extensive bilateral trade, there is repeated criticism that its potential has not been fully realised. One important reason for this is the lack of binding, con­fidence-building bilateral trade and invest­ment protection agreements. So far, the only legal basis for bilateral trade and ser­vices is the most-favoured-nation principle enshrined in the WTO treaty. Although the EU grants tariff preferences to India, it tem­porarily suspended them at the beginning of 2023 because the initiated increasing Indian imports in the EU exceeded the defined safe­guard thresholds. There are currently no agreements for bilateral investment trade since India unilaterally terminated almost all existing older nationally agreed investment protection treaties with EU member states.

New negotiations alongside three individual agreements

The first attempt to reach consensus on a free trade agreement failed in 2013 after seven years of fruitless negotiations due to irreconcilable differences over content. The new negotiations launched in 2022 are tak­ing place under more favourable auspices. Both sides want success and cannot afford failure. Relations between the EU and India are based primarily on economic cooperation, whereas in foreign and security policy issues, both sides focus on their relationship with the United States. The raison d’être of the European-Indian partnership would be called into question if there were another failure to conclude forward-looking agreements on bilateral trade and investment. This time, negotiations in the areas of trade, investment protection, and geo­graphical indications (GI) will be conducted separately and not, as is often the case, as chapters of one single, comprehensive agree­ment. This increases the likelihood that a result can be reached in at least one or two areas.

In the case of geographical indications, agree­ment seems easiest, as the EU has already been able to reach a corresponding agreement with China. However, India would first have to establish its own imple­mentation and control regime for GIs to be defined. In total, fewer conflicts are to be ex­pected compared to other comparable agreements with partners facing similar production patterns, and thereby similar GI interests. Europe’s and India’s production patterns tend to complement each other.

An investment protection agreement, on the other hand, will be particularly difficult to reach. Since this is an area of mixed com­petence in the EU, not only must the Euro­pean Parliament (EP) and the Council of the EU approve the agreement negotiated by the EU Commission, but the EU member states must also ratify it. Yet, the investment protection chapters were some of the most controversial parts of the trade agree­ments and provoked great resistance in the past, especially from civil society. In the same way as in the agreements with Canada, Singapore, and Vietnam, the EU is also pursuing its ambitious new model of improved investor-state arbitration with India: In addition to an appeal option, this includes a commitment by both sides to support a multilateral court. For the EP and some member states, such improvements are crucial preconditions for ratifying an agreement. Although India – after defeats in investor-state arbitration – itself har­bours strong reservations about the older procedures still in use worldwide, an agree­ment appears difficult due to the limited room for manoeuvre in European negotiations.

There are still also obstacles to the con­clusion of the third part, the trade agreement, although both sides have moved closer to­gether. India signed important International Labour Organization (ILO) conventions on child labour in 2017. In the agreement with the UAE, the country has partially opened its public procurement markets. In addi­tion, as a result of the recently decreed tem­porary suspension of EU tariff preferences, India has a special incentive for legally binding, duty-free access to the EU’s inter­nal market. In view of the rampant short­age of skilled workers, the EU may be also more open to an influx of individuals than in the past, for example in the IT sector.

Negotiations in troubled waters

However, the positions of the negotiating partners are still miles apart in many areas. First, it is unlikely that India will be willing to substantially liberalise imports in the socially and politically sensitive agricultural sector. In particular, the dairy, beef, poultry, and grain sectors are likely to remain sacro­sanct. Modi’s agricultural reforms failed in 2021 due to resistance from farmers, who are also likely to oppose an overly generous opening towards world markets. Second, Euro­pean demands for a substantial open­ing of India’s manufacturing and services markets continue to be met with opposition from powerful lobby groups and a protec­tion­ist-nationalist attitude in politics and administration. India’s small retailers are part of the core constituency of the ruling BJP, making it difficult to imagine an open­ing of the market to large European retail­ers. Third, the European catalogue of sus­tainability demands is considerably more extensive than it was in 2013. In addition to the multilateral labour, environmental, and climate commitments to be met, the EU pro­posal text also includes other issues such as gender equality, biodiversity, and sustainable food systems, including animal welfare.

Conflicts seem inevitable. Europe not only criticises India for its failure to ratify the ILO core standards on collective labour law and its poor climate record. There are also doubts as to whether even accepted sustainability standards are effectively im­plemented at the state level. India, on the other hand, sees these demands to some extent as hidden “neo-colonial” protectionism on the part of the EU. In principle, India continues to insist on its national sovereignty in these matters.

In general, expectations on both sides of the agreement are likely to diverge in terms of the level of ambition and the conducting of negotiations. India is keen to conclude an agreement as quickly as possible and has its sights set on easily achievable liberalisations. The EU, on the other hand, is striving for a broad trade agreement that will not only bring about substantial improvements in access to sensitive market segments such as motor vehicles, wine and spirits, bank­ing, and business services. It should also contain provisions that commit India in the long term. According to the EU’s wishes, these would concern, for example, rules of origin, technical barriers to trade, regulations, subsidies, intellectual property right protections, and the sustainability issues mentioned above.

Europe’s political interest in India requires special efforts to find a compromise in trade policy. The WTO principle of spe­cial and differentiated treatment of devel­oping countries already implies that an asymmetric tariff liberalisation, that is, one that accommodates India’s interests, must be implemented. Europe should then give in on the demanded opening of the Indian market and offer longer transition periods in particularly sensitive sectors. For the sake of sustainability, the EU should draw up a joint implementation plan with India. At the same time, it should definitely insist that India’s import liberalisations have sub­stance. The opening of the markets must be sufficiently attractive economically to make the trade expansion and foreign trade inte­gration that Europe and India are mutually striving for possible.

In view of the existing differences, it will take a great deal of flexibility and willingness to compromise on both sides to reach a viable conclusion in these difficult nego­tia­tions. There is good reason to doubt whether the two parties’ differing visions of open mar­kets, liberalisation, and sustainability can be reconciled. These European demands can only be met over several rounds of nego­tiations, if at all. In the socially and politi­cally critical areas of dairy farming, poultry farming, and retail trade, they are likely to once again be met with resistance from non-governmental organisations in Europe and India.

However, there is also reason for cautious optimism, as there are promising approaches for solving the critical issues: The fast-track Early Harvest Agreement of 2022 between India and Australia offers starting points for negotiations with the EU on the agricultural sector. This could help to counter India’s con­cerns about a destructive surge in im­ports, for example in the dairy sector, by requiring only low tariff reductions of India or longer phasing-in periods for tariff cuts, as well as through possible safeguard clauses in the event of an increase in imports. The EU should pursue its own agricultural inter­ests through GIs for special quality products rather than via demands for market access. At the same time, this approach can also support India’s interests in certain seg­ments: For example, individual Indian GIs in a relevant agricultural area could be accompanied by EU support programmes as part of broader economic development.

On the issue of sustainability, the new EU Strategy for Enhanced Partnership, pub­lished in summer 2022, can help to resolve contentious issues in the sustainability chapters of trade agreements. According to this strategy, joint priorities, concrete time­tables, and options for support should be defined for intermediate goals. However, the EU should also help India comply with the EU’s new due diligence requirements for the sustainability of supply chains for sales in the EU, which will soon have to be met anyway, irrespective of whether a trade agreement is concluded. These new obli­gations can then serve as an incentive and opportunity for India to accept the sustain­ability requirements of an agreement that have so far been perceived as a threat.

Foreign and geopolitical interests as driving forces

A successfully concluded trade agreement will reap gains in terms of income, employ­ment, and welfare. In addition to the eco­nomic benefits, the agreements also have an important political dimension, as a suc­cessful outcome serves the geopolitical interests of Germany and the EU. First, the agreements underpin the strategic part­ner­ship between Europe and India, which, as dis­cussed above, rests on economic co­opera­tion at its core. Second, both the EU and India are seeking to diversify their external economic relations, reduce their respective dependencies on China, and raise their trade and foreign policy profiles in the Indo-Pacific region through a bilateral agree­ment. Third, such an agreement would send clear signals to Beijing and Washington, as Brussels and New Delhi repeatedly emphasise their stra­tegic autonomy. Fourth, a successful con­clu­sion of the negotiations would be an un­mistakable trade policy statement against the global tendency towards pro­tectionism. And fifth, Germany and Europe must be interested in a prosperous India that is capable of balance vis-à-vis China.

Since the breakdown in negotiations in 2013, the foreign policy and trade policy environment has fundamentally changed for both sides. In world trade and the global economy, the weight of the Global South, especially China, has increased consider­ably. At the same time, trade policy has also become geopolitics. Although the Sino-Amer­ican rivalry forms a defining geopoliti­cal framework internationally, the EU and India are each seeking as independent a role as possible. Like the United States, Europe and India see China’s totalitarian gov­ernance, mercantilist industrial policy, and expansive power projection as an exis­tential threat to peace, stability, the inter­national order, and their own prosperity. Despite their fundamental accord with the United States, they are not prepared to sub­ordinate their political and economic rela­tions with China to Washington’s geopolitical imperative. Whereas the United States is using punitive tariffs, sanctions, and tech­nology boycotts to decouple itself economically from China, India and the EU are only partially following US guidelines in their foreign trade policies. Instead of general decoupling, both are concerned with reduc­ing economic dependencies and vulnerabilities. Diversification through closer bilateral exchanges is therefore in the common Indian-European interest.

For European industry, India is – measured by its size and growth potential – the only plausible, medium-term, attractive alter­native to China as an investment and production location and as a sales market. Like India, the EU is also isolated in the Indo-Pacific region in terms of trade policy, as it is not part of the RCEP and CPTPP trade alliances. A free trade agreement with India – complementing those with Japan, Korea, Singapore, and Vietnam – would raise the EU’s trade profile considerably. In addition, the agreement would contribute towards strengthening the EU’s global part­nerships.

For India, Europe is an indispensable trade and economic partner thanks to its huge domestic market; a provider of invest­ment capital, technology, and infrastructure; and a gateway to global sales markets. India rejects integration into Asian trade alliances and supply chains if this increases its dependence on China. At the same time, however, India will be denied non-discrimi­natory access to the US market for quite some time. Therefore, the only substantial trade policy option remaining is the en­visaged free trade agreement with the EU. In the foreseeable future, India’s free access to the European single market and the estab­lishment of European companies in India could provide an effective impetus for the development of a competitive industry envisaged by New Delhi. This would be a sig­nificant step towards achieving the desired high level of economic growth on a sustained basis.

Last but not least, it is also geopolitically important for India to develop substantially in economic terms. In view of an increasing­ly China-centred Asia and Russia’s in­creasing dependence on China, India needs sustained high-level economic growth in order to realise its foreign policy ambitions, and thus assert itself in the future multi­polar concert of powers. This can only be achieved through greater integration in the international division of labour. An eco­nomically strong India that can serve as a counterweight to China in the Indo-Pacific is also in Europe’s geopolitical interest.

European institutions face various chal­lenges in this regard. The Commission must find a compromise between the diverging perspectives of the Directorate General for Trade (DG Trade) and the External Action Service (EEAS) in order to live up to its self-imposed claim of being a geopolitical com­mission with regard to India. In the EP, the parties have to reconcile economic interests with political issues, especially concerning the autocratic tendencies in India and the restrictions on freedom of expression, free­dom of the press, and civil society.

Outlook

The negotiations paradoxically are both easier and more difficult than the previous one’s from 2007 to 2013, which ultimately failed in 2013. Today, India and the EU have more in common on foreign policy than before, for example with regard to their international role and their relationships with China and the United States. But their respective internal developments have caused the EU and India to drift apart in recent years. Put simply, the EU has become more “sustainable” and “normative”, where­as India has become more “nationalistic” and “protectionist”. However, renewed fail­ure is not an option for either side, as bilat­eral relations would otherwise be severely damaged. A success factor on the European side could be the flexible handl­ing of the ratification mechanisms in the three indi­vidual agreements envisaged. Even a small success in one area could be a big step towards continuing negotiations in other areas, thus strengthening European-Indian relations in the long term.