Why India is playing spoilsport at the WTO

06 August, 2014

Last December at the World Trade Organization meeting in Bali, the Indian government—then run by the UPA—agreed to sign the Trade Facilitation Agreement (TFA), which was being hailed as a landmark in trade reforms. But the new NDA government has, surprisingly, backtracked from that commitment. As a result, the TFA has now missed its planned deadline of 31 July 2014.

The TFA aims to facilitate smoother international trade by simplifying customs processes and making them uniform for all 160 WTO member nations. It includes a wide range of provisions for expediting the movement, release and clearance of goods by ensuring that customs authorities and other related authorities of member nations will employ very similar forms and procedures. It also contains provisions that allow for special treatment for developing and least-developed countries, aimed at helping them implement the agreement.

If customs processes are unified and simplified, there could be huge benefits for the world economy—estimates suggest that it could enable the creation of an additional $1 trillion in global GDP and create 21 million new jobs across the world. This would be a boost of over 1 percent to the global GDP simply via the reduction of red tape.

India’s refusal to sign on the dotted line has, therefore, caused alarm and disappointment. In the seven months since Bali, quite a few countries have already started to make their customs procedures TFA compliant.

The reason for the change in policy is that the Indian government now wants a fast, favourable reworking of the WTO rules on agricultural subsidies before it signs the TFA. India’s vast and expanding food procurement and distribution programme may well be in violation of the current statutes. It is using the TFA as a bargaining tool in demanding a review of the WTO food subsidy norms, though these are, in fact, not directly linked to the TFA.

The subject of food subsidies was also on the agenda at Bali—in fact, India had negotiated what seemed like a major concession there. The WTO agreed to review the current policy and to make changes by 2017. Until then, India could continue with its current methods of stockpiling and distributing food. The four-year timeline seemed ample for the Indian government to make any necessary changes and also to persuade the WTO to rewrite its statutes in a favourable way. Nevertheless, the government chose to halt TFA negotiations till its demands on subsidies were met.

India’s stand on subsidies is linked to its commitments both to procure food at high prices from farmers, as well as to distribute food at low prices. In 2013, India passed the National Food Security Act. The NFSA entitles 820 million people (67 percent of the population) to receive rice, wheat and millet at highly subsidised prices. (The public distribution system, or PDS, served 320 million people prior to the NFSA.) Each eligible individual can buy 5 kg of rice, wheat and millet per month at prices between Rs 1 and Rs 3 per kg.

The government buys those commodities from farmers at far higher prices and bears the costs of stockpiling and distribution. In 2013, the total cost to the government of buying, storing and distributing rice and wheat was about Rs 18 per kg.

The total food subsidy in 2012–2013 (prior to the NFSA) was about Rs 101,000 crore. This rose to about Rs 125,000 crore in the 2013–2014 budget. The cost is estimated to increase to Rs 140,192 crore and Rs 157,701 crore in the 2014–2015 budget and the 2015–2016 budget, respectively.

Actually, the costs could become a lot higher, since the public distribution infrastructure has to be refurbished. More warehousing capacity and transportation is required. Selling prices are fixed under the act as it stands and cannot be adjusted upwards. Factoring in inflation as well, future subsidies could balloon further.

In addition to the NFSA, Modi, at an election rally in Solapur, Maharashtra, on 9 April 2014, made a commitment to ensure that farmers receive a 50 percent profit on their crop. This is also in the BJP election manifesto. The commitment to the “small farmer” has been reiterated in recent briefings, so it is fairly certain that the government will pay farmers generous procurement prices.

It is here, with the procurement system and the pricing formulae, that India runs into a problem. Current WTO rules allow governments to buy food directly from farmers at a price that is no more than 10 percent above the “total cost of production.” There is no way to keep the domestic commitments of the NFSA and give farmers 50 percent profits, without exceeding the WTO’s 10 percent limit.

India has pointed out that some technical details of the WTO trade rules, such as the method of cost calculation, need review. Agricultural commodity prices can be very volatile. The WTO uses a method that  is designed to average out fluctuations while adjusting for inflation. The base period for WTO cost calculation is 1986–1988. The average prices of those three years are adjusted by a standard index to calculate the current rates.

In theory, this should give a stable, inflation-adjusted, averaged set of current prices. Unfortunately, inflation adjustment measures don’t work well in practice over such long periods. Even more unfortunately, India has experienced massive food inflation in the last three years. So the 1986–1988 base period formula seriously underestimates the current cost. Thus, not only is the 10 percent margin over cost much lower than India would like, the cost itself as calculated by the WTO formula is much lower than the costs in real terms.

There are ways around WTO regulations. Other countries, including the United States, Japan, France and Germany, have found alternative methods of giving farm subsidies, such as offering farmers better agriculture infrastructure—or giving them zero-interest loans to create better infrastructure—to reduce costs. They can also be offered power, fertilisers and other resources at reduced costs, as indeed, the Indian government does, without breaching WTO regulations.

But currently, the Indian government also holds and distributes vast amounts of food at throwaway prices. There are very real fears that this will create distortions in food prices—the sort of distortion that the WTO regulations try to prevent.

India is one of the world’s biggest producers of rice and wheat—in 2013, its reserves of rice and wheat were more than double the government’s buffer requirements. India is also one of the biggest exporters of these crops. The availability of large surplus stockpiles and low domestic prices make it quite likely that India could flood world markets with artificially cheap rice and wheat. This would hurt farmers elsewhere, and it would mean that the Indian government was offering subsidised food to the rest of the world.

As it happens, India’s stance in insisting that food regulations be sorted out before TFA is signed has found very little support. Cuba, Bolivia and Venezuela—three left-wing Latin American regimes that also have local food procurement programmes—appear to be the only countries backing India on this with any commitment.

There are several ways in which a permanent solution could be found to the food subsidy issue. Some of these were suggested before the Bali agreement was thrashed out. For example, the WTO could:

i) keep the subsidy paid to poor farmers for procurement of food items within the NFSA outside the ambit of the WTO formula;

ii) change the base for subsidy calculation from 1986–1988 to current periods;

iii) realistically index 1986–88 prices to current levels; or

iv) insert a “peace clause” so that there is no challenge at the WTO even if the 10 percent limit is breached.

But none of these have been adopted, because it was decided at Bali to review the issue at leisure. India’s stance will now lead to an accelerated schedule of review, and presumably these options and others will be discussed in detail.

The WTO takes a one-month break in August. If a solution is found after that, the TFA could be signed in September. Some pragmatic observers believe that a deal will be found by December in any event. Other WTO members have already started talking about bilateral trade agreements or the creation of trade zones—India risks being left out of such arrangements if the TFA founders.

India’s veto of the TFA will probably be presented to the electorate as an attempt to ensure food security and also to ensure the prosperity of small farmers. Presumably, the government sees this as a move to woo a large rural base by doing some grandstanding around a complex issue. Cynics say that the BJP will try and assess the impact of the hold-out on rural voters and then take a call on future action at the WTO. (In the remainder of this year, there are assembly elections due in Haryana, Maharashtra, Arunachal Pradesh and Sikkim.)

But by using the TFA as a bargaining counter, the government runs the risk of penalising entrepreneurs, even as it might gain some brownie points with the farm lobby. Seen in purely economic terms, while agriculture contributes about 17 percent to India’s GDP, about 42 percent of India’s GDP is generated by overseas trade. The Organisation for Economic Cooperation and Development estimates that, for countries like India, the TFA could help reduce international trade costs by 14.5 percent, which would inevitably lead to growth in trade, and the generation of jobs.

This is a political gamble the government seems prepared to make. But its measures to safeguard the interests of farmers will remain compromised as long as India’s PDS is as wasteful and leaky as it is at present. In 2013, the PDS had around 40 percent leakage, according to Ashok Gulati, who was then the Chairman of the Commission for Agriculture Costs & Prices. While government subsidies already artificially lower prices, and present a concern for international trade, these leaks exacerbate the situation even further. In this respect, the government doesn’t have as high a moral high ground as it seeks when it talks of providing food to the undernourished as well as ensuring decent profits to farmers. If it has to go beyond political showmanship, it has to fix the PDS, whatever else it may say or do.

Devangshu Datta is a regular contributor to leading finance and business publications.