New Delhi is signaling a shift in its approach to global trade, moving – cautiously – away from decades of skepticism and self-reliance. After years of prioritizing domestic industries and resisting comprehensive trade agreements, India has recently finalized a series of deals with key economic partners, including the United Arab Emirates, Australia, the United Kingdom, and the European Union. This change reflects a growing recognition that increased trade openness can bolster India’s economic aspirations, but it’s a path being navigated with deliberate care and a continued emphasis on protecting strategic sectors.
For much of its post-independence history, India favored a protectionist economic model. The infamous “Licence Raj,” a complex system of government controls implemented around 1950 and lasting until the early 1990s, required businesses to obtain licenses for many types of imports, fostering a culture of self-sufficiency but also stifling competition and innovation. Although reforms initiated in 1991 began to open up the economy, a deep-seated caution towards free trade persisted, shaped by concerns about protecting domestic industries and ensuring regional equality. Now, India is attempting to balance these long-held priorities with the benefits of deeper integration into the global economy.
The initial foray into trade agreements came under the prime ministership of Manmohan Singh, considered the architect of India’s post-1991 economic reforms. During his tenure, India signed agreements with the Association of Southeast Asian Nations (ASEAN), Japan, and Korea. Singh also oversaw a significant reduction in average tariff rates, which fell to around 9% by 2014. However, this liberalization faced pushback, and a prevailing narrative emerged that these earlier agreements had exposed Indian manufacturers to unfair competition, contributing to rising trade deficits.
A Step Back, Then a Return to the Table
Narendra Modi, the current Prime Minister, initially expressed skepticism towards free trade. His government’s decision in late 2019 to withdraw from negotiations on the Regional Comprehensive Economic Partnership (RCEP), a massive trade pact encompassing ASEAN nations, China, Japan, and Australia, signaled this reluctance. The move was applauded by powerful domestic constituencies, including the agricultural sector – fearing competition from countries like Australia and New Zealand – and manufacturers concerned about a surge of low-cost goods, particularly from China. Opposition also came from the Rashtriya Swayamsevak Sangh (RSS), a Hindu nationalist organization affiliated with Modi’s Bharatiya Janata Party (BJP), and its agricultural and labor unions.
To protect domestic industries, Modi’s government raised import duties on over 3,500 tariff lines and increasingly used standards as barriers to trade. However, beginning in 2021, India unexpectedly resumed active trade negotiations, securing agreements with Mauritius, the United Arab Emirates, Australia, the United Kingdom, the European Free Trade Association, New Zealand, and, most significantly, the United States and European Union. This shift isn’t a complete embrace of free trade, but rather a strategic exploitation of India’s growing economic and geopolitical influence to negotiate favorable terms, including exemptions for sensitive agricultural sectors.
The deal with the European Union, expedited in part by the need to counter the effects of US tariffs, is particularly consequential. Approximately 91% of India’s exports to the EU will now benefit from the elimination of duties, particularly in sectors like textiles, apparel, plastics, and toys. European automakers, currently holding a small market share in India, are exploring establishing local production facilities for both domestic sales and export.
Structural Challenges Remain
Despite these advancements, significant structural challenges continue to hinder India’s manufacturing competitiveness. A key issue is an “inverted tariff structure,” where tariffs on essential inputs are often higher than those on finished goods, increasing costs for Indian manufacturers. Critical inputs like steel and textile fibers lack competitive pricing, impacting the overall efficiency of the production process.
Policymakers face a dilemma: India wants to avoid becoming solely an assembly hub, like Vietnam, with limited domestic supply chains. Notice also concerns about being overwhelmed by overcapacity in sectors like steel and chemicals, particularly from China. Some argue that prioritizing assembly-based manufacturing, coupled with gradually increasing domestic sourcing requirements, could create jobs for India’s large pool of underemployed graduates. The smartphone sector offers a potential model, having seen success with limited tariffs on inputs, and New Delhi is now exploring subsidies to promote both exports and local content.
The path forward will likely depend on India’s political economy. Notably, companies like Apple, along with their South Korean and Chinese competitors and suppliers, currently face limited domestic competition within India.
As India continues to navigate this evolving landscape, the focus will be on balancing the benefits of trade liberalization with the need to protect domestic industries and foster sustainable economic growth. The coming years will reveal whether India can successfully leverage trade to achieve its development aspirations and solidify its position as a major global economic power.
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