Impact of Trade Liberalisation on Agricultural and Manufacturing Sectors in India: A Simulation Analysis Using Computable General Equilibrium (CGE)

5.2 Impact of Trade Liberalisation on Agricultural and Manufacturing Sectors in India: A Simulation Analysis Using Computable General Equilibrium (CGE)

Since the Uruguay Round of Trade Negotiation, India has been described as a protectionist state, having policies against sectoral liberalisation, particularly, in the agricultural sector. It has been India’s position that a vast majority of India’s rural population is drawing its livelihood from the agricultural sector, and thus, it requires protection for ensuring livelihood security for millions. Experiences of developing countries indicate that radical liberalisation in any sector including the vibrant manufacturing sector can generate imbalances among sectors in the economy. Therefore, the effect of liberalisation in any sector is an empirical question, and the implication of such policies may have nation-wide implications. Considering the sensitivity of the issues, we have used a simulation analysis to examine the impact of specific sectoral policy liberalisation on India economy.

5.2.1. Aggregations of regions and sectors In a simulation analysis, the implications of complete trade liberalisation in the agriculture and manufacturing sectors are analysed separately on different sectors of the Indian economy in a Computable General Equilibrium (CGE) framework. Global economy in this analysis is aggregated into twelve broad regions where India and China are kept separately in the aggregation, using the GTAP Ver.7 database (see for example, aggregation of regions and sectors in Appendix I). Regionalisation in the model is broadly based on continents and their sub-regions. Similarly, production sectors are aggregated into thirteen broad sectors where the agricultural sector is represented by four sub-sectors and the manufacturing sector by seven sub-sectors. The mining and services sectors are presented separately in the sectoral aggregation.

5.2.2. Agricultural Sector Liberalisation Effects on Economic Welfare:

The simulation analysis has examined the implication of complete unilateral liberalisation of the agricultural sector on the Indian economy. The liberalisation in the agricultural sector is simulated, leaving the manufacturing and other sectors to operate under the business as usual conditions. The results indicate that complete opening up of the agricultural sector is like to experience losses of economic welfare to India. Surge of agricultural imports and a decline in the production of agricultural products in India may have an adverse impact on some regions of the global economy as for example China, Sub- Saharan Africa, and East Asia, among others.

Adverse Effects on Agricultural Production Trade liberalisation in agriculture has an adverse impact on the level of sectoral

production. Results show that agricultural production in value added terms is expected to decline, following a removal of trade barriers in the agricultural sector. Decline of production will be experienced in several agricultural sub-sectors including food grains, animal products including milk products and processed food and other crops. These sub-sectors cover broad product categories like vegetables and oils & fats; and a declining production performance are likely to be experienced in these sub-sectors.

Complete removal of barriers in the agricultural sector will result in a decline of production by 1.1 per cent of the total output expected to be produced in the sector in the pre-liberalisation period. The largest decline in production will be experienced in the animal product sector (-1.3 per cent), followed by the processed food (-1.25 per cent) and food grains (-1.06 per cent) sub-sectors. Since production bases are different for different sub-sectors, the absolute impact of reduction of production will be felt differently in individual sub-groups.

Shortfall of production is expected to be the largest in the food grain sub-sector, followed by processed food and animal products. Nearly, 57.7 per cent of total

contraction of agricultural output will be in the food grain sector whereas the processed food and animal products sectors would share 29.5 per cent and 12.8 per cent respectively, of the total output losses in the event of complete removal of trade barriers in the agricultural sector.

Trade Imbalance Complete trade liberalisation in the agricultural sector is likely to contribute to a

widening of the trade deficit in the sector. The expected sectoral trade deficit alone would be to the level of 2.1 per cent of the total imports of India. The expected agricultural deficit is likely to be 11.5 per cent of the overall trade deficit, which is hovering at around 3.5 per cent of GDP. Full-blown liberalisation in agriculture alone is likely to widen the trade deficit to an unsustainable level of over 0.4 per cent of GDP.

The agricultural sector in the present model comprises of four sub-sectors. In a scenario assuming complete trade liberalisation in the sector, food grains is likely to

contribute 52.7 per cent of the total expected agricultural trade deficit. The second largest overall agricultural trade deficit may be processed food with a sectoral contribution of 32 per cent followed by the animal product sector as show in Figure

5.2. Agricultural liberalisation may not necessarily contribute to a depletion of production in all sub-sectors, rather some off-farm activities may be strengthened with farm sector liberalisation, particularly forestry and other allied activities.

Figure 5.2 : Agricultural Trade Deficit by Sector

(Complete Agricultural Liberalisation) AgrOth

GrainsCrops AnimLstk ProcFood AgrOth

AnimLstk 12.4%

Source: Global Trade Analysis Project (GTAP) database, Version 7.0, Department of Agricultural Economics, Purdue University, USA.

The results are consistent with the overall trade policy of India in the sense that radical liberalisation in the agricultural sector may adversely affect overall welfare of the country on account of reduction of domestic production in agriculture and other allied sectors. Adverse welfare effects may be because of declining purchasing power in the agrarian sector. With increased imports and a declining domestic production, trade imbalances are likely to expand. These developments would adversely affect food and the livelihood security of people living in the rural sector.

5.2.3. Manufacturing Sector Liberalisation India has considerably liberalised its manufacturing sector to match the tariff level

of ASEAN countries in recent years. In many manufacturing sub-sectors, India’s average tariff rates 41 are comparable or better than those of China 42 in the last decade. In this context, trade theories 43 stipulate that protection is required for the manufacturing sector (which may be to a limited extent) for nurturing them in their

41 Both in terms of average simple tariff and import weighted tariffs. 42 Discussed in the section on analysis of tariff. 43 Theories such as infant industry protection and strategic trade theory share the similar views on

protection.

infancy to compete with the rest of the world at a later stage. Therefore, gradual liberalisation of the manufacturing sector has been the most stylised approach

adopted by both developed and developing countries. However, the whole issue is about the speed of liberalisation, which varies across counties depending upon the structure of the manufacturing sector in individual countries. In this analysis, we have examined the implication of complete liberalisation in the Indian manufacturing sector on the rest of the economy, allowing other sectors like agricultural, mining and services to follow the business as usual conditions. In this model, we have assumed unilateral liberalisation committed by India with the rest of the world, without negotiating for reciprocal commitments from the rest of the world.

Effects on Economic Welfare The results show loss of welfare for the Indian economy while implementing

complete unilateral trade liberalisation in the manufacturing sector. Loss of welfare is expected to reach US$ 17.7 billion for the year 2011. This will be around 0.9 per cent of GDP in the same year. The manufacturing liberalisation would invoke loss of welfare due to expected imports in several manufacturing sectors, adverse terms of trade and deteriorating trade balance with the rest of the world. Manufacturing sector liberalisation in India has no adverse impact on the major regions of the world including China, but rather most of them are likely to benefit from a gainin market access in India. If India liberalises, the major beneficiaries are expected to be the European Union, the North America and the East Asian countries. However, India’s liberalisation is likely to enhance global economic welfare, though it is at a minuscule level.

Impact on Balance of Trade Liberalisation in the manufacturing sector is likely to enlarge trade imbalances of

the country, because most of the broad manufacturing sectors are sensitive to radical trade liberalisation. Sectoral trade deficit on account of manufacturing liberalisation could be to the extent US$ 16.9 billion in 2010. The manufacturing trade deficit is like to be 25.6 per cent of the overall trade deficit or 4.5 per cent of India’s present imports.

Complete trade liberalisation in the manufacturing sector is likely to affect all most all the sub-sectors in the Indian economy, leading to further aggravation of the existing trade deficit as shown in Figure5.3. Among various broad manufacturing sectors in the CGE model, the largest trade deficit will be felt in the textile and clothing sector. The expected trade deficit in the sub-sector is likely to be 16.8 per cent of the overall trade deficit and 3 per cent of country’s total imports. Other sectors also likely to register a trade deficit, include base metal, chemicals, automotive, heavy manufacturing and machinery sub-sectors. Complete trade liberalisation may not have an adverse impact on all the sub-sectors in the manufacturing sector. A positive impact of liberalisation is likely to be felt in the light manufacturing sub-sector, which is represented by industries like leather Complete trade liberalisation in the manufacturing sector is likely to affect all most all the sub-sectors in the Indian economy, leading to further aggravation of the existing trade deficit as shown in Figure5.3. Among various broad manufacturing sectors in the CGE model, the largest trade deficit will be felt in the textile and clothing sector. The expected trade deficit in the sub-sector is likely to be 16.8 per cent of the overall trade deficit and 3 per cent of country’s total imports. Other sectors also likely to register a trade deficit, include base metal, chemicals, automotive, heavy manufacturing and machinery sub-sectors. Complete trade liberalisation may not have an adverse impact on all the sub-sectors in the manufacturing sector. A positive impact of liberalisation is likely to be felt in the light manufacturing sub-sector, which is represented by industries like leather

partly absorb trade imbalances generated in other sub-sectors.

Fig.5.3: Impact of Manufacturing Sector Liberalisation on Sectoral Trade Balance

Impact of Manufacturing Sector Liberalisation on Sectoral Trade Balance

(% t

40.0 ci fi

e 20.0 D f

n 0.0 M

gf

n n i -20.0

a -40.0 M

ma

m c h y to v

e -60.0

h e a ig

C H -80.0

Au

Source: Global Trade Analysis Project (GTAP) database, Version 7.0, Department of Agricultural Economics, Purdue University, USA.

The adverse impact of manufacturing liberalisation is also felt in other sectors. The most affected sector outside manufacturing sector could be the energy sectors, where large pressure is expected for imports. With increased demand for industrial activities, import on petroleum, oil and lubricants (POL) is expected to rise. The results indicate that the trade deficit in the sub-sector would be 8.5 per cent of the overall trade deficit and 1.5 per cent of total import bill of India.

Results of the simulation analysis present that trade prospects of the country are likely to be affected adversely with the radical liberalisation in the manufacturing sector. This is indicated further by the expected decline in India’s terms of trade. The implication of complete trade liberalisation in the manufacturing sector alone may allow terms of trade to deteriorate by 3 per cent. Therefore radical liberalisation in either agricultural or manufacturing sector may adversely impact the overall welfare position of the country. Trade liberalisation unilaterally or on a reciprocal basis should be made gradual, and sequencing of sectoral liberalisation is required on the basis of the sensitivity of sectors.