Whalesbook
India’s ambitious Free Trade Agreements (FTAs) are facing scrutiny as data reveals rising trade deficits with partner nations. Low utilization rates for Indian exporters, combined with structural issues like inverted duty structures, are creating hurdles for domestic manufacturing competitiveness.
What Happened
India's strategy to boost exports through Free Trade Agreements (FTAs) is encountering significant challenges. While the government has been actively signing and pursuing new trade deals to integrate India into global value chains, recent assessments indicate that these agreements are leading to wider trade deficits rather than the intended surge in exports. A key issue highlighted is that trade deficits with several long-standing FTA partners have increased, raising questions about whether these pacts are effectively delivering on the goal of reaching $1 trillion in merchandise exports.
The Utilization Gap
One of the most telling signs of the current struggle is the difference in how these agreements are used. Data indicates that only 20 to 30 percent of Indian exports are actually utilizing the benefits offered by these trade deals. For many businesses, particularly Micro, Small, and Medium Enterprises (MSMEs), the cost and effort of proving the origin of their goods—known as Rules of Origin compliance—often outweigh the small tariff savings provided by the agreement.
In contrast, import-side utilization rates are significantly higher, ranging between 60 and 70 percent. This means that while foreign goods are successfully entering the Indian market with tax benefits, Indian exporters are not finding it as easy to send their goods abroad under the same agreements. This imbalance is a primary driver behind the widening trade deficit with FTA partners.
The Inverted Duty Problem
Beyond administrative hurdles, domestic manufacturers are grappling with the structural issue of inverted duty structures. This occurs when the import tax on raw materials or intermediate parts used to make a product is higher than the tax on the finished product itself.
For example, if a domestic manufacturer has to pay high duties to import essential components, their final cost of production rises. Simultaneously, if the finished product from an FTA partner enters India at a lower or zero duty rate, the local manufacturer struggles to compete on price. This puts domestic producers at a disadvantage, effectively subsidizing foreign production over local manufacturing.
Why This Matters For Investors
Investors typically view trade agreements as a growth driver for sectors like textiles, chemicals, and auto components. However, the current data suggests that trade treaties alone may not be enough to boost manufacturing margins. If these agreements do not address the high internal cost of doing business—such as logistics, credit access, and labor efficiency—the expected gains for listed manufacturing companies may be slower to materialize than anticipated.
When a sector faces structural disadvantages, such as higher input costs compared to imported finished goods, it creates pressure on profit margins. For long-term investors, understanding whether a company has the efficiency to compete despite these structural hurdles is more important than the mere existence of a new trade deal.
What Investors Should Track Next
Moving forward, investors may look for signs of structural reforms rather than just more trade treaties. This includes improvements in logistics efficiency, as transport and handling costs remain a significant portion of GDP, and any policy changes aimed at correcting inverted duty structures.
Key monitorables include government updates on rationalizing customs duties, changes in import-export policies for specific sectors, and evidence of higher FTA utilization rates by domestic firms. Tracking these factors will provide a clearer picture of whether the manufacturing sector can truly benefit from India’s global trade integration.