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Impact on Import of Tea in India after ASEAN INDIA FTA Agreement: A Simulation analysis

Summer 2010

1. IntroductionThe last two decades have witnessed a virtual explosion in the number of free trade agreements (FTAs), some of them involving several countries, many of them bilateral. The proliferation of FTAs has led to fierce debate about the merits of these agreements. While some herald the FTAs as steppingstones towards worldwide free trade, others such as Bhagwati (1994), fear that preferential trading arrangements may lead to trade diversion and welfare loss. Recently, with the signing of the FTA with the 10 member states of the Association of South East Asian Nations (ASEAN), India too has belatedly joined the bandwagon. According to this agreement, about 80 percent of the traded goods will be subjected to tariff reduction or tariff elimination. The countries under ASEAN are: Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, & VietNam.

2. Objective of this term paper:This paper will focus on the impact of the agreement in the selected plantation commodity, Tea, which is part of what is called the special products in Indias tariff reduction negotiations. Indias present tariff rate in this commodity is quite high by international standards. The ASEAN-India FTA (henceforth AIFTA) envisages that the tariff rates in these commodities will be brought down in a phased manner during 2010-19. ASEAN and India signed the ASEAN-India Trade in Goods (TIG) Agreement in Bangkok on 13 August 2009, after six years of negotiations. The signing of the ASEANIndia Trade in Goods Agreement paves the way for the creation of one of the worlds largest free trade areas (FTA) a market of almost 1.8 billion people with a combined GDP of US$ 2.75 trillion. The ASEAN-India FTA will see tariff liberalisation of over 90% of products traded between the two including the so-called special products, such as palm oil (crude and refined), coffee, black tea and pepper. Tariffs on over 4,000 product lines will be eliminated by 2016, at the earliest. The ASEANIndia TIG Agreement entered into force on 1 January 2010. (ASEAN) Since this commodity has been overly protected in India, tariff reduction may lead to a significant increase of Indias imports of Tea from the ASEAN countries. The possible surge in imports may have adverse impact on the domestic prices in India with significant implications for the livelihood of the Indian farmers engaged in the production of these commodities. Against this background, the present study attempts to quantify the extent of import increase in Tea import as result of Indias tariff reduction commitments. Trade creation and trade diversion effects of the proposed tariff reduction schedules is simulated using partial equilibrium model, called the SMART model, developed jointly by UNCTAD and World Bank. The SMART model also allows us to analyze the welfare and revenue effects associated with tariff reduction. The results of the SMART model, however, are sensitive to the underlying assumptions about the various elasticity parameters. Therefore, the SMART model simulations are complemented with simulations based on gravity model analysis. The advantage with the gravity model simulation is that it does not depend on any elasticity parameters. Tariff rates in the importing countries are used as one of the explanatory variables in the gravity model. The coefficient of the tariff variable in the estimated gravity model measures the responsiveness of imports to tariff changes. The estimated model is then used for analyzing the impact of different tariff reduction scenarios. (Lang)

3. Presentation of Topics:The paper is prepared according to following section: Section I discusses the main features of the

EM 556: Managing International Trade & Investment

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Impact on Import of Tea in India after ASEAN INDIA FTA Agreement: A Simulation analysis

Summer 2010

AIFTA as applicable to Tea. Section II analyses the trends and patterns of India and ASEAN bilateral trade in Tea. Section III deals with the SMART model simulations, where we quantify the extent of total import increase and decompose this into trade creation and trade diversion under different tariff reduction scenarios. This section also analyzes the revenue and welfare effects associated with tariff reduction. Section IV estimates the gravity model and then, using the estimated model, quantifies the extent of the increase in Indias imports under different tariff reduction scenarios.

4. Methodology used and Data presentation:Basically the whole project is based on descriptive analysis and statistical analysis using SMART Model and Gravity Model discussed in the analysis part. The graphical presentation of the proposed framework depicted the pattern of the structure of the relationship among the sets of measured variable. The purpose of the study is to measure correlation among the variables.

5. Source of Data:All the information sources are taken from World Wide Web and National Tea Board of India.

6. Limitations of Data1. Lack of time and budget 2. Limited source of information

7. Indian Tea IndustryThe tea industry in India is about 172 years old. It occupies an important place and plays a very useful part in the national economy. Robert Bruce in 1823 discovered tea plants growing wild in upper Brahmaputra Valley. In 1838 the first Indian tea from Assam was sent to United Kingdom for public sale. Thereafter, it was extended to other parts of the country between 50's and 60's of the last century. However, owing to certain specific soil and climatic requirements its cultivation was confined to only certain parts of the country. Tea plantations in India are mainly located in rural hills and backward areas of North-eastern and Southern States. Major tea growing areas of the country are concentrated in Assam, West Bengal, Tamil Nadu and Kerala. The other areas where tea is grown to a small extent are Karnataka, Tripura, Himachal Pradesh, Uttaranchal, Arunachal Pradesh, Manipur, Sikkim, Nagaland, Meghalaya, Mizoram, and Bihar. Unlike most other tea producing and exporting countries, India has dual manufacturing base. India produces both CTC and Orthodox teas in addition to green tea. The weightage lies with the former due to domestic consumers preference. Orthodox tea production is balanced basically with the export demand. Production of green tea in India is small. The competitors to India in tea export are Sri Lanka, Kenya, China, Indonesia and Vietnam. Tea is an agro-based commodity and is subjected to vagaries of nature. Despite adverse agro climatic condition experienced in tea growing areas in many years, Indian Tea Plantation Industry is

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Impact on Import of Tea in India after ASEAN INDIA FTA Agreement: A Simulation analysis

Summer 2010

able to maintain substantial growth in relation to volume of Indian tea production during the last one decade. There has been a dramatic tilt in tea disposal in favour of domestic market since fifties. While at the time of Independence only 79 M.Kgs or about 31% of total production of 255 M.Kgs of tea was retained for internal consumption, in 2008 as much as 802 M.Kgs or about 82% of total production of 981 M.Kgs of tea went for domestic consumption. Such a massive increase in domestic consumption has been due to increase in population, greater urbanisation, increase in income and standard of living etc. Indian tea export has been an important foreign exchange earner for the country. There was an inherent growth in export earnings from tea over the years. Till 70s, UK was the major buyer of Indian tea Since 80s USSR became the largest buyer of Indian tea due to existence of the trade agreement between India and erstwhile USSR. USSR happened to be the major buyer of Indian tea accounting for more than 50% of the total Indian export till 1991. However, with the disintegration of USSR and abolition of Central Buying Mechanism, Indian tea exports suffered a set back from 1992 -93. However, Indian Tea exports to Russia/CIS countries recovered from the setback since 1993 under Rupee Debt Repayment Route facilities as also due to long term agreement on tea entered into between Russia and India. Depressed scenario again started since 2001 due to change in consumption pattern, i.e. switch over from CTC to Orthodox as per consumer preference and thus India has lost the Russian market. Another reason for decline in export of Indian tea to Russia is offering of teas at lower prices by China, South Asian countries like Indonesia and Vietnam. (Chatergee) The major competitive countries for India in tea in the world are Sri Lanka, Kenya, China and Indonesia. China is the major producer of green tea while Sri Lanka and Indonesia are producing mainly orthodox varieties of tea. Kenya is basically a CTC tea producing country. While India is facing competition from Sri Lanka and Indonesia with regard to export of orthodox teas and from China with regard to green tea export, it is facing competition from Kenya and from other African countries in exporting CTC teas.( Chatergee) The tea industry occupies a place of considerable importance in the Indian economy, producing a fourth of the worlds annual tea outputamong them some gardens producing high quality teas - and employing around 1.26 million people at tea plantations and 2 million people indirectly. With domestic demand at an estimated 825 million kg (MKg) as of 2008, India is one of the largest consumers of tea globally. However, as domestic demand accounts for over 85% of the countrys tea output and since tea imports are permitted only for re-export, Indias share of the global tea trade is on the lower side. Nevertheless, ex