Problems in Trade Talks with EU

Since 2007, India and the European Union have been negotiating a free trade agreement (FTA) — covering trade in goods and services, intellectual property rights and government procurement – that is fraught with problems. The agreement is expected to be finalised by mid-2011.

One of the contentious issues came to light on January 20, 2011, when the European Commission (EC) sought an expansive mandate from the European Council to negotiate on investment issues with India.

The EC has put forward a wider definition of investment. It includes foreign direct investment, shares, debentures, loans, interests, business concessions, movable and immovable property, intellectual property rights, technical processes and know-how.

An unduly wide definition of investment is one of the main reasons for the widespread critique of Chapter 11 of NAFTA and the failed Multilateral Agreement on Investment negotiations at the OECD. India’s existing bilateral agreements contain a rather limited definition of investment.

NATIONAL TREATMENT

The EC has proposed national treatment (NT) and most favoured nation (MFN) status. The principle of national treatment (treating foreign and local investors equally) is highly contentious, because most countries refrain from giving national treatment to foreign investors without substantial qualifications.

It is well recognised that unlike trade, foreign investment is a economically and politically sensitive issue, since it essentially means exercising control over ownership of national assets and resources.

Despite opening up of India’s economy since 1991, foreign investment is still prohibited in some sectors such as multi-brand retail, legal services and Railways (train operations). India still maintains pre-admission and post-admission restrictions, in addition to sectoral equity limits on foreign investment in banking, insurance, telecommunications, media and aviation.

Not just in India, even within Europe (particularly in France and Germany), policymakers are concerned about the recent acquisitions of their domestic assets and resources by sovereign wealth funds from West Asia and Southeast Asia.

AGAINST PERFORMANCE NORMS

The EC would like to “impose disciplines on performance requirements” under the FTA. Performance requirements are conditions imposed on foreign investors, such as local content requirements, export obligations, preference to local people in employment, location of an industry in a ‘backward’ region, and mandatory technology transfer.

In many policy circles, performance requirements are often viewed as inefficient and harmful, thereby hampering foreign investment and economic growth. But evidence points to the opposite result: performance requirements such as local content and technology transfer help to establish industrial linkages upstream (for instance, with suppliers) and downstream (for instance, with buyers) and contribute significantly towards the host country’s economic development. In the absence of local content requirements, a foreign corporation is likely to source many inputs from outside the country, which could impede the development of local clusters in the host countries.

India had extensively imposed performance requirements in the form of export obligations on foreign companies to ensure that they earned enough foreign exchange to balance foreign exchange outgo via repatriation of profits, royalty, and other payments.

CAPITAL TRANSFERS

Another problematic issue pertains to the removal of restrictions on capital transfers. The EC would like all transfers (including profits, dividends, capital gains, royalties and fees) related to investment between India and Europe to be made freely. Such provisions could restrict the ability of both trading partners to deploy capital controls and other restrictions in order to prevent and mitigate financial crises.

Just a few months ago, a number of developing countries (from South Korea to Brazil to Indonesia) imposed restrictions on hot money flows which could pose a threat to their economies and financial systems. Post-crisis, even the IMF endorses the use of capital controls to prevent and mitigate financial crises.

It would be a grave mistake for India to surrender the ability to deploy capital controls in return for more favourable market access in EU.

India protected itself from the contagion unleashed by the South East Asian financial crisis of 1997 because of a restricted capital account. Given the overriding presence of short-term volatile capital flows in its forex reserves, India remains vulnerable to a sudden reversal of capital inflows. Therefore, New Delhi should reject legally binding provisions on capital transfers and maintain the policy space to deploy appropriate forms of capital regulations.

CONFLICT RESOLUTION

The EC has specifically proposed investor-to-state dispute settlement provisions (in addition to state-to-state) under the FTA. This mechanism would allow investors to bring claims against Governments of both trading partners before a panel of arbitrators with hardly any public participation or accountability. This is modelled on the controversial Chapter 11 of the North American Free Trade Agreement (NAFTA).

Private corporations from NAFTA member-countries have exploited the provisions of the agreement to challenge a wider range of regulatory measures on health, environment and public safety that infringe on their expansive investment rights. Investors have used provisions under Chapter 11 to sue Governments and demand cash compensation for Government policies and regulations which affect their investment rights. The Canadian Government has paid over $150 million in damages to investors for the alleged breaches of Chapter 11.

Not long ago, India had opposed the inclusion of investment issues under the WTO framework on similar grounds. The global financial crisis has underscored the need for greater regulation and supervision of private capital flows.

Several countries are tightening existing investment rules or enacting new rules to protect “strategic sectors” from foreign investors. Therefore, it would be unwise for New Delhi to accept such provisions that would legally bind it to serve the private interests of investors, while constricting the policy space to intervene in the public interest.

The author works with Madhyam, New Delhi (www.madhyam.org.in). This article was published by The Hindu Business Line on February 18, 2011.