Empowering Indian SMEs – Role of Free Trade Agreements

In the present-day paradigm of international trade, integrating small and medium-sized enterprises (SMEs) into global value chains (GVCs) have become increasingly significant. Fueled by advancements in information and communication technologies (ICT), SMEs can now specialise in specific tasks within production chains, access niche markets, and compete globally. This trend presents a significant economic development opportunity for countries like India, where a robust SME sector can be a powerful engine for growth, job creation, and innovation.

India has registered 316,05,581 (Udyam Registration Portal, December 2023) Micro, Small, and Medium Enterprises (MSMEs are the Indian definition of SMEs, which is the fundamental concept, therefore used interchangeably). SMEs account for 30 percent of the Indian GDP.

Despite their potential, SMEs struggle in international markets due to limited access to foreign market information, complex trade procedures, and resource limitations compared to larger firms. Free Trade Agreements (FTAs) can be vital in overcoming these challenges by creating a more level playing field for SMEs.

Recent agreements such as the Trade and Economic Partnership Agreement (TEPA) with the European Free Trade Association (EFTA) hold immense potential for boosting investment in India. TEPA is expected to generate $100 billion in investments over the next 15 years and create 10,00,000 jobs in India. However, for maximising FTA benefits for SMEs, the FTAs require specific provisions to such end.

This article examines how FTAs in India, considering global best practices, can address SME challenges and boost their participation in international trade.

Today, about 70 percent of global trade involves GVCs, where goods and services are produced across borders. This trend reflects the integration of trade and services in the worldwide market. Businesses strategically outsource activities where skills and resources are available at competitive costs, shaping trade dynamics. For SMEs, linking with GVCs offers financial stability, technological advancement, increased productivity, and access to new markets. The global fragmentation of the production process has increased the opportunities for SMEs to specialise in niche markets. Through GVCs, SMEs can become suppliers of parts to prominent lead firms. This allows SMEs to enter global markets bypassing the need to master the entire production process. An example of the interconnectedness of GVCs is illustrated by phones assembled in India, featuring design elements from the United States, computer code from Europe, components from Brazil, and IT support from India – showcasing the shared value among participating countries.

Understanding the factors hindering SMEs’ full participation in GVCs becomes crucial in unlocking their untapped potential and promoting sustainable growth in the global trade landscape. Such factors include:

• Accessing timely credit is difficult due to complex collateral requirements and cumbersome loan procedures.

• Lengthy documentation processes for compliance with market regulations incurs high costs and requires specialised skills that smaller businesses often lack.

• Infrastructure deficiencies, especially in logistics and digital connectivity, increase costs and limit market access.

• Limited adoption of technology and branding capabilities challenges meeting importers’ standards and creating a market presence.

• Financial constraints restrict procurement of raw materials at competitive costs and limited market knowledge inhibits responsiveness to market demands.

• SMEs struggle with accessing export distribution channels, navigating legal frameworks, and protecting intellectual property rights.

• Limited awareness of potential markets and non-tariff barriers complicates market integration for SMEs.

In recent years, FTAs have undergone a significant transformation, thereby playing a crucial role in helping SMEs integrate into GVCs. These modern FTAs have evolved beyond trade concessions. They address global challenges and aim for deeper integration, covering health, safety, labour migration, and banking areas. Notable examples include the INDIA - UAE FTA and the EU - Vietnam FTA, reflecting a broader scope of cooperation among nations.

While India has signed fifteen FTAs, only eight explicitly address SMEs. The India - UAE FTA stands out with a dedicated SME chapter promoting information sharing, market expansion, digital integration, and support for youth and women-owned businesses. Other FTAs, including the recently signed TEPA, mention SMEs but lack a standalone chapter. 

A snapshot of certain SME related provisions in few FTAs are:

• South Asian Free Trade Area (SAFTA): Technical assistance and skill development for SMEs in Least Developed Countries.

• India - Nepal FTA: Reduced duties for certified Nepalese small-scale manufactured goods.

• India - Thailand FTA: Emphasis on cooperation to strengthen SME ties.

• India - ASEAN CECA: Potential cooperation in IT and ICT training for SMEs, but not mandatory.

• India - Japan CEPA: Comprehensive support for SMEs, including technology transfer, skill development, and access to finance. However, restrictions exist on foreign investment in small-scale sectors.

• India - Malaysia CECA: Encourages a sub-committee on economic cooperation to identify areas for SME collaboration.

Globally, two FTAs have pioneered the recognition of SMEs’ importance: the Comprehensive and Progressive Agreement for Trans - Pacific Partnership (CPTPP) and the EU - Japan Economic Partnership Agreement (EPA). These agreements showcase different approaches to regulating e-commerce and digital trade, highlighting the challenge of balancing innovation with consumer protection. The EU - Japan EPA, for instance, prioritises SME support by establishing  ‘SME contact points’ and an ‘EPA Helpdesk’ to assist SMEs in cross-border business between the EU and Japan. Under the CPTPP, customs procedures are expedited for express shipments, ensuring quick release within six hours, such as exporters introducing self-certification of origin. Similarly, the EU - Japan aligns customs procedures with international standards, avoiding compulsory customs brokers or inspections. Certain FTAs offer compliance exemptions to domestic SMEs, providing cost relief. A growing trend is the dissemination of SME - specific support schemes and activities beyond online services, as seen in the Chile - Vietnam FTA.

Despite variation across FTAs, these set precedents for recognising and supporting SMEs within international trade frameworks, signaling a global trend towards inclusivity and cooperation.

For India, it is well known that a thriving SME sector will strengthen domestic markets and position them competitively in the global arena. Thus, stronger language and clearer provisions in India’s FTA, such as in the India - UAE CEPA, shall empower SMEs in global trade effectively.

Keeping the above in mind, some Key Policy Recommendations are:

1. Information Access: Mandate knowledge sharing with clear, simplified information tailored for SMEs, including relevant business contacts.

2. Cooperation: Promote information networks, financial assistance, innovation programs, and collaboration to strengthen SME competitiveness.

3. Collaboration: Establish dedicated SME committees with government and private sector representatives to address critical SME issues.

4. Trade Facilitation: Simplify documentation, reduce compliance procedures, and leverage technology to streamline trade processes and access to credit.

5. Strong Language: Use clear and binding language in FTAs to ensure the implementation of agreed-upon SME support measures.

6. Flexible IPR: Consider flexible IP requirements in FTAs to facilitate technology transfer and innovation for SMEs in developing countries.

7. Focus on Women-Led Businesses: Integrate gender-specific capacity-building programs, networking platforms, and data collection mechanisms to empower women entrepreneurs.

8. Support Indigenous Businesses: Include provisions for reciprocal arrangements and policy support for Geographical Indications (GIs) and Traditional Knowledge systems.

FTAs can become a powerful tool for inclusive and sustainable economic growth in India by empowering SMEs through enabling provisions and thus, bridging the gap between potential and reality.

About the authors: Sucharita Basu is the Managing Partner of AQUILAW. Swati Sharma is Senior Policy Analyst (Legal).