Indian Tea Industry

Impact on Import of Tea in India after Summer 2010
ASEAN INDIA FTA Agreement: A Simulation analysis
1. Introduction
The 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 stepping-
stones 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 India’s tariff reduction negotiations. India’s 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 ASEAN-
India Trade in Goods Agreement paves the way for the creation of one of the world’s 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 ASEAN-
India 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 India’s 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 India’s 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 Page 1 of 20

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 India’s 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 Data
1. Lack of time and budget
2. Limited source of information
7. Indian Tea Industry

“The 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

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 world’s annual tea output—among 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
country’s tea output and since tea imports are permitted only for re-export, India’s share of the global
tea trade is on the lower side. Nevertheless, exports have a critical role to play in maintaining the
demand-supply balance in the domestic market. Although tea is produced in 14 States in India, five of
them—Assam and West Bengal in North India, and Tamil Nadu, Kerala and Karnataka in South India
account for over 98% of India’s tea production. Within that, North India alone accounts for around
75% of India’s total tea production, of which 85-90% is consumed in the domestic market. The
balance, much of it of high quality, is exported. Tea is among the most labour-intensive of all
plantation crops. On an average, around 65% of the cost of production is incurred on labour.” (Roy &
Das, 2009)
Because of absence of large domestic base and due to comparatively small range of exportable
items, Sri Lanka and Kenya have an edge over India to off-load their teas in any international markets.
This is one of the reasons of higher volume of export by Sri Lanka and Kenya compared to India.
Another important point is that, U.K has substantial interest in tea cultivation in Kenya. Most of the
sterling companies, after Indianisation due to implementation of FERA Act started tea cultivation in

Kenya. So, it makes business sense for U.K. to buy tea from Kenya and Kenya became the largest
supplier of tea to U.K.
Tea is an essential item of domestic consumption and is the major beverage in India. Tea is
also considered as the cheapest beverage amongst the beverages available in India. Tea Industry
provides gainful direct employment to more than a million workers mainly drawn from the backward
and socially weaker section of the society. It is also a substantial foreign exchange earner and provides
sizeable amount of revenue to the State and Central Exchequer. The total turnover of the Indian tea
industry is in the vicinity of Rs.9000 Crs. Presently, Indian tea industry is having (as on 18.12.2009 )
• 1692 registered Tea Manufacturers,
• 2200 registered Tea Exporters,
• 5848 number of registered tea buyers,

• Nine tea Auction centres.
8. Import of Tea into India

India's tea imports are low, but had increased significantly until FY2005. Quantitative restrictions on
tea imports were removed from March 2001. However, customs duty was raised from 35% to 70%,
and subsequently to 100%. The bulk of the tea imported by India is orthodox tea from Indonesia,
Vietnam and Sri Lanka. The industry is encouraging orthodox tea production as an import substitution
strategy to reduce imports. India's tea imports are estimated to have declined significantly from 31.8
mkgs in FY2005 to around 18.7 mkgs in FY2006. India also imports Tea to various countries like
Argentina, Bangladesh, China, Indonesia, Keya, Nepal, South Africa, Vietnam etc. with a high import
duty of 70%. But from 2003-2008 the tariff rate significantly higher comparative to other SAARC
countries. As a result the domestic deadweight loss is very high in that period.” (Tea Board of India)
Import of Tea in to India
Values
Quantity Unit C.I.F.price
Year (Rs.
(M.Kg) (Rs./kg)
Crs.)
1992-93 1.37 5.14 37.52

1993-94 0.87 3.99 45.86
1994-95 0.2 1.1 55
1995-96 0.45 2.41 53.56
1996-97 1.25 6.21 49.68
1997-98 2.61 17.79 68.16
1998-99 8.93 64.73 72.49
1999-2000 10.36 61.97 59.8
2000-2001 15.35 96.67 63
2001-2002 16.79 86.59 51.56

2002-2003 22.49 105.32 49.82

2003-2004 11.36 66.23 58.41
2004-2005 32.53 145.15 44.61
2005-2006 17.41 102.77 59.03
2006-2007 20.8 111.02 53.37
2007-2008 16.75 108.07 64.51
2008-2009 22.3 181.45 82.36
Source: Archives from Tea Statistics in Tea Board of India
I mport of Tea in I ndia
200
180
160
140
Quantity & Value
120 Quantity
(M.Kg)
100
Values
80 (Rs. Crs.)
60
40
20
0
19 -93
19 -94
19 -95
19 -96
19 -97
19 -98
99 -99
07 07
08 08
9
00 00
01 01
02 02
03 03
04 04
05 05
06 06
00
20 -20
20 -20
20 -20
20 -20
20 -20
20 -20
20 -20
20 -20
20 -20
96
97
19 98
92
93
94
95
-2
19
Year
Source: Archives from Tea Statistics in Tea Board of India
Tariff:
Tax levied upon goods as they cross national boundaries, usually by the government of the importing
country. The words tariff, duty, and customs are generally used interchangeably. Usually assessed on
imports, tariffs may apply to all foreign goods or only to goods produced outside the borders of a
customs union. A tariff may be assessed directly, at the border, or indirectly, by requiring the prior
purchase of a license or permit to import specified quantities of the good. Examples of tariffs include
transit duties and import or export taxes, which may be levied on goods passing through a customs
area en route to another destination. In addition to providing a source of revenue, tariffs can effectively
protect local industry by driving up the price of an imported item that competes with domestic
products. This practice allows domestic producers either to charge higher prices for their goods or to
capitalize on their own lighter taxes by charging lower prices and attracting more customers. Tariffs
are often used to protect “infant industries” or to safeguard older industries that are in decline. They
are sometimes criticized for imposing hidden costs on domestic consumers and encouraging
inefficiency in domestic industries

9. AIFTA’s Tariff Reduction Schedules

“The ASEAN-India Free Trade Agreement (AIFTA), which has been concluded after protracted
discussions, is a strategic event that holds promise for both parties. The FTA signals India’s readiness
to contribute to the development of the region, and seek benefits from the process. There is no doubt
that ASEAN welcomes India’s involvement in the region. India’s trade with ASEAN has not been
spectacular. India has been running a deficit with ASEAN in the last decade, and the deficit has been
growing. India’s trade deficit with ASEAN has increased from about US$2 billion in 1998 to around
US$15 billion in 2007. The widening trade deficit is a reflection of India’s trade trends with ASEAN.
In 2004-05, India’s total imports from ASEAN were worth roughly $9 billion, with exports amounting

to $8 billion. In 2007-08, total imports ($22 billion) continued to exceed exports ($16 billion), with a
trade deficit around $6 billion. But total trade between the two has been increasing rapidly.”(Nambiar,
2010)
“India has been willing to extend tariff reduction commitments on 89 per cent of its tariff lines through
the AIFTA. India has also signaled its intention to lower tariffs on highly sensitive items like palm oil,
tea, coffee and pepper. The import duties on these commodities will be lowered to around 40-45 per
cent by 2019. The stance that India has taken on these agricultural commodities, in the face of
domestic resistance, indicates the store the government puts on the agreement. It is also an indication
of India’s long-term economic interest in ASEAN and the synergy that it envisages it could develop
with the region over time.”( Nambiar, 2010)
As per the agreement, the tariff lines (HS 8-digit items) subject to tariff reduction and/or elimination
are categorized into four groups. First, about 74% of India’s tariff lines are under the ‘normal track’
category, where tariff rates will be reduced first and subsequently eliminated. Second, about 15% of
the tariff lines are under the ‘sensitive track’, where tariff rates are to be reduced to 5% or less by a
certain date. Third, a few tariff lines (about 40) are refereed to as India’s ‘special products’, where
India has decided to reduce tariff rates at a much more gradual pace than either the normal track or the
sensitive track. The ‘special products’ include plantation commodities such as coffee, tea, pepper and
palm oil. Finally, there is an ‘exclusion list’, where no tariff reduction commitments have been made.
The agreement provides for safeguard measures in the event of imports causing substantial injury to
the domestic producers. The agreement also has quite strict provisions for rules of origin.
Chart 2 shows the changes in India’s import tariff rates in the three plantation commodities during the
period 1990-2008. It can be seen that the tariff rates of Tea were as high as 100% in 1990. As part of
the trade liberalization process initiated in India since 1991, the tariff rates had been brought down
considerably during the 1990s. However, in a significant reversal of this trend, the tariff rates have
been raised significantly during the early 2000s and remained high till 2008.

Table 2 shows the AIFTA’s proposed tariff reduction schedule for the Tea. The applied tariff rates for
tea will be reduced in accordance with the tariff reduction schedule shown in the Table. It can be seen
that, during the period from 2010 to December 2019, the tariff rates for Tea will be brought down
from the base rate at an average annual rate of 6.9%. It may be noted that the extent of tariff reduction
is rather modest and even by 2019 tariff rates would remain quite high. However, since this product
has been overly protected in India, even a modest tariff reduction can lead to significant increase of
imports.
Table 2: Tariff Reduction Schedule for Tea
Base Proposed Tariff Rates

Commodities
Rate Dec
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2019
Tea 100 95 90 85 80 75 70 65 60 55 50 45
Source: India-ASEAN Trade in Goods Agreement
India-ASEAN
Trade in Tea:
General Trends
and Patterns

Export Import
Commodities
Low tariff High tariff Low tariff High tariff
phase: phase: phase: phase:
Tea -12.6 25.4 136.6* -26.4
*
Note: (i) Import growth rate for Tea is calculated for the period 1995-99 due to
non-availability of data for 1993 and 1994.
Source: COMTRADE-WITS
From Chart A2 it is clearly visualized that India’s imports are generally are higher than exports in Tea.
The period starting from 1993 is considered since the full convertibility on current account was
adopted in India in the year 1993. India’s tea imports show significant fluctuation throughout the
period 1995-2008 while exports showed some increase in 2006 and then declined in 2008.
In order to gauge, from the past data, the effect of tariff rates on import growth rate, we identify two
distinct phases based on the tariff data shown in Table 2: low tariff phase (1993-1999) and high tariff
phase (2004-2008). The tariff rates started showing an increasing trend in the year 2001. However,
tariff data are not available for 2002 and 2003. Therefore, based on the available information, we
consider the sub period 2004 -2008 as the high tariff phase. During this period, tariff rates remained
high for all the commodities – that is, 100% for Tea. Table 3 reports the average annual growth rates
of India’s exports and imports (in quantity terms) in the three commodities during the two phases.
Table 2: Average Annual Growth Rates of Exports and Imports, Quantities (KG)

As expected, the import of tea showed a very high growth rate during the low tariff phase while the
growth rates have been negative during the high tariff phase. In the meanwhile, the growth rate of
export was negative during the low tariff phase and positive in High Tariff phase. Therefore, the
analysis indicates that the reduction in tariff may cause significant increase in imports while its impact
on exports is not clear.
10. Simulation Analysis

C. Veeramani and Gordhan K. Saini (2010) from Indira Gandhi Institute of Development Research
(IGIDR) conducted a simulation analysis on the features of the partial equilibrium models used to
simulate the trade impact of the AIFTA in subsection IV.1. Subsections IV.2 and IV.3 discuss the
simulation results based on the SMART and gravity models respectively as discussed earlier. I will be
discussing some of the outcomes from that experiment to get an idea about how AIFTA will impact on
the tariff reduction and thereby economic welfare.
10.1 Partial Equilibrium Analytical Tools for Trade Policy Simulations
According to the theory of customs unions, whether or not the increase in trade caused by the FTA
would be welfare improving depends on the source of the increased trade; that is the extent of trade
creation relative to trade diversion (Viner, 1950). Trade creation occurs when the lowering of tariffs
allows partner country imports to replace high-cost domestic production; this improves welfare. Trade
diversion, on the other hand, occurs when the removal of tariffs causes trade to be diverted from a
third country to the partner country despite the fact that, were the countries treated equally, the third
country would be the low cost source of imports.
SMART Model
In order to simulate the trade creation and trade diversion effects of the proposed tariff reduction in the
selected commodities, we use an ex ante partial equilibrium model (called the SMART model),
measuring the first-round effects of the simulated tariff changes. “Unlike the general equilibrium
models, the partial equilibrium models do not take into account the second-round effects of trade
policy changes. A major advantage of the partial equilibrium approach is that it is relatively simple to
compute and can be applied at a very fine level of detail. The SMART model, developed by UNCTAD
and World Bank, is available in the World Bank’s World Integrated Trade Solution (WITS). The
WITS brings together the various databases on trade flows and trade policy instruments. It also
integrates analytical tools that support simulation analysis. The SMART model is one of the analytical
tools in the WITS used for simulation purposes.”( WITS official website)
The SMART contains in-built analytical modules that support trade policy analysis, covering the
effects of multilateral tariff cuts and preferential trade liberalization. It focuses on one importing
market (in our case India) and its exporting partners (in our case ASEAN countries) and assesses the
impact of a tariff change scenarios by estimating new values for a set of variables. “In addition to
decomposing the total trade effect in to trade creation and trade diversion, the SMART model can be
used to analyze welfare and revenue effects. The net welfare gain/loss estimated in the SMART model,
depends on (i) the additional tariff revenue entailed by the increase in imports and (ii) the additional
consumer surplus entailed by the increase in imports.” (WITS official website)
Veeramani & Saini mentioned that the SMART model relies on Armington assumption – that is,
similar products from different countries are imperfect substitutes. The representative agent maximizes

her welfare through a two-stage optimization process: First, given a general price index, she chooses
the level of total spending/consumption on a ‘composite good’. The relationship between changes in
the price index and the impact on total spending is determined by given import demand elasticities.
Second, within this composite good, she allocates the chosen level of spending among the different
‘varieties’ of the good, depending on the relative price of each variety. The extent of the between-
variety allocative response to change in the relative price is determined by the Armington substitution
elasticity (1.5 in the SMART model). However, SMART Model is very sensitive to the choice of the
different elasticity values
That why Veeramani & Saini used second model named Gravity model which does not rely on any
elasticity parameters and can be used to simulate ex ante the potential increase in imports under
different tariff reduction scenarios. These models have been widely used to analyze the bilateral trade
flows between country pairs and have been successful to a high degree in explaining trade flows.
(Harrigon, 2001 and Anderson and van Wincoop, 2004). In addition to the standard gravity variables,
they included the tariff rate in the importing countries as a separate independent variable. 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.
10.2 Simulation Analysis using the SMART Model

Veeramani & Saini quantified trade impact of the proposed tariff reduction scenarios of Tea. It is
evident from the tariff reduction schedule shown in Table 2 that the tariff rate in Tea will be reduced
from the base rate of 100% to 70% by 2015 and further to 45% by December 2019. Accordingly, two
tariff reduction scenarios have been considered as follows:
Scenario 1: base tariff rate to be reduced to the scheduled rate for the year 2015; tariff rates for
Tea will be brought down from 100% to 70%.
Scenario 2: base tariff rate to be reduced to the scheduled rate for December 2019; tariff rates
for Tea will be brought down from 100% to 45%.
The simulation results at the under the above two scenarios are shown in Table 3 and 4. The simulation
results in Table 3 are based on the assumption of infinite export supply elasticity (suppose say for
Indonesia the infinite export supply elasticity for Green Tea, HS Code: 090210, is -37.23579) while
the results in Table 4 are obtained based on the assumption of finite export supply elasticity values.
The table reports the increase in total imports of tea and its decomposition in to trade creation and
trade diversion. It also reports the loss in tariff revenue and the overall welfare effects.
Table 3: Aggregate Impacts in each Commodity under Different Tariff Reduction Scenarios,
Simulation Results Based on the SMART Model (values in 000 US$)

Table 4 Aggregate Impacts in each Commodity under Different Tariff Reduction Scenarios,
Simulation Results Based on the SMART Model (values in 000 US$)
Base Year Trade Loss in

Total Increase Trade Price Total
Commodity Import Diversion Tariff
in Imports Creation Effect Welfare
2007) Revenue
Scenario 1
Value % % % % Value Value
Tea 10312
Base Year 3603 34.9 20.0 11.7 3.2 Loss
-1903
in 2096
Total Increase Trade
Scenario 2 Trade Total
Commodity Import Tariff
in Imports
Value % Creation
% Diversion
% Value Welfare
% Revenue Value
(2007)
Tea 10312 6683 64.8 36.7 22.2 5.9 -5183 3492
Scenario 1
Value % % % Value Value
Tea 10312 3801 36.9 23.2 13.7 -1841 2207
Scenario 2
Tea 10312 7065 68.5 42.5 26.0 -5170 3671
The results in both the tables reveal that trade creation dominate over trade diversion and under both
the scenarios. The results suggest that the total increase in imports is mostly driven by trade creation. It
is evident that, at least in the context of tea, the AIFTA does not lead to significant trade diversion. As
discussed earlier, trade creation improves welfare as the new imports replace high-cost domestic
production.
The analysis shows that the proposed tariff reduction may lead to significant tariff revenue loss to the
government under both the scenarios. However, the gain in consumer surplus (due to the fall in
domestic price) outweighs the loss in tariff revenue leading to net welfare gain.
The assumption of infinite export supply elasticity implies that trade does not affect domestic prices
and hence the results in Table 3 do not include price effects (which is zero). The assumption of finite
export supply elasticity, however, implies that tariff change will generate price effects (positive or
negative). Therefore, the results in Table 4, which assume finite export supply elasticity, show the
price effect. It can be seen that the price effects in Table 4 are positive, which implies a terms of trade
gain for India. The mechanisms that lead to India’s terms of trade gain can be explained as follows.
There will be a downward pressure on prices in India due to her higher imports (or excess supply) and
there will be an upwards pressure in the ASEAN due to higher exports (or excess demand). If the
downward pressure on price (in India) is higher than the upward pressure (in ASEAN), there will be a
net fall in the prevailing price in ASEAN post tariff reduction (The Indian price (pi) is related to the
ASEAN price (pa) as follows: pi = (1+t) pa, where t is the tariff rate. Therefore, pa = pi / (1+ t)). India,
being an importing country, derives a terms of trade gain (loss) if the ASEAN price falls (increases) in
the post tariff reduction equilibrium. It may be noted that India derives a terms of trade gain in tea.

There will be a positive optimal tariff that will maximize national welfare of India.
We now turn to examine how the total trade creation tea is distributed across the ASEAN trading
partners (Table 6). Vietnam accounts for the largest share of trade creation while Indonesia accounts
for the largest share in coffee. The contributions of Malaysia, Singapore and Thailand are not
significant.
Table 6: Trade Creation in each Commodity with each ASEAN Partner (values in 000 US$)
Scenario 1 Scenario 2
Base Year Import
Commodity (2007) Trade Creation Trade Creation
Value Value Value

Tea 10312 2063 3782
Indonesia 3014 (29.2) 607 (29.4) 1113 (29.4)
Malaysia 97 (0.9) 19 (0.9) 36 (0.9)
Singapore 0 (0.0) 0 (0.0) 0 (0.0)
Thailand 0 (0.0) 0 (0.0) 0 (0.0)
Vietnam 7201 (69.8) 1436 (69.6) 2633 (69.6)
Note: (i) figures in parentheses are percentage shares of each commodity total; (ii) finite export supply
elasticity values are assumed.
While we have noted that trade creation generally dominates over trade diversion, it is of interest to
identify the countries from which trade is being diverted to the ASEAN. In the present context, trade
diversion is said to occur when the removal of tariffs causes trade to be diverted from a non-ASEAN
country to one or more of the ASEAN country. Table 7 provides a list of the top 10 non-ASEAN
countries whose trade is being diverted to the ASEAN due to the AIFTA. It can be seen that, as
expected, the list contains a large number of least developed or developing countries. The most
affected country in tea is Kenya.
Table 7: List of Top 10 Non-ASEAN Countries whose trade is being diverted to the ASEAN
Countries (values in 000US$), Scenario 2
Tea
sl.
No. Country Value
1
Kenya -1021.1
2
Nepal -593.6
3
China -235.7
4
Argentina -230.5
5 Papua New Guinea -109.3
6

Sri Lanka -91.2

7
United Kingdom -69.4
8
Malawi -68.2
9
Iran, Islamic Rep. -49.2
10
Brazil -16.9
Note: (i) finite export supply elasticity values are assumed.
Gravity Model Analysis

As mentioned earlier, SMART simulation results are very sensitive to the choice of the elasticity
parameters. An alternative approach, Veeramani & Saini used the gravity model. Tariff rates in the
importing countries are used as one of the explanatory variables. 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 to simulate the likely increase in imports under the different tariff reduction
scenarios.
The main idea of the gravity model is borrowed from the Newtonian model of gravitational forces –
that is, the force of attraction between two bodies is proportional to the product of their masses and
inversely proportional to the square of the distance between them. The simplest gravity model predicts
that the trade between two countries willbe proportional to the product of their gross domestic
products and inversely proportional to the physical distance between them. This basic model can be
augmented using other variables that can facilitate or hinder bilateral trade flows. The reduced
form of the augmented gravity model is specified as follows:

Veeramani & Saini used the Tobit model, which addresses the estimation problems arising from the
truncation of the dependent variable. The Tobit regression results are shown in Table 8. They
estimated two regression equations; one using simple average tariff rate and another using weighted
average. It is evident that the coefficients of all the independent explanatory variables show correct
signs and are statistically significant at 1 percent level. As expected, both the tariff variables yield
negative signs with statistical significance for tea. The point estimates suggest that the elasticity of
import of tea with respect to tariff is in the range of –0.24 to –0.26. Taking the midpoint of the
elasticity range for tea, the results imply that a 10% reduction in import tariff (TARj) increases import
by about 4.2 percentage points, which is quite large.
Size of the exporting and importing countries are measured by their GDP. More specifically, GDPi
will capture the effect of the level of supply in the exporting country while GDPj will capture the
effect of the level of demand in the importing country. As expected both GDPi and GDPj show a
statistically significant positive coefficient, which implies that higher output levels (GDP) in both the
exporting and importing countries stimulate higher volume of trade. The results show that higher
population size of the exporting country (POPi) causes higher volume of exports due to their higher
supply. In contrast, higher population size of the importing country (POPj) causes lower volume of
imports.
That the volume of bilateral trade falls with geographical distance is a well documented fact (e.g.,

Leamer and Levinsohn, 1995). The volumes of bilateral trade between geographically closer countries
tend to be higher due to the lower transport and search costs and other advantages arising from greater
geographical proximity. Indeed, the variable DISTij yield a large statistically significant negative
coefficient, indicating that the countries that are geographically closer trade more.
Table 8: Tobit Estimation Results of the Gravity Model, 2007
Explanatory Tea
Variables (1) (2)
GDPi 1.090 1.091
(0.057) (0.057)
GDPj 1.462 1.463
(0.069) (0.071)
POPi 0.766 0.765
(0.063) (0.063)
POPj -0.423 -0.424
(0.075) (0.078)
DISTij -2.001 -1.996
(0.082) (0.082)
BORDij 1.550 1.562
(0.330) (0.330)
LANGij 2.575 2.594
(0.177) (0.177)
COLij 2.204 2.191
(0.343) (0.343)
SMCTYij 1.878 1.878
(0.460) (0.460)
TARj (Simple -0.258
Average) (0.059)
TARj
(Weighted
-0.235
Average) (0.059)
-59.085 -59.205
Constant (1.629) (1.630)
Number of
observation 18792 18792
- -
Log likelihood 10189.620 10191.275
LR chi2(10) 5204.620 5201.310
Prob > chi2 0.0000 0.0000
Note: (i) values in parenthesis represent standard error; (ii) all coefficients are significant at 1
percent level
Countries that share a common border are likely to trade more again due to lower transport and search
costs and other advantages arising from greater geographical proximity. As expected the border
dummy (BORDij) show a significant positive coefficient. Similarily, common cultural and political
history can stimulate bilateral trade. Thus we include the dummies to capture common language

(LANGij ), colonial history (COLij) and political history (SMCTYij). As expected, the coefficients of all
these variables are positive and statistically significant.
Using the estimated regression equations in Table 8, we now proceed to simulate the extent of import
increase due to tariff reduction under the two scenarios considered earlier. While the SMART and
gravity models provide some differences on the relative magnitude of import increase of tea. The
gravity model suggests that under both the scenarios the percentage increase for tea in import is 10%
and 22% respectively under scenario 1 and 2 while the SMART model indicates the percentage
increase for tea in import is 20% and 36% respectively under scenario 1 and 2 (Table 9).
Table 9: Import Increase in each Commodity under Scenario 1 & 2, Simulation Results based on
the Gravity Model (values in 000 US$)
Import Increase under Import Increase under

Base Year Import Scenario 1 Scenario 2
Commodity
(2007)
Value % Value %
Tea 10312 981 10 2318 22
Finally, Table 10 shows the partner-wise distribution of import value increase in tea under the two
scenarios. Overall, the pattern remains the same as discussed earlier with reference to the SMART
simulation results.
Table 10: Partner-wise Import Increase in each Commodity under Scenario 1 & 2, Simulation
Results based on the Gravity Model (values in 000 US$)
Scenario 1 Scenario 2
Base Year Import
Commodity (2007) Import Increase Import Increase
Value Value Value
Tea 10312 981 2318
Indonesia 3014 287 678
Malaysia 97 9 22
Singapore 0 0 0
Thailand 0 0 0
Vietnam 7201 685 1619

11. Conclusion
Overall, the results suggest that the AIFTA will cause significant impact in increase in imports mostly
driven by trade creation rather than trade diversion. From the point of view of economic efficiency,
trade creation improves welfare as the new imports replace the high-cost domestic production. The
analysis shows that the proposed tariff reduction may lead to significant tariff revenue loss to the
government. However, the gain in consumer surplus (due to the fall in domestic price and the
consequent reduction in dead-weight loss) outweighs the loss in tariff revenue leading to net welfare
gain.
Even though, the AIFTA envisages rather modest reduction of India’s import tariff in tea, my analysis
shows that even such a small reduction in tariff will lead to significant import increases into India.
While the AIFTA is welfare improving for the consumers of tea in India, the surge of new imports
may have adverse impact for the livelihood of the farmers engaged in the production of these
commodities. Farmers will have to realign the structure of production according to the changing price
signals and hence it is critical to provide adjustment assistance to the affected farmers.

References:
Anderson, J.E, and van Wincoop, E (2004), “Trade costs” Journal of Economic Literature, 42(3),
pp. 691-751.
Bhagwati, J (1994), “Regionalism and multilateralism: an overview”, in J. de Melo A. Panagariya

(eds), New Dimensions in Regional Integration, Cambridge University Press, Cambridge.
Chatterjee, Subhajit.“ Indian Tea Indutry since the 1990s”

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1152135
Comprehensive review of the theoretical foundations of the gravity model can be seen in Harrigon
(2001) and Anderson and van Wincoop (2004).
Harrigan, J (2001), “Specialization and the volume of trade: do the data obey the laws”, NBER
Working Paper 8675.
http://wits.worldbank.org/witsweb/download/data/individual-country-elasticities.zip
http://www.aseansec.org/64.htm
Leamer, E. E,. and Levinsohn, J (1995), "International trade theory: the evidence,", in G. M.
Grossman and K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 26,
pages 1339-1394, Elsevier.
Lang, Rémi. A partial equilibrium analysis of the impact of the ECOWAS-EU Economic Partnership
Agreement. Web. July, 30,2010
http://www.hubrural.org/pdf/uneca_partial_equilibrium_analysis_of_impact_of_ecowas_eu_epa.pdf
Roy, Jayanta & Das , Kaushik. “INDIAN TEA INDUSTRY: OUTLOOK POSITIVE FOR THE
SHORT TO MEDIUM TERM”
Tea Statistics 1999-2000

http://www.teaboard.gov.in/pdf/tea_statistics/Tea_Statistics_1999-00.pdf








Union Budget 2010-11 http://exim.indiamart.com/budget-2010-11/
Union Budget 2009-10 http://exim.indiamart.com/budget-2009-10/
Using SMART in WITS

http://wits.worldbank.org/witsweb/download/docs/Using_SMART_in_WITS.pdf
Veeramani, C. and Saini Gordhan K. “Impact of ASEAN-India FTA on India’s Plantation

Commodities: A Simulation Analysis”. Indira Gandhi Institute of Development Research, Mumbai,
April, 2010
<http://www.igidr.ac.in/pdf/publication/WP-2010-004.pdf>
Viner, J (1950), The Customs Union Issue, Carnegie Endowment for International peace, New York.
<www.icra.in/files/pdf/specialcomments/2009-september-indian-tea.pdf, ICRA, Sep, 2009>

Indian Tea Industry

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Impact on Import of Tea in India after Summer 2010

ASEAN INDIA FTA Agreement: A Simulation analysis

2. Objective of this term paper:

EM 556: Managing International Trade & Investment Page 1 of 20

4. Methodology used and Data presentation:

7. Indian Tea Industry

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EM 556: Managing International Trade & Investment Page 3 of 20

• 1692 registered Tea Manufacturers,

• 2200 registered Tea Exporters,

• 5848 number of registered tea buyers,

8. Import of Tea into India

Import of Tea in to India

1992-93 1.37 5.14 37.52

EM 556: Managing International Trade & Investment Page 4 of 20

2002-2003 22.49 105.32 49.82

I mport of Tea in I ndia

Source: Archives from Tea Statistics in Tea Board of India

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9. AIFTA’s Tariff Reduction Schedules

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Table 2: Tariff Reduction Schedule for Tea

Base Proposed Tariff Rates

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10. Simulation Analysis

10.1 Partial Equilibrium Analytical Tools for Trade Policy Simulations

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10.2 Simulation Analysis using the SMART Model

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Base Year Trade Loss in

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Value Value Value

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Sri Lanka -91.2

Note: (i) finite export supply elasticity values are assumed.

Gravity Model Analysis

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Table 8: Tobit Estimation Results of the Gravity Model, 2007

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Import Increase under Import Increase under

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Bhagwati, J (1994), “Regionalism and multilateralism: an overview”, in J. de Melo A. Panagariya

Chatterjee, Subhajit.“ Indian Tea Indutry since the 1990s”

Tea Statistics 1999-2000

Tea Statistics 2000-01

EM 556: Managing International Trade & Investment Page 19 of 20

Tea Statistics 2001-02

Tea Statistics 2003-2004

Tea Statistics 2004-05

Tea Statistics 2006-07

Tea Statistics 2007-2008

Tea Statistics 2009-2010

Union Budget 2010-11 http://exim.indiamart.com/budget-2010-11/

Union Budget 2009-10 http://exim.indiamart.com/budget-2009-10/

Using SMART in WITS

Veeramani, C. and Saini Gordhan K. “Impact of ASEAN-India FTA on India’s Plantation

<www.icra.in/files/pdf/specialcomments/2009-september-indian-tea.pdf, ICRA, Sep, 2009>

EM 556: Managing International Trade & Investment Page 20 of 20

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