The FTA Gamble: Can India Escape the Middle-Income Trap?

The ever-growing trend of bilateral FTAs in the global economy today can provide lessons to New Delhi amid its own push for the same. One such example would be Kuala Lumpur. Malaysia has been restructuring its EU FTA since 2025. The agreement focuses on adding value to the Malaysian semiconductor industry and on moving from assembly to chip design and fabrication. Trade access is being used as leverage to secure technology and R&D investment. 

Illustration by The Geostrata

This sounds familiar to the Indian manufacturing sector. An assembly-dominant stagnating sector. Delhi has pursued a different approach. Agreements have been finalised with New Zealand, Oman, the UK, and EFTA. A deal with the US is reaching its final stages. While the Malaysian focus seems to be moving towards industrial upgradation, Delhi's seems to be on optics. Every signing ceremony projects global confidence without structural change beneath the surface. At the current trajectory, Delhi would take close to 75 years to escape the middle-income threshold entirely. 

THE MIDDLE-INCOME TRAP

The middle-income trap is a threshold where a nation reaches 10-15% of the American levels of per capita income and stalls due to the inability to compete with lower-wage economies on cost or with the higher-income advanced economies on innovation.

India’s per capita GDP currently sits below the World Bank's middle-income threshold, near the $ 6,000- $ 6,100 mark. The manufacturing sector contributes roughly 17% of the GDP.

The number has remained stagnant over the last decade despite policy measures like Make in India. Post-pandemic, workers saw a turn toward agriculture rather than industry and high-skill services. Real wages rarely keep pace with inflation despite publicised high GDP growth numbers. These warning signs are similar and are the markers that the trap identifies. India is growing, but growth without upgrading national productivity is premature expansion without structural depth for the long run. 

This premise is where India’s FTA diplomacy needs to be scrutinised. India’s FTA utilisation rate of products actually getting preferential treatment has historically been between 5% and 25% compared to 70-80% for most developed nations. This gap tells us that while these FTAs bring us market access and a diverse supply chain, they also bring responsibility. Indian manufacturers are not competitive enough to benefit from negotiated tariff windows. The FTAs themselves are the easiest element. However, building supply chains, logistical infrastructure, and quality standards through reform incentivised by these commitments is harder, and that is where Delhi has failed to adequately profit from these agreements.

While newer agreements with Australia and the UAE show encouraging rates of over 50% with the Emiratis and as high as 90% with Australia, these are exceptions in a largely underperforming framework. 

FTAs have also damaged Delhi’s trade balance. The ASEAN Trade in Goods Agreement, after coming into effect in 2010, saw India’s trade deficit with the bloc at nearly $5 billion. The figure has since ballooned to around $44 billion in FY23. The growth rate of imports was 186%, while the growth rate of exports was only 65%. The India-Korea CEPA shows a similar pattern.

The bilateral deficit grew to $9.5 billion by 2021-2022. A NITI Aayog review found that India has shown a net loss in nearly every single agreement, except Sri Lanka. The Commerce Ministry has also explored a review of the agreement to reduce the import burden on India and the trade deficit. 

THE RED DRAGON

The China problem compounds these losses. India withdrew from the RCEP in 2019 due to fears that Chinese goods would flood the Indian market due to an inherent cost advantage. China has a far stronger supply chain than India today, and using the advantage of scale, it can provide goods at much lower prices than Indian producers. While the withdrawal is a shield, the protection is partial. The period between 2020-21 and 2022-23 saw India’s imports from ASEAN surge 84.6%. 

The rise closely tracks ASEAN’s increasing imports from China. The mechanism is similar to the oil compromise India exploited. Russia is selling oil to India at discounted prices, and India is refining and selling it for a profit. Similarly, the Chinese manufacturers export components to ASEAN nations.

These nations then assemble and re-export these to India at preferential FTA rates. The agreements that were designed to diversify our supply chains and move away from the Washington-Beijing axis are acting as a backdoor for Chinese goods. Domestic manufacturers cannot compete with the prices Beijing can manufacture at and are undercut by these agreements.

THE FTA MIDDLE-INCOME QUICKSAND

The risk of entering into FTAs before building the capacity to leverage them is that capital-rich multinational corporations may outcompete domestic firms, deepening existing competitiveness gaps and making industrial upgrading more challenging. India suffers from what economists call premature deindustrialisation, which effectively is a decline in the share of manufacturing in national income at per capita levels as compared to levels at which richer countries experience it today. 

To escape the middle-income trap, India needs to prioritise what South Korea and Taiwan did. The requirement is to build domestically controlled firms capable of investing in and making globally competitive supply chains. The FTAs need to be accompanied by higher investment in R&D, prioritising innovation and higher patent standards, rather than assembly-focused manufacturing.

India’s R&D expenditure is a declining share of GDP at roughly 0.65% of GDP, making it lower that  25% of what countries like South Korea invest. The PLI scheme has attracted investment in sectors such as electronics, but this investment has failed to translate into broader employment generation in the sector or technological advancements. FTAs underscore the need for Indian firms to become more competitive, both against low-cost producers and against innovation-led economies. The path forward lies in strengthening domestic capabilities, improving productivity, and moving towards higher-value production. 

WHAT CAN WE LEARN FROM KUALA LUMPUR

Malaysia’s experience draws parallels to India. For decades, Malaysia relied on electronics assembly dominated by multinational corporations. They were the engine of manufactured exports. However, despite rapid growth initially, the growth plateaued because domestic firms never developed their own technology. As a result, Malaysia has remained stuck in the middle-income trap for more than 4 decades. 

This is not because of a lack of trade agreements, but the resulting trade exposure did not create indigenous capabilities to grow proportionally. The difference between South Korea’s and Malaysia’s growth models was the focus on domestically competitive firms. Hyundai, Samsung, and POSCO actively competed to break through the global technology frontier, setting a standard for all developing countries. Learning from its own structural deficiencies, Malaysia’s new EU FTA is designed with explicit and outlined motives to develop a strong semiconductor sector within its own borders. 

There is market access in exchange for technology transfer and value-chain integration that does not bind Kuala Lumpur to these agreements in the form of dependency. In contrast, Indian FTAs have been, for the most part, an exchange of tariff concessions to gain concentration in the services and IT sectors. These gains are most certainly valuable, but they do not generate the kind of manufacturing-centric, high-skilled employment that India needs to capitalise on the young demographic dividend. 

WHY ARE WE WHERE WE ARE

The political optics behind the FTAs are no secret. Each agreement generates headlines and gives the government tangible deliverables to showcase its capability to global partners and investors. In the context of the US- China decoupling, there is value in projecting Delhi as an integrated global partner. There is export potential in services too. IT, finance, and professional services, which agreements like the UK CETA are meant to unlock, are gains that deserve credit. 

However, agreements that open Indian markets up faster than Indian producers can adapt don’t allow the nation to build quickly the capabilities needed for these agreements to work. The risk is that premature trade liberalisation can contribute to a middle-income trap, while simultaneously reducing the policy space and urgency required for the reforms needed to escape it. 

The real challenge lies not in signing more FTAs, but in answering a set of pressing questions: how to build a larger and more sophisticated manufacturing base, reduce import dependence, create globally competitive domestic technology firms, and deliver sustained wage growth through higher-productivity industries. The speed with which Delhi addresses these issues may ultimately determine whether India escapes the middle-income trap.

The FTA strategy has ticked all the boxes when it comes to diversity of supply chains and market access. However, until the strategy is tied to a priority of industrial expansion along with airtight rules of origin enforcement, investment in R&D, and conditional technology transfers, the agreement barrage risks becoming a substitute for structural reforms the Indian economy needs to breathe in the long run, and the short-term solution in the barrage will make the pursuit of these reforms even tougher. 

Delhi’s current strategy promises to bring immense opportunities to producers, but market access alone will not guarantee economic gains. To actually leverage these agreements, India needs to shift its focus to enhancing industrial competitiveness, investment in innovation and complementary reforms. The success of India's FTA strategy will therefore depend less on the agreements it signs and more on its indigenous capacity building.

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BY KRISH

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