Capital goods exports: Missing the punch?

CATR | January 28, 2021

India’s exports of capital goods increased by almost US$ 23 billion till 2018. But during the same time frame, imports proliferated by US$ 68.7 billion, which is roughly three times. To develop as a globally competitive capital goods exporter in the age of smart manufacturing and swiftly changing technologies, it is vital that India encourages technological upgradation of domestic producers of capital goods.

Exports data of capital goods reveals that since 2010, India’s exports of capital goods increased by almost US$ 23 billion till 2018. But during the same period, imports proliferated by US$ 68.7 billion, which is roughly three times.
Since the RCA figures remained significantly less than 1, it is difficult to say if exporters actually utilized the EPCG scheme in gaining competitiveness for capital goods exports. In fact, there is growing evidence that the Indian capital goods sector is becoming less self-sufficient and is relying more on imports to meet domestic demand.
Approximately US$ 90 billion out of US$ 131.6 billion (WITS Data) worth of capital goods imported by India comes from non-RTA member countries, which include China, USA, Hong Kong and Europe.
The government may give emphasis on addressing issues like inverted duty structure and the unintended consequences of export promotion policies like zero duty on import of capital goods and import of second-hand machinery, which affect the competitiveness of domestic capital goods producers.

Analysing India’s Export Performance of Capital Goods - TPCI IBT

Source: https://bit.ly/2NJjlbm

It is universally recognised, perhaps aptly, that capital goods are the backbone of any country’s economic progress. Essentially, capital goods can be defined as those durable goods, which have high value-added content and need sophisticated technology to manufacture. As per Directorate General of Foreign Trade (DGFT), capital goods imply any plant, machinery, equipment or accessories required for manufacturing or production, either directly or indirectly, of goods or for rendering services, including those required for replacement, modernisation, technological upgradation or expansion. Capital goods may be deployed for use in manufacturing, mining, agriculture, aquaculture, animal husbandry, floriculture, horticulture, pisciculture, poultry, sericulture and viticulture as well as the services sector. Computer systems and software are also a part of capital goods.

Independent India’s initial development plan (second five-year plan), also known as Nehru-Mahalanobis plan aggressively focused on heavy industries. Mahalanobis identified the rate of growth of investment in the economy with rate of growth of output in the capital goods sector within the economy. Thus, capital goods have always remained a focus area, but the same was not juxtaposed by empirical outcomes.

Therefore, the Indian government came up with a policy to promote exports of capital goods through Export Promotion Capital Goods Scheme (EPCG). Under the scheme, EPCG stakeholders are issued with actual user condition and import validity of 2 years to import capital goods (except those specified in negative list) for pre-production, production and post-production at zero customs duty. It is subject to fulfilment of specific export obligations equivalent to six times of duties, taxes, and cess saved on capital goods, to be fulfilled in six years from the date of issue of authorisation.

What data has to say?

Looking at the export data of capital goods, it can be said that from 2010, India’s exports of capital goods increased by almost US$ 23 billion till 2018. But during the same time frame, imports proliferated by US$ 68.7 billion, which is roughly three times. This indicates that, either our dependence on capital goods has surged or EPCG scheme has acted as a catalyst in fuelling the surge of capital goods imports, mainly from 2014 onwards.

The issue can be better understood when we see the revealed comparative advantage (RCA) figure of capital goods. Since the RCA figures remained significantly less than 1, it is difficult to say that we actually utilized the EPCG scheme in gaining competitiveness for capital goods exports. Thus, there is growing evidence that the Indian capital goods sector is becoming less self-sufficient and is relying more on imports to meet domestic demand.

Table 1: India’s trade snapshot of capital goods

Partner name	Year	Product group	Export (US$ billion)	Import (US$ billion)	Export product share (%)	Import product share (%)	Revealed comparative advantage
World	2010	Capital goods	25.80	63.21	11.71	18.06	0.38
World	2014	Capital goods	41.55	73.5	13.08	16	0.39
World	2018	Capital goods	48.38	131.66	15.01	21.31	0.42

Source: WITS Data

Figure 1, Revealed Comparative Advantage of capital goods of selected economies

Revealed Comparative Advantage of Capital Goods vs. Country - TPCI

Source: WITS Data

India lacks significantly in export competitiveness of capital goods, as our RCA is only 0.42. Let’s have a look at the export and import destinations of capital goods to understand if regional trade agreements have any role to play? Approximately US$ 90 billion out of US$ 131.6 billion (WITS Data) worth of capital goods imported by India come from non-RTA member countries, which include China, the US, Hong Kong and Europe. Similarly, the top three export destinations are US, UAE and Germany, again markets where we do not benefit from any trade agreements.

India’s trade destinations of capital goods as per 2018

S. No.	Export destination of capital goods	Import destination of capital goods
1	US	China
2	UAE	Germany
3	Germany	US
4	Bangladesh	Hong Kong
5	UK	Singapore
6	Singapore	South Korea
7	China	Japan
8	Sri Lanka	Vietnam
9	Nepal	Italy
10	Indonesia	Thailand

Source: WITS Data, yellow highlighted cells indicate that India does not have any trade agreements with them

The government’s plan to influence RTAs to buttress the export potential of capital goods will work only when our domestic manufacturers are at par with their counterparts across the world in terms of competitiveness.

The incremental capital output ratio (ICOR) is the amount of capital required to produce one unit of output. The higher the ICOR, the less efficient the use of capital. India’s incremental capital output ratio (ICOR) suggests that so far, our effective utilization rate of capital is moderate and not high. This means that the output produced by increasing one additional unit of capital is high; henceforth, there is a scope of milking the possible positive outcomes by using more and more capital. Delays in the completion of projects, lack of complementary investments in related sectors and non-availability of critical inputs can all lead to a rise in ICOR. The ICOR in India has increased from 3.8 in 2016-17 to 6.9 in 2019-20, which is an undesired direction from the economic perspective (Ghosh, 2020).

The Indian government has come up with National Capital Goods Policy in 2016, which has all the requisite recommendations to bolster our export competitiveness. The same is expected in the upcoming Foreign Trade Policy 2021. Now, as we know that the gestation time to see the results of these policies are high. Therefore, we may see the early impact of export competitiveness by 2022 or so.

To develop as a globally competitive capital goods exporter in the age of smart manufacturing and swiftly changing technologies, it is vital that India encourages technological upgradation of domestic producers of capital goods. The government may give emphasis on addressing issues like inverted duty structure and the unintended consequences of export promotion policies like zero duty on import of capital goods and import of second-hand machinery, which affects the competitiveness of domestic capital goods producers. Attracting foreign direct investment with requisite technology inputs is another way to boost the sector’s prospects.