Sustaining the green shoots of Indian economy

The Indian economy is showing green shoots again after the brutal second wave of COVID-19 which almost paralyzed economic activity for a year. Exports are currently robust, and India has a critical window of opportunity to build on this momentum. This article explores major focal points for policy reform and implementation that will help India exploit this opportunity.

• Recent data on India’s GDP growing by more than 20% in Q1, driven primarily by high exports and followed by construction and manufacturing growth, is indicative of the commencement of economic revival. Sustaining this growth is of paramount importance to pull out millions from poverty and facilitate India’s sustainable development.
• The Economic Survey established that states which engage with the world markets as well as with the other states within the country are richer. So, it’s important to improve the export competitiveness of Indian states. For this, state governments need to cooperate very closely with the central government and build certain value chain areas where each state would specialize in and therefore the focus on clusters is very important for this policy to succeed.
• Further, OECD simulations point out that, if India cuts tariffs and non-tariff measures, restricting trade by 20% and improves trade facilitation, domestic production would rise by about 3% and exports by 14%.
• India also needs to urgently overcome bottlenecks related to infrastructure, export credit and shortage of containers.

Image credit: Shutterstock

Good news dawns as the Indian economy is showing green shoots again after the brutal second wave of COVID-19, which almost paralyzed economic activity for a year. Recent data on GDP growing by more than 20% in Q1, driven primarily by high exports and followed by construction and manufacturing growth, is indicative of the economic revival.

India exported goods worth US$ 33.14 billion in August, up 45.17% on-year, as demand continued to remain robust from other countries (India’s exports have been doing quite well since the last six months, registering an average growth of more than 40%). It is now becoming a key player in the global economy, partly reflecting reduction in tariffs since the last decade and relatively low non-tariff barriers.

India’s services exports increased 24.1% month-on-month to US$ 19.72 billion in June 2021. Its share of world services trade more than quadrupled from 0.5% in 1995 to 3.5% in 2018. It has become one of the major exporters of business services, notably ICT and legal services. Medical and wellness tourism is also supporting growth in service exports. Exports of services now account for more than one-third of total exports. India is also developing specific action plans for twelve identified champion services including tourism, transport, and logistics. Product Linked Incentive Scheme (PLI) will further provide a thrust to investment and exports in time to come.

Undoubtedly, India’s large diaspora, which is well integrated into other economies of the world, is helping develop new export markets and facilitate the transfer of technology, fuelling the fastest export growth in recent months. This diaspora, the largest in the world, has helped develop trade networks and linkages, while also making remittances and savings that have supported investment and domestic consumption. Its openness to trade has led to increase in India’s exports- and imports-to-GDP ratio. It now stands almost at par with China. The large share of services in total exports, however, stands out.

Consequently, India’s market share for some skill- and capital-intensive goods has surged. For pharmaceutical exports, India accounted for 2.5% of total world exports in 2018, up from 1.1% in 1995, making it the 11th largest exporter in the world and, by far, the first among emerging markets. In the smartphone segment of electronic goods, India has transformed itself from being a net importer to a net exporter, registering a growth of 250% during April- June 2021, compared to the same period last year. Crude refining capacity has expanded (most crude oil is imported), and the share of petroleum products in total exports has increased steadily. India is also the largest manufacturer of cut and polished diamonds, exporting 93% of its production.

India has succeeded in increasing the number of goods exported and in serving new markets/countries. Its export basket is highly diversified and exports to emerging economies are growing fast. However, few sectors like furniture and chemicals and ceramics need to be focused on to make the export basket more robust. Such a diversification reveals the high potential of the Indian economy to adjust to new demands. It also reduces exposure to risks such as lower demand in one country or for one specific product.

Furthermore, India has improved significantly on trade facilitation since the mid-2010s by reducing the number of documents and level of fees, and thus trade costs. It is now close to best performance in OECD countries on many dimensions identified in the OECD indicators. Still, the number of documents for importers and exporters is high and agency cooperation at the border could be improved. Overall, the time and costs for border compliance with customs and other regulations are relatively high. The government announced new measures to reduce processing time at ports and airports in September 2019: the adoption and testing of standards will be encouraged, while export clearances – including some customs requirements which are currently processed manually – will gradually become digital. The Goods and Services Tax (GST), which allowed firms to deduct taxes on inputs, is a clear improvement and the manufacturing sector has benefitted most.

To make India a hub for global value chains under the Make in India flagship; it must focus on efforts to boost foreign investment inflows by modernizing regulations and attract more savings from Indians living abroad. As an encouraging sign, some multinationals have made India a manufacturing hub for automobile exports to Africa. The imposition of US tariffs on Chinese products could accelerate the rejigging of value chains. Preliminary data suggests that India has seized some of the market share lost by China, with more success in the capital- and skill-intensive industries than in labor-intensive ones. This article discusses major areas that India needs to exploit these opportunities to enhance its international trade.

Ease of business and trade

India could perform better in some areas for export competitiveness. These include labor-intensive manufacturing exports, where India has a clear competitive advantage, and foreign direct investment. Low wage demand of Indian workers is an opportunity, as more dynamic manufacturing exports could be created. This would create jobs, including for the many unskilled workers currently unemployed or under-employed in the low-paid unorganized sector. The increase in Chinese workers’ incomes creates a window of opportunity for Indian exports, as demand from China is increasing.

Special Economic Zones (SEZs) benefits to the operating companies have ended, which has led to the stopping of investments in SEZ. India has more than 230 operational SEZs, which accounted for 18% of exports of goods and services and employed more than two million people. At present, an exporter in an SEZ and a foreign exporter are at par when it comes to selling goods to a domestic tariff area (DTA). Therefore, an exporter within the SEZ should be incentivized on the degree of value addition he brings to a product. He should be allowed to import raw material at zero duty and avail duty rebate proportionate to value addition. This will keep him in an advantageous position as opposed to importing finished products from another country. Also, it will lead to automatic cauterization as the incentive will act as a pull factor.

The Economic Survey adds that states which engage with the world markets as well as with the other states within the country are richer. So, it’s important to improve the export competitiveness of states, which will also mitigate regional disparities through export-led growth and enable the consequent rise in the standard of living. State governments need to cooperate very closely with the central government and build certain value chain areas where each state would specialize in and therefore the focus on clusters is very important for this policy to succeed.

In effect, exports of labour-intensive manufacturing products could grow faster. For example, within textile exports, the share of yarns and fabrics, which are increasingly automated, has increased while the share of labour-intensive products, like carpets, has declined. A focus on the low-technology segment for textiles, garments, and footwear, reveals that India has stopped gaining market shares since 2013; Vietnam now has a larger market share. Overall, manufacturing exports have fallen as a share of total exports and their composition has shifted from labour-intensive to high-skill and technology-intensive items.

However, labour regulations are more stringent for industries. Since these regulations become binding as firms grow, they create incentives for the firms to stay small. Firms cannot exploit economies of scale and productivity suffers, as does the competitiveness of labor-intensive manufacturing exports. In addition, employment protection legislation, which requires firms with 100 or more employees to obtain prior government permission to dismiss one or more workers.

Barriers to trade growth

India is a prominent exporter of agricultural products and its trade surplus in agricultural commodities has grown. The recent review of agricultural policies in India suggests that value chains in the food sector, however, remain relatively under-developed. Therefore, a more open and stable trade policy regime is essential for India to develop a sophisticated domestic processing and distribution industry to fully exploit its comparative advantage to export certain agricultural commodities.

Indian exporters face difficulty when it comes to trading on 100% credit & no safety for their payments. A dedicated credit policy with ESCROW payment facilities connecting the banks across the country is needed. The provision of pre & post-shipment credit with interest subvention for F&B products is also recommended. In few cases like Iran, there is no direct system of remittances to India through normal banking channels in respect of payments against consignments sent to Iran. Few bankers dealing in forex are reluctant to honor such payments/LCs to close the shipping documents.

The percentage of products and share of imports covered by non-tariff measures (NTMs) are both relatively low in India. NTMs are related to measures that pursue regulatory objectives. Sanitary measures and technical barriers and standards are mostly implemented in the food sector, often to overcome or reduce the impacts of perceived market imperfections, such as those related to health risks. Frequent border control measures and quantitative restrictions on vehicles may be a case in point.

India is also considering introducing a steel import norm whereby foreign steelmakers would need to get certification from the Bureau of Indian Standards for high-grade steel products being used by Indian manufacturers. The Indian auto industry could be penalized before local steel manufacturers start producing the specialized grades of steel they need for some auto-components while foreign manufacturers may not be interested in getting certification due to the low volume involved.

Non-tariff measures may raise trade costs and penalize more small companies with less access to legal and regulatory information. On the other hand, India relies on local content requirements, requiring firms to use domestically-produced goods and services, in particular in electrical machinery and equipment (including solar panels and telephone sets). By restraining competition from imports, local content requirements reduce the choice of inputs or providers and raise production costs.

Infrastructure enhancement

Quality of infrastructure is a key determinant of countries’ participation in global value chains. As exports of goods tend to be more intensive in energy and transport than services, they suffer more from infrastructure bottlenecks. The competitiveness of electricity-intensive exports has suffered from relatively high electricity prices and the lack of reliable provision in some parts of the country.

In addition, commercial and industrial users pay a higher price than households and farmers. Cross-subsidisation, coupled with large technical and transmission losses, has been reflected in relatively high electricity prices for industries. In India, the government has made laudable progress in increasing electricity generation and transmission capacities, in particular from renewable sources, to fulfill its commitment to provide electricity for all. Several reforms, such as reducing the number of electricity prices and making retail tariffs more cost-reflective, are being implemented in some states and would help make industrial companies based in India more competitive.

On the other hand, transport infrastructure bottlenecks, by increasing costs for exporting goods and importing intermediate inputs, are weighing on firms’ competitiveness. They also make it difficult for some regions to seize the opportunities that trade can offer for local development. The construction of highways and rural roads, however, has accelerated in recent years. India has also made great progress in building airport-related infrastructure.

However, seaport infrastructure lags behind and, together with poor trade logistics, hampers India’s external competitiveness. Around 90% of India’s external trade (by volume) and 70% (by value) is handled by ports. Most container handling ports lack the capabilities to handle large container vessels due to inadequate depth. India has only one trans-shipment port in Kochi. A large share of containers is thus transhipped through other ports, such as Colombo and Dubai, creating additional costs and delays.

Weak hinterland connectivity between production centres and gateway ports is another issue. It takes 46 hours to move shipments between a warehouse in Delhi and a port, i.e. at least 3 times more than the time required in other large emerging economies. Freight capacity by rail is saturated, although several dedicated freight corridors, under construction or preparation, should double freight capacity by rail. Inefficient regulations add to the infrastructure gaps.

Of late, there has been a severe container shortage, which has pushed ocean freight by more than 300%. The industry is worried that if this situation persists, there can be a 5% to 8% increase in the cost of goods from India. This will have an impact on exports too, due to equipment shortages or shipments will be postponed due to very high ocean rates.  Demand for Indian products will slow down due to high costs.

A digital container exchange forum to connect all the ports, shipping lines and container manufacturing and rental companies along with all logistics service providers, could solve the crisis momentarily. This will facilitate real-time availability along with the freight rates that will be completely market-driven. It should also have options of forwarding booking.

Investment promotion

India has liberalised its FDI policy in many sectors over the past two decades. The government aims at making India a more attractive FDI destination. FDI restrictions in single-brand retail, digital media, contract manufacturing and coal sector were loosened in August 2019. Local sourcing norms for single-brand retail FDI have been softened, which has resulted in record investment in India.

Foreign investment usually brings technology, knowledge and management skills, boosting productivity and export performance in the host country. It may also facilitate access to global markets. Empirical evidence suggests that inflows of foreign direct investment (FDI) in India have promoted services exports. In the automobile industry, some foreign companies have built production capacity in India, making India an export hub for markets such as Africa and West Asia.

Some Indian auto-part manufacturers became world leaders by having first acquired technical and managerial skills from leading original equipment manufacturers. FDI can also boost activity in small and medium-sized enterprises (SMEs) to global value chains, contrary to the frequent belief that benefits accrue mainly to large firms.

India will benefit more if barriers to trade and investment are reduced multilaterally. In the absence of a multilateral agreement, the economy would also gain from further liberalization of trade and investment. Although India faces restrictions on its exports in several key markets, OECD simulations point out that if India cuts tariffs and non-tariff measures, restricting trade by 20% and improves trade facilitation, domestic production would rise by about 3% and exports by 14%.

Trade agreements

India has used preferential trade agreements as a key component of its trade and foreign policy. Empirical evidence on the impact of preferential trade agreements on export performance is mixed. Some sectors appear to have benefitted, while others have experienced an increase in imports. Several factors may affect these results. First, the depth of most preferential agreements signed by India is relatively low– those with Japan and South Korea are exceptions since they also included services trade, investment, standards and competition.

Second, the initial level of tariffs matters: as tariffs tend to be higher in India than elsewhere, trade agreements may, in the short run, boost imports more than exports. Third, in the absence of concomitant improvement in the business environment, exports may fail to fully exploit the opportunities offered by foreign market opening. The intensification of trade agreements with CIS countries and Africa could add to exports. The government is already negotiation trade deals with the EU, USA, Australia, etc. Being markets where India has natural complementarities, these are important partners where India must make an aggressive push for trade agreements, while addressing genuine concerns expressed by the domestic industry.

---

The author is Director, Media & Corporate Communications, Trade Promotion Council of India. Views are personal.