Policy Brief Series Issue 1, Aug 2011
India’s Trade Recovery after the Global Financial Crisis: Good Luck or Good Policies? Sasidaran Gopalan and Ramkishen S. Rajan1
Key Points • The Indian economy has been growing rapidly over the last decade along with surging external trade. • While the global recovery has been uneven and tepid, India’s exports have recovered from the global slowdown and the government has set an ambitious export target of US$400 billion by 2014. • Policy makers in India are actively trying to enhance the country’s export competitiveness through a judicious use of bilateral free trade agreements and tapping the dynamism of India’s services sector. • However, far greater efforts are needed to minimise the transaction costs and procedural complexities, a point not lost on the government which created a task force in October 2009 to identify ways to reduce export transaction costs.
Introduction The Indian economy has been growing very rapidly over the last decade, expanding at an annual average of 7.2 per cent between 2000 and 2009. Over this period, the economy has also become much more outward-oriented, both in terms of cross-border capital flows as well as international trade flows. The merchandise trade-to-GDP ratio doubled from about 21 per cent in 2000 to 42 per cent in 2008. By way of comparison, the same ratio was just 13 per cent in the pre-reform period in 1990 (Figure 1). Indeed, India has experienced an international trade renaissance in the last few years. India's merchandise exports (including re-exports) more than doubled from about US$95 billion in fiscal year April 2005-March 2006 to
Ramkishen Rajan is currently a Visiting Professor at the Lee Kuan Yew School of Public Policy, National University of Singapore and Professor of International Economic Policy and Public Policy, George Mason University, USA. E-mail: rrajan1@gmu.edu. Sasidaran Gopalan is a Research Scholar at the School of Public Policy, George Mason University, USA. E-mail: sasi.daran@gmail.com. All errors are our own. 1
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nearly US$180 billion in the 2009/10 budget year while its merchandise imports also more than doubled from about US$138 billion to exceed US$280 billion in the same period (Figure 2). Buoyed by these impressive figures, the Indian Ministry of Commerce and Industry has set an ambitious export target of US$400 billion by 2014, to more than double the value of exports in the five years of the 2009-2014 foreign trade policy plan. This said, as this policy brief illustrates, the government is well aware that it needs to undertake far greater efforts to minimise transaction costs and procedural complexities, a point it has acknowledged by forming a task force for this purpose in 2009.
Figure-1: GDP Growth Rate (%) and Trade as a Percentage of GDP
Source: Compiled from World Development Indicators Database.
Figure-2: India's Growth, Exports and Imports (FY2005/06 to FY2009/10)
Source: Adapted from IBEF (2010) ), available at www.ibef.org.
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India's External Trade - Key Facts Ever since India initiated wide-ranging trade and industrial reforms in 1991, it has gradually opened up its economy by lowering trade and investment barriers. The average applied import MFN (Most Favoured Nation) tariff rates for non-agricultural and non-fuel products in 2009 stood at 9 per cent (though the median applied agricultural tariff was 35.2 per cent in 2009), while India liberalised its foreign direct investment regime over the past two decades. This shift towards outward orientation has helped put India on a much faster growth trajectory. India’s exports have surged, growing at an annual rate of nearly 20 per cent between the period 2000 and 2009, averaging US$100 billion annually. It is significant that India’s exports averaged an annual growth rate of about 24 per cent between 2004 and 2008 before the global downturn hit. This in turn kept India’s trade deficit at around US$50 billion on average for the period from 2000 to 2009 (Figure 3), or 1.5 per cent of the country’s GDP. India moved rapidly up the global trade rankings and was among the top 25 of the world’s leading merchandise exporters in 2009, though its share of global exports was a rather low at 1.3 per cent. India was even more impressive in the case of exports of commercial services, being placed at 12th position in 2009 and contributing about 2.5 per cent of the world service exports.
Figure-3: Merchandise Exports, Imports and Trade Balance
Source: Compiled from Reserve Bank of India Database available from http://www.rbi.org.in/scripts/statistics.aspx
Examining the composition of India’s trade (Figure 4), in FY1999/2000, half of the country’s merchandise exports were destined for the advanced economies such as the United States (23 per cent), United Kingdom (6 per cent), Germany (5 per cent), Hong Kong, China (7 per cent), Japan (5 per cent) and United Arab Emirates (6 per cent), which remained
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the top six trading partners in that period. However by FY2009/10, there was a marked shift in India’s export direction. With the exception of the UAE (which continues to be a significant partner due to its oil trade with India and which has also risen in importance over the years), almost all the other economies have seen their shares go down substantively, with the decline most pronounced in the case of the U.S. (11 per cent). Figure-4: Major Export Destinations of India (% Share of Total Exports)
*Note: FY 2009-2010: April-September Source: Compiled from Reserve Bank of India Database; Ministry of Commerce and Industry, India; Economic Survey 2010-2011
The emergence of China as an important trade partner in the last decade, with about 6 per cent of India’s exports directed to the country, is notable. The other East Asian country that has become India’s major trading partner is Singapore, after the signing of the bilateral free trade agreement, the India-Singapore Comprehensive Economic Cooperation Agreement. Indian exports to Singapore have risen significantly since 2005 while Indian exports to Singapore hovers at 5 per cent. During the fiscal period April 2009 to September 2010, Asia (including ASEAN) remained India’s largest export destination to account for 55 per cent of total exports. It was just 40 per cent in FY2001/02. During the recent period, Asia’s share was more than double that of the EU (21 per cent), and more than quadruple that of North America (12 per cent).
Impact of the Global Financial Crisis and Recovery While the Indian economy was, on the whole, relatively immune from the global economic crisis during FY 2008/09, India’s exports declined along with global trade. India’s export growth slowed to 13.6 per cent in FY 2008/09 before shrinking 3.5 per cent during FY 2009/10. India’s monthly growth rate of exports and the global exports growth rate moved
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together, exhibiting a strong correlation. The monthly growth rates of both global and India’s merchandise exports hit a trough in November 2008 (Figure 5).
Figure-5: Monthly Growth Rate of Global Exports and India’s Exports (May 2007-March 2010)
Source: Compiled from World Trade Organization Statistics and Reserve Bank of India Database
During the third quarter of FY 2008/09, in the October-December period, while global exports declined by 22 per cent, India’s exports fell by 8 per cent. The bulk of the decline in India’s exports was concentrated in the developed world, namely the US and EU, particularly in exports of gems and jewellery, chemicals & related products and engineering goods with respect to these markets. However, overall, exports in all the sectors including manufacturing, primary products, petroleum crude and products were hurt by the recession. India’s exports of services such as IT and related services were not as badly affected as the merchandise exports and they reached US$106 billion in FY 2008/09. However, as a result of the global recession, owing to substantial declines in demand from the Western countries, the exports of services took a hit in FY2009/10, registering a decline of just under 10 per cent. With the exception of the dominant software services that continued to be resilient (though the rate of growth slowed during the crisis period), the share of all the other services such as business, communication, travel and transportation experienced a decline (Figure 6). While the global recovery has been rather uneven and tepid, available data for 2011 suggests that India’s merchandise exports have recovered from the crisis and may reach US$ 225 billion in FY 2010/11 mainly due to a sharp upturn in demand in the US and Latin America where exports rose by more than 30 per cent between January 2010 and January 2011. Apart from Latin America, exports to other non-traditional markets such as Africa have
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Figure-6: India’s Services Exports (% Share)
Note: GNIE – Government Not Included Elsewhere. Source: Compiled from Economic Survey 2010-2011.
also contributed to the robust turnaround in India’s exports. In contrast, merchandise exports to the traditional markets such as Europe remained below the pre-crisis levels in 2008.
India’s Foreign Trade Policy (FTP) 2009-2014 In the midst of the anaemic global recovery, especially in the Western world, India unveiled in August 2009 its new Foreign Trade Policy (FTP) for the fiscal years 2009/10 to 2013/14 with the immediate short-term objective of stemming and reversing the declining trend in exports growth and to provide additional incentives to sectors badly affected during the global downturn. The FTP hopes to achieve an annual export growth of 25 per cent to take India back to its pre-crisis export growth path by 2014. The FTP aims to double India’s share in global trade to around 3 per cent by 2020.
Trade Promotion One of the major objectives of the new FTP is to enhance the process of diversification of India's export products and markets. The shift to non-traditional markets has been actively aided by offering a range of incentives to exporters to explore 39 new markets - 26 under the Focus Market Scheme (FMS) and 13 under market-linked Focus Product Schemes (FPS). The FMS primarily aims to offset high freight costs involved in choosing select international markets in order to enhance India’s export competitiveness in these countries. It has also increased the duty credit scrip - which either provides credit for payment of import duties or other forms of settlement of export finances for exporters - from 2.5 per cent to 3 per cent of the value of exports under the FMS. Under the Focus Product Scheme (FPS), a number of products including automobiles and other engineering products have been included for in-
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centives, where the objective is to encourage the production and exports of those products that possess high employment elasticity. India also extended incentives (mainly in the forms of rebates or exemptions on imported inputs) to certain sectors including capital goods and textiles until March 2011, the end of the fiscal year, to boost exports. While it is unclear whether India’s export markets in the US and EU will continue to recover on a sustainable basis, Indian policymakers view market diversification as an important goal to reduce the country’s dependence on the developed world export markets. Free Trade Agreements (FTAs) are also being used to help diversify exports markets and increase market access for Indian exports.
India’s Approach to FTAs As global trade talks have stalled, countries in Asia and elsewhere have been using FTAs as an instrument to promote their trade interests worldwide. While India has been relatively slower off the mark than many of their Asian counterparts in negotiating trade deals, there have been some notable agreements in recent times. India has pursued a number of bilateral deals with countries such as Sri Lanka, Republic of Korea, Thailand, Singapore, Malaysia, New Zealand, Canada and Israel as well as trade blocs, namely, MERCOSUR and ASEAN. Other trade pacts are at various stages of consideration, including ones with the European Free Trade Area, the EU, Japan, Russian Federation, South Africa, Egypt and Turkey (Table 1).2 These FTAs are designed to allow more access to Indian exporters in overseas market and reduce export transaction costs, though care must be taken to ensure that the trade creTable-1: Recent Bilateral/Regional Initiatives by India (2000-2010) Trading Partners
Nature of Agreement
Status (2010)
Singapore
FTA
In force
Sri Lanka
FTA
In force
APTA
FTA
In force
Bhutan
FTA
In force
Nepal
FTA
In force
SAFTA
FTA
In force
Canada
FTA
Proposed
Several of these agreements were started well before the global crisis began and hence it would be inappropriate to conclude that India’s active pursuit of FTAs were an outcome of the crisis. However it is likely true that with the muted recovery of the advanced economies such as the US and the EU, India is likely to intensify its efforts towards regionalism in Asia and other countries of the “Global South” as part of its overall diversification strategy. 2
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Trading Partners
Nature of Agreement
Status (2010)
Thailand
EPA/FTA
Framework Agreement Signed
ASEAN
FTA
In force
BIMSTEC
FTA
Framework Agreement Signed
SACU
FTA
Framework Agreement Signed
MERCOSUR
FTA
In force
GCC
FTA
Framework Agreement Signed
New Zealand
FTA
Under Negotiation
Afghanistan
PTA
In force
Chile
PTA
In force
Russia
CEPA
Proposed
USA
FTA
Proposed
China
BIPA & FTA
Proposed
Korea
FTA & CEPA
In force
Mauritius
CEPA
Under Negotiation
Japan
EPA/FTA
Under Negotiation
Colombia
FTA
Proposed
Australia
EPA/FTA
Proposed
Egypt
PTA
Under Negotiation
EU
FTA
Under Negotiation
EFTA
FTA
Under Negotiation
Indonesia
EPA/FTA
Proposed
Israel
FTA
Proposed
Turkey
FTA
Proposed
Uruguay
FTA
Proposed
Venezuela
FTA
Proposed
Nepal
FTA
In force
CEPEA/ASEAN+6
EPA/FTA
Proposed
Source: Adapted from Sally (2011 ), “Indian Trade Policy after the Crisis,” ECIPE Occasional Paper 4/2011.
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ation benefits outweigh those of trade diversion. India must also recognise that many of its trade pacts still do not focus as much on services as it should, as it is unlikely to benefit from narrow agreements that cover only goods. Hence its interests would lie in maximising the trade-offs from concessions it makes in goods with benefits it can gain in the areas covering services, investments, and movement of labour. India is pushing hard for a more liberal global trade regime in services and is also pursuing separate service trade pacts with ASEAN nations.
Price Competitiveness and Indian Manufacturing Apart from transaction costs, India also needs to be sensitive to its external price competitiveness, especially vis-à-vis China and other East Asian economies. A simple but useful measure of such competitiveness would be to look at India’s real effective exchange rate (REER). During the period 2001-2010, India’s REER rose around 17 per cent while China’s rose about 3 per cent. This sharp difference is a combination of both relatively higher nominal appreciation of the Indian rupee (which is relatively more flexible than the Chinese Yuan) as well as the outpacing of inflation rates in India over those in China (Figure 7).
Figure-7: Trends in Real Effective Exchange Rates - India and China (2001-2010)*
* Figure shows data from the fourth quarter of FY2001/02 to the fourth quarter of FY2009/10 Source: Compiled from BIS Effective Exchange Rate Database
India’s rising REER relative to China along with general rising labour costs in India has raised some concerns about India’s possible loss of cost-competitiveness in the labourintensive segments of the IT and IT-enabled services (ITES). Against this are signs that China's labour and overall manufacturing costs are increasing, making it cost-competitive for Indian firms to manufacture parts/goods locally rather
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than rely on Chinese imports. Escalating costs in China along with India's rising manufacturing prowess has led India to export more automobiles than China in 2010. According to a 2011 consulting study by Booz Allen & Company, the Indian Automobile industry would become the world’s fourth largest by 2015 with the industry selling nearly 6 million units annually by 2020. India’s low cost of operations has also resulted in key players such as Volkswagen AG and Ford Motor Company increasingly sourcing auto components from local suppliers. Over the last two years, India has secured investments worth more than US$1.9 billion in the auto components industry. It is also perhaps opportune that the government has approved the draft National Manufacturing Policy (NMP) to increase the share of manufacturing in the GDP to 25 per cent by 2025 from the current share of 16 per cent. The NMP aims to build mega-industrial zones with world-class infrastructure facilities and create 100 million new jobs. The NMP is also expected to complement the FTP to assist export promotion activities by providing the necessary environment to emerge as a global manufacturing hub. While the policy incentives have focussed on manufacturing, India’s services sector has been largely ignored. The only notable incentives post-crisis pertaining to services have been the extension of a 10-year tax holiday for export-oriented units in the Information Technology (IT) industry under the Software Technology Park of India (STPI) scheme and the increase in duty free entitlement of foreign exchange earnings from 5 per cent to 10 per cent for hotels under the new FTP.3
Focus on Export Transaction Costs Trade facilitation measures broadly pertain to the reduction of key transaction costs from the administration and enforcement of trade policies. Bureaucratic and procedural delays significantly raise the cost of compliance. According to the World Bank's Doing Business Report (2010), the average cost of export in India is US$945 per container, driven mainly by export related documentation. The report estimates that in 2010, trade related transaction costs in India amounted to approximately US$17 billion, or 10 per cent of the nation's export value. The government has signalled its intent to meet, if not surpass, its export growth targets and acknowledged the importance of minimising such high transaction costs by creating a task force in October 2009 to identify ways to improve “the functioning of export processes and reduce time and money spent in export transactions, with a view to enhance the competitiveness of Indian exports”. The task force identified elements of transaction costs that could be addressed both in the short run and long run. The government has accepted many of the recommendations of the taskforce and has begun implementing measures within various ministries to reduce procedural complexities with the aim of enhancing the global competitiveness of India's merchandise export sector.
3
However, the tax holiday under STPI was not extended beyond March 2011.
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Such measures include round-the-clock customs clearance at selected ports, reduction in levies, and electronic message exchange between the Customs authority and the Director General for Foreign Trade (DGFT) that facilitates faster clearances. These are expected to reduce the export transaction cost by around US$460 million. Other key proposals in line for implementation include the integration of all trade-related agencies through a “singlewindow eTrade initiative” and the development of port-related infrastructure. The proposed recommendations of the Task Force, especially the ones focusing on short-term measures, if implemented, would potentially reduce the transaction costs significantly.
Port Development Available data reveals the importance of India’s seaports, which handle about 95 per cent of the country's total trade volume and about 70 per cent in terms of value.4 With Indian port utilisation exceeding 90 per cent on average (Figure 8), the continued development of its ports is urgently needed in order to both sustain the nation’s higher trade and overall economic growth trajectories. Recognising this, the Ministry of Shipping has recently released the Maritime Agenda 2010-2020 that aims to upgrade India’s port infrastructure by tripling capacity in the coming decade. The government’s Maritime Agenda 2010-2020 projects that by FY 2019/20 port capacity will more than triple to 3.2 billion tons if the slated investment of US$100 billion
Figure-8: Capacity Utilisation in India's Ports
Source: Compiled from Ministry of Shipping documents, Government of India.
The 13 major ports handle around 67 percent of India's external trade while the remaining 33 percent is handled by the minor and intermediate ports. It is pertinent to note that the share of minor ports has increased from less than 10 percent five years ago to 33 percent today, while that of the major ports has shrunk during the same period. 4
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towards building of new ports is realised. If these targets are met, the growth in port capacity is expected to be faster than the projected growth in port traffic, which indicates that capacity utilisation ought to decrease gradually to 80 per cent by FY2019/20. While this port expansion is much-needed, there are a number of other structural constraints that ail India’s ports such as relatively slower turn-around times, the absence of a multi-modal system of transport to enable connectivity to the hinterland, limited use of Information Technology (IT) infrastructure, and productivity-related inefficiencies. All of these issues need to be tackled with much more urgency. India’s port tariffs also need to be streamlined, rationalised and regulated to be on par with internationally acclaimed benchmark ports.
Conclusion India has recovered well from the global financial meltdown – so far. This recovery has been aided by the revival of its external trade. The government has been proactive in this regard by unveiling a slew of export promotion measures to explore new additional markets and products as part of the larger export diversification strategy. Such strategies are particularly crucial given the likelihood of continued turmoil in the global economy and on-going concerns in the US and Euro-zone economies. There is also much greater appreciation of the need to bring down export transaction costs. In addition to the stated objectives and the ones that have been implemented under various schemes, a broader focus on upgrading India’s hardware (ports, roads, airports) would augur well for boosting the competitiveness of India’s exports. These efforts are likely to have far greater sustained benefits than ad hoc fiscal incentives, an artificially weak currency, or Special Economic Zones (SEZs), which have been somewhat controversial. They must therefore be pursued with greater conviction if India is to sustain its growth environment in an increasingly turbulent global economy.
The Lee Kuan Yew School’s Briefing Room Series is edited by Toby Carroll, Senior Research Fellow at the Centre on Asia and Globalisation, and Claire Leow, Senior Manager for Research and Dissemination at the Research Support Unit. Feedback should be sent to: research.lkyschool@nus.edu.sg