India blames external forces for exports mess but problem is internal. Budget 2020 can help

To boost exports, India must accept its challenge is internal, even though it keeps raising fingers at unfavourable external factors like trade protectionism.

An employee walks past shipping containers at the Jawaharlal Nehru Port in Navi Mumbai | Representational Image | Photographer: Dhiraj Singh/Bloomberg

Amid India’s worsening economic slowdown caused primarily by sluggish domestic demand for goods and services, exports could support economic growth. However, India’s exports in US dollar value terms have declined in six out of nine months in the current financial year, with December 2019 being the fifth straight month of contraction.

Yet, sluggish exports are not getting the attention they deserve, neither in mainstream media nor among the policymakers despite an ambitious target of US $1 trillion in goods and services export by 2024-25. Contrary to widespread belief, a series of bad regulations and internal mismanagement – and not really exogenous factors – have worsened India’s exports crisis.

The upcoming Union Budget 2020-21, therefore, provides the Narendra Modi government the right opportunity to junk its raw material protectionism, end inverted duties, and ensure tax neutrality in textile fibres that have been hampering manufacturing exports – something that the government didn’t do in its previous Budgets despite the demand from several quarters of India Inc.

Instead, the Modi government raised import duties on major industrial inputs such as ferrous and non-ferrous metals (steel and aluminium), parts and components for automobiles, camera, television and smartphones. To make matters worse, it has pulled out from the Regional Comprehensive Economic Partnership (RCEP) – whose 15 countries account for 20 per cent of India’s merchandise exports, according to official data – and has been dragging its feet on a free trade deal with the European Union (which accounts for another 17 per cent) that could provide new opportunities to push exports.

The sluggishness in India’s exports is not a recent phenomenon. Our merchandise exports have been hovering around US $300 billion. It was US $305 billion in FY 2011-12 and US $330 billion in FY 2018-19, even though the country’s GDP has gone up by over 60% from US $1.8 trillion to US $2.9 trillion during this period. The goods export has grown at a CAGR of 1.13 per cent between 2011-12 and 2018-19, and the prospects remain bleak in the current financial year, which is expected to post negative growth.

Not all on external forces

The Modi government has been hinting that global headwinds are behind sluggish exports, and not without reason. The EU is struggling with Brexit-related uncertainties and slowing growth in its larger economies such as Germany and France. The Middle East, another major exports destination for Indian merchandise, is troubled by its over-reliance on oil and gas, and regional political disturbances. Supply chains are now sourcing more locally than before. That is bound to affect India’s exports. Increasing trade protectionism, especially in the US, is creating further complications for India.

However, it seems we are giving too much credit to unfavourable external factors for our exports mess. India’s share in global merchandise export is so low (1.7 per cent) that it should be able to increase its share irrespective of external conditions. Given this backdrop, it would be interesting to analyse what’s been holding up India’s exports for long.

Narrow basket

The most important factor responsible for India’s exports stagnation is a narrow export basket. Not more than 20 product groups out of 99 account for 80 per cent of the total exports. We are targeting a smaller global exports pie (20 per cent, even as the balance remains largely untapped) and a narrow set of time-tested low-risk markets in Europe, North America, South East and West Asia. Even within Europe, the EU accounts for 90 per cent of India’s total exports to the region – something similar to the US in North America. However, the whole of Latin America, Commonwealth of Independent States (CIS) and Baltic states together account for less than 5 per cent of India’s total merchandise exports. That’s why the country’s total exports remains so low compared to the GDP.

To make matters worse, barring automobiles and a few other items, most of India’s exports are a commodity in nature, that is, undifferentiated products with no brand or pricing power. Thus, a woollen suit that retails for US $2,000-2,500 in New York or Tokyo doesn’t fetch more than US $200-250 for its Indian exporter. Just like IT and BPO services, most of India’s goods exports such as apparels or leather goods survive on exploiting labour cost arbitrage. No wonder India is losing to countries such as Bangladesh and Ethiopia, which not only have a competitive edge over labour cost but also have preferential access to top consuming markets such as Europe and North America.

That is not all

India’s excessive raw material protectionism, which often results in inverted duties – lower import duties on finished goods and higher duties on raw material – discourages manufacturing, and, in turn, the export of value-added products. In fact, it induces imports of high-value merchandise. That’s not difficult to understand. If the raw material is expensive, the finished products are most likely to be expensive. 

Thus, higher import duty on polyester and synthetic fibres, compared to those on apparels, is incentivising import of apparels into India rather than their export out of India. As there is more demand for synthetic fibres-based clothing in international markets, India’s fibre import policy is actually pushing export of low-value raw material such as cotton fibre and yarn to China rather than apparels to the EU and the US. Shrinking domestic demand for apparels aggravates the misery of Indian apparel manufacturers. Why produce apparels in India when you can import them cheap and duty-free from countries like Myanmar or Ethiopia?

Cost on dynamic goods, GDP

Similarly, being a common industrial input, expensive steel (due to India’s excessive steel protectionism that has increased under the Modi government) is imposing cost inefficiencies on much more dynamic downstream products such as automobile and auto components, engineering goods, electrical equipment and machinery, and in turn, dampens their export prospects. It makes the import of steel-intensive capital goods such as earthmovers, bulldozers and cranes more economical and attractive for users.

Logistics inefficiencies, especially those related to ports and customs, further put India’s merchandise exports at a disadvantage. Concerns on quality and safety remain a key deterrent for importers of Indian food and pharmaceutical products. Moreover, India has failed to take advantage of free trade agreements (FTAs) and regional trade agreements (RTAs) to push exports, mainly because of lack of domestic reforms – for instance, those related to land and labour markets as well as increasing raw material protectionism. One FTA that could give a big boost to India’s exports is with the EU, but the Modi government has not been able to break the deadlock on negotiation by being extremely unreasonable on investment protection.

Relatively poor exports performance adds to India’s current account woes and chops off a few hundred basis points of GDP growth. Given this backdrop, an over-valued exchange rate is bound to hurt India’s exports price competitiveness, but a weaker currency may not help much in pushing exports. That remains India’s major exchange rate policy dilemma.

The way forward

To give a real boost to exports, it is important to realise that India’s bigger challenge is internal, even though it keeps raising fingers towards unfavourable external factors such as increasing trade protectionism. Moreover, too much focus on demand for incentives and tax sops to compensate for many of the disabilities, such as logistical inefficiencies, prevents India from analysing the contributory role of poor regulations that have been hampering the country’s exports for long.

What Indian exporters, potential or actual, need on priority are prudent actions that effectively deal with the country’s bad regulation pile-up, which has proven disadvantageous for Indian merchandise vis-a-vis competing countries. This calls for putting an end to raw material protectionism and inverted duties to start with. Sops on exports, in any case, will have to be phased out as they violate World Trade Organization (WTO) rules. India needs to think beyond subsidies. It must also broaden the product and market mix. It can’t excessively rely upon a few product groups, such as refined petroleum products, chemicals and pharmaceuticals, and textiles, or a few low-risk markets such as Europe and North America to achieve its US $1 trillion exports target by 2024-25 without effectively dealing with internal impediments. The question is: will Finance Minister Nirmala Sitharaman’s upcoming Budget on 1 February deliver on this?

The author is a business economist and currently the CEO of Indonomics Consulting Private Limited. Views are personal.