The Budget (FY14) has recognised the rising current account deficit (at 4.6 per cent of GDP in FY12) as the biggest threat to India’s macro-economic stability. Given the inelastic nature of India’s major imports (e.g. crude, coal, edible oil and fertilisers) and the insatiable demand for gold, the long-term solution to the problem of CAD lies in attracting foreign investment or increasing exports.
Of the two key components of foreign investment, FII is highly volatile and its net inflows depend on risk-weighted return in equity markets. FDI inflows depend upon the overall attractiveness of India as an investment destination.
Given the huge demand for FDI across the regions and India’s poor record on ease of doing business, there is a limit to how much FDI India can get. This leaves us with only one viable alternative — to push exports.
Export of services
The sectoral composition of an economy must be in congruence with its export basket. However, India’s share in the world export of services is just 3 per cent, compared with China’s 4.5 per cent, despite India’s tertiary sector accounting for roughly 60 per cent of the GDP.
Export of services (as much as manufacturing or farm exports) does not suffer from infrastructural and regulatory impediments. Yet the sector accounts for not more than one-third of India’s total exports of goods and services taken together.
India’s export of services has a narrow base (in terms of product offerings and market mix) with the share of IT and ITES in India’s export of services alone being 40 per cent. Of that, more than 75 per cent goes to just three countries — the US, the UK and Canada. There is a growing sentiment against outsourcing, especially in the US.
These markets do not have much scope for incremental exports. Fast-growing emerging markets should have been the focus for export of services, but these remain largely untapped.
Another sector with a huge potential for earning foreign exchange is tourism, but it is constrained by infrastructural limitations (such as high cost of real-estate) and of late growing safety concerns, of women tourists in particular.
Export of merchandise
Farm exports suffer from poor post-harvest infrastructure, less emphasis on processing and policy flip-flops on export.
Manufacturing exports suffer from a series of bottlenecks, ranging from poor transport infrastructure to rising input cost (aggravated by the disadvantageous exchange rate of rupee and import parity pricing of inputs).
Slower regulatory approvals, and rising cost of compliance with red tape make India’s merchandise exports uncompetitive, and lead to increasing exports of low value raw materials/intermediates, such as fibre or yarn instead of apparel, or mineral ores instead of finished products.
The share of manufactured goods in India’s export has declined from 78.8 per cent in FY01 to 69 per cent in FY11 and further to 64.5 per cent in April-November FY13.
On the other hand, imports from low-cost countries are on the rise because domestic manufacturing is increasingly becoming uncompetitive. Export incentives of 2-5 per cent of the export value cannot compensate for 7-9 per cent of export transaction cost.
Export Incentives
To comply with its commitments to WTO, India will have to phase out most of its export incentives (except duty drawback and Textile Upgradation Funds Scheme) once it reaches per capita GNP of $1,000 at 1990 prices. Export competitiveness is deemed to be achieved if a country’s global export share of a specific product group (to be defined as a section heading of the India Harmonised Code System) is 3.25 per cent or more in two (consecutive calendar) years.
As a result, export sops for sectors such as textile and clothing (falling under section heading XI of the Harmonised Code System) will have to be phased out. Yet, most of our export promotion talks centre around incentives and sops, though there is no denying their utility as a short-term measure.
What can be done?
As per the World Bank’s Ease of Doing Business Report 2013, over one-third of the cost of export formalities is on export documentation. Rationalisation of documentation requirement (as suggested by Task force on Trade Transaction Cost), therefore, will be a real thumbs-up for India’s exports.
Expediting preferential trade agreements (given the stalemate over WTO Doha Round) with emerging countries in Asia, Africa and Latin America (e.g. India-Mercosur) will help, given the prohibitive tariff and non-tariff barriers, low levels of existing bilateral trade, comparable incomes and similar consumer preferences.
However, not all preferential arrangements can be helpful to India’s exports. For instance, 30 per cent domestic content requirement under SAFTA meant for duty-free import of garments from LDCs like Bangladesh, is actually leading to backdoor entry of Chinese fabrics into India.
Ensuring cooperation on harmonisation of trade regulations can further increase intra-SAARC trade and boost India’s exports.
Besides, India will have to increase its exports to China in order to reduce its burgeoning trade deficit with the country.
Trade pacts with developed countries are another area. India-EU may support export of Mode 4 services, but market access benefit for India’s merchandise exports will be limited because of the existence of low tariff barriers in EU.
Non-tariff barriers
Advanced EU countries are increasingly resorting to non-tariff barriers that are too difficult to penetrate through free trade pacts, such as carbon trade measures. Mutual Recognition Agreements, whether under the framework of FTAs or outside, will be needed, given the increasing cost of compliance with such regulations, thereby decreasing net realisation from exports.
Many of India’s key exports are low margin affairs, such as readymade garments. Margins will be under further pressure (in future) because of the increasing competition from low cost countries such as Bangladesh, Cambodia and Vietnam.
The result would be more volume but not much addition to the value of exports. Some kind of product differentiation (such as voluntary carbon labelling) will protect our margins in key export markets such as EU and the US, and needs incentivisation.
India’s share of 1.7 per cent in global merchandise export, as compared with China’s 10.5 per cent, is quite low.
There is, thus, immense potential to increase it to 5 per cent in the next few years.
In the light of the rising cost of skilled workers, the key to promoting exports of services lies in ensuring adequate supply of skilled workers, in addition to broadening our offerings in services and reaching out to emerging markets.
The author is Group Economist of a corporate house. Views are personal.