PLUSES & MINUSES. How to solve India’s exports puzzle

The steady decline in India’s exports over the past one-plus year has been at the centre of a raging debate in India. Granted, global factors such as tepid global demand, erosion of commodity prices and high volatility in currency markets have contributed to this conundrum. However, trade performance of any country is determined by internal as well as external factors.

External factors consist of global economic conditions, market access, possibilities of export diversification, and effective trade agreements. Internal factors include macroeconomic management (price and income elasticity of exports, exchange rates, trade policy, interest rates and inflation), goods and services market reforms, and sound institutional and regulatory policies.

A combination of these factors determines the productivity and overall competitiveness of exports. Therefore, the current decline in India’s exports must be analysed by taking into account the state of play of these external and internal factors.

Many policy thinkers argue that an overvalued rupee is partially responsible for the recent decline in India’s exports. To understand the relationship between exports and exchange rate, we need to look at the growth of India’s exports and real effective exchange rate (REER) between 2002 and 2015.

Till 2013, the relationship between export growth and REER was mixed ( See chart ). After this period, it exhibits a clear trend that an overvalued rupee has affected the growth of India’s exports.

This corroborates a well-tested hypothesis that “a stronger currency is not good for export outlook”. Many countries in East Asia including China pursued the strategy of relatively undervalued currency to make their exports competitive in global market under their export led industrialisation.

However, one has to keep in mind that a relatively undervalued currency does not generate additional demand nor is it a permanent solution to all the ills prevailing in the domestic economy.

But in a highly complex and competitive world, where countries are competing for their export interest, the value of currency must be fairly placed vis-à-vis competing currencies to make one’s export competitive.

Another factor behind the steep decline in India’s exports could be over-dependence on a few markets such as the US and European Union countries which together account for 40 per cent share in India’s total exports. It is particularly important in view of falling demand, stagnant growth and resultant aggregate demand in these countries.

The Regional Hirshman Index (RHI), a standard measure of export market diversification, demonstrates that while India’s RHI with the EU and the US declined from 0.067 and 0.061 in 2005 to 0.033 and 0.036 in 2015, there is not much corresponding increase in the RHI with Asia and Africa.

This increased from 0.229 and 0.004 in 2005 to 0.246 and 0.011 in 2015. The overall RHI of India’s exports has witnessed a marginal decrease: from 0.5742 in 2005 to 0.5713 in 2015.

While improved RHI with Asia is because of India’s extensive engagements with Asian countries through regional and bilateral trade agreements, it has made limited progress in terms of diversifying its exports to non-traditional markets such as in South America, Africa and the Eurasian countries.

The diversification of export markets is important in the context of future sources of global aggregate demand and the changing dynamics of the global trading through mega regional trade agreements.

It is widely believed that competitiveness of exports hinges on the price and income elasticity of exports which largely depend on the nature of exports of the country. In this regard, a study carried out by Mehdi Raissi and Volodymyr Tulin — ‘Price and Income Elasticity of Indian Exports: The Role of Supply-Side Bottlenecks, 2015’ — provides a fair insight about price and income elasticity of India’s exports.

It says India’s exports are sensitive to relative price competitiveness and global demand. It corroborates the popular perception that the current decline in India’s exports is caused by a fall in global demand and loss in price competitiveness.

Therefore, in view of such external shocks, a slight adjustment in exchange rate could serve as an effective instrument to address challenges emanating from relative price competitiveness and can help India’s exports.

Exchange rate management alone will not relieve India’s export conundrum. The country should make continuous efforts in alleviating supply-side bottlenecks to boost sectoral productivity and export competitiveness.

Therefore, India should adopt a calibrated approach towards structural reforms to address cyclical as well as structural factors at the external and internal fronts, which are adversely affecting our export performance.

On the external front, India should engage with those trade agreements which would help in securing better market access, can diversify our exports and provide greater space for our producers to participate in global production networks.

On the internal front, India should emphasise on reforming domestic policies and institutions dealing with macroeconomic management (exchange rate, inflation and interest rates), standards, intellectual property rights, trade facilitation, and organisations vis-à-vis operational aspects of trade and investment rules and regulations.

In all this, the Centre should use its national organisations such as the Council for Trade and Development, the Board of Trade and the export promotion councils more effectively to work out national strategies to take the agenda forward.

The writer is the secretary general of CUTS International. With inputs from Surender Singh