External Sector

Trade Policy
• In the initial years of economic planning India adopted an 'inward
looking' strategy of industrialization. The strategy relied on
encouraging domestic production for the domestic market behind
high tariffs and high degree of effective protection to the domestic
industry
• India's participation in world markets declined steadily during second
half of the 20th century, with only a marginal improvement following
the reforms of the 1990s
• Import tariffs, based on the recommendations of the Tariff
Commission were initially used to provide infant-industry protection
to selected industries
• Rapid growth through industrialization needed the import of
machines which required a huge amount of foreign exchanges. This
led to BoP deficits. Persistent deficits in the BoP were mitigated by
increases in tariff levels rather than by devaluation of the rupee
• Alexander Committee recommended simplification of the import
licensing procedure and provided a framework involving a shift in the
emphasis from 'controls' to 'development’. The implementation of
the committee recommendations made import of capital goods
easier
• Abid Hussain Committee argued in favour of reduction of effective
protection, announcement of trade policies for longer periods to
maintain stability. Following the recommendations the government
started announcing long term (3-5 years) export-import policies
The Crisis of 1991
• The current account deficit rose to a record 3.2% of GDP in 1990, and debt.
Service payments amounted to as much as 35.3% of current foreign
exchange receipts
• Short-term debts amounted to a dangerously high level of 146.5% of
foreign exchange reserves by the end of March 1991. The inflation soared,
exceeding 10% in 1990
• The severity of the economic crisis of 1991 provided an opportunity for the
government to undertake major macroeconomic policy reform
• The focus of these reforms has been on liberalization, openness,
transparency and globalization with a basic thrust on outward orientation
focusing on export promotion activity and improving competitiveness of
Indian industry to meet global market requirements.
• There has been a clear shift in emphasis from import substitution to
export promotion
• The reach of the export incentives has been broadened to cover a
large number items of non-traditional and non-manufactured export
• The policy stance marks a move away from the provision of direct
export subsidy to indirect promotional measures
• The ratio of exports plus imports to GDP increased from 21.8% in
2000 to 38.2% in 2015. This implies that India has become more
integrated with the world economy
Structural Changes in India's Foreign Trade
during 1980s and 1990s
• India has gradually transformed from a predominantly primary
products exporting county into an exporter of manufactured goods
• The commodity composition within the major groups has also
undergone a considerable change. Within the 'primary products
group’, the share of ‘ores and minerals’ in total exports has declined,
while the share of ‘agriculture and allied products’ remained almost
unchanged from 1990 to 1998 but declined thereafter in 2000
• There is an increase in share of 'engineering goods' within the
manufactured products group. There is also increase in the exports of
processed agricultural products
• However, the shares of traditional export items such as tea, coffee,
cereals, handicrafts and carpets declined
• Organisation for Economic Cooperation and Development (OECD)
group continues to be our major export market followed by the OPEC
countries. The share of Eastern Europe in total exports of India had
seen a decline. This is possibly due to the collapse of the Soviet
Union. The loss of this market share was, however, made up by
increasing the shares in developing countries and the OPEC region
• India’s exports as percentage of world export improved: 0.48%
(1980s), 0.56% (1991-1996), 0.65% (1996-2002), 0.71% (2000)
India's Merchandise Exports
• The global financial crisis of 2008 significantly affected the
composition of trade. However, there was a rebound in 2010-11 in
terms of robust global growth
• The top eight export sectors: petroleum products, gems and
jewellery, textiles, chemicals and related products agriculture and
allied sector, transport equipment, base metals and machinery
continue to dominate India s export basket, accounting nearly 86.4%
of total exports in 2014-15 (as compared to 78.1% in 2010-11)
• Petroleum, crude and products occupy top position among the top
eight export sectors
• Export growth in 2016-17 was fairly broad based with positive growth
in major categories except textiles and allied products, and leather
and leather manufactures. There was good export growth in
engineering goods and petroleum crude and products, moderate
growth in chemicals and related products, and textiles & allied
products in 2017-18
• India’s merchandise trade balance has improved from 2009-14 to
2014-19, although most of the improvement in the latter period was
on account of declining crude oil prices in 2016-17
• India has consistently run a trade surplus since 2014-15 with USA and
United Arab Emirates. On the other hand, India has trade deficit with
China, Saudi Arabia, Iraq, Germany, Korea, Indonesia and Switzerland
since 2014-15
• Over the years the merchandise exports to GDP ratio has been
declining entailing a negative impact on the BoP position
• Petroleum, Oil and Lubricants (POL) exports have a dominant share in
India's export basket in value terms. Drug formulations, biologicals
exports has shown a growth between 2011-12 and 2019-20
• India's largest export destination country continues to be the United
States of America (USA) in 2019-20 followed by United Arab Emirates,
China and Hong Kong
India's Merchandise Imports
• Merchandise imports to GDP ratio over the years has been declining
for India entailing a net positive impact on the BoP position
• Crude oil and gold imports have a large presence in the import basket
• A fall in merchandise imports to GDP ratio may be a reflection of a
deceleration in GDP growth. Non-Petroleum, Oil and Lubricants (POL),
non-gold imports fell as a proportion to GDP from 2009-14 to 2014-
19. This decline is followed by a decline in investment and a decline in
growth rate of GDP
• China continues to be the largest exporter to India followed USA, UAE
and Saudi Arabia. In recent times, Hong Kong, Korea and Singapore
have also emerged as significant exporters to India
Service Trade
• India’s service exports have consistently hovered between 7.4 to 7.7%
of GDP reflecting the steadiness of this source in contributing to the
stability of BoP
• Software services, business services, travel and transportation are
exported by India
• Over the years, service imports in relation to GDP has been steadily
rising putting pressure on BoP to worsen
• Constituents of service imports have not varied much with business
services constituting about a third of service imports
India's Balance of Payment Trends: 1950-51
to 2014-15
• Six major events had a lasting impact on our BoP
The devaluation in 1966: In the early 1950s, India was reasonably
open but later the share of external sector in India's GDP gradually
declined with the inward looking policy of import substitution. Indian
export basket comprised mainly traditional items like tea, cotton
textile and jute manufactures. The scope of world trade expansion in
these commodities was less and also India faced a lot of foreign
competition. Import-substituting strategies were expected to
gradually increase export competitiveness but rather it was seen that
our external sector contracted in relation to GDP. Emphasis on heavy
industrialization in the Second Five Year led to a sharp increase in
imports.
A severe BoP crisis emerged after the war with China and Pakistan.
Withdrawal of foreign aid and insufficient storage of foreign exchange
reserves made devaluation inevitable
Oil Shocks of 1973 and 1980: After devaluation BoP remained
comfortable during the 1970s. Exports, benefited by the expansion in
global trade. Private transfers rose increased during the first oil shock
and financed roughly 80% of the trade deficit. Within two years the
current account balance came into a surplus. The impact of the
second oil shock of 1979, was more severe than that of the 1973-74.
Value of imports almost doubled. Export performance was depressed
by the severe international recession of 1980-1983. Net invisible
receipts continued to provide support to the BoP. Various measures
were undertaken to promote exports and liberalize imports for
exporters during this period. There was a deterioration is fiscal
position of the government leading to a twin deficit
The Balance of Payment Crisis of 1990-1992: In 1991, India found
itself in its worst BoP crisis since 1947. Reform policies were
introduced. The policy changes improved India’s current account
deficit position. We could manage to stay insulated during the East
Asian Crisis of 1997 and dot com bubble of 1999-2000
The Y2K event of 2000: India's software exports got a boost in this
period. The surplus in the services exports and remittance account of
BoP increased sharply as a result. Software exports rose from 0.9% of
GDP (1999) to a peak of 3.8% of GDP (2008). Private remittances also
rose during this period. After a period of stability, India's BoP came
under stress in 2008 reflecting the impact of global financial crisis
External Debt
• Over the years, the proportion of concessional debt in total debt in
total external debt came down from an average of 42.9% (1991-2000)
to 28.1% (2001-2010) to 8.8% (March, 2015)
• Non-government external debt has been predominant in total
external debt and its proportion has been growing over the years
• US dollar denominated debt accounted for 50% of India’s total
external debt in 2017
• India’s external debt has remained in safe limits. External debt to GDP
ratio was 23.7% in 2014-15
• As per the World Bank data, India is the third largest debtor country
among the developing countries (after China and Brazil)
Foreign Exchange
• India continues to be one of the countries that have sizeable foreign
exchange reserves. RBI intervenes into the forex market to manage
the exchange rate of the rupee and guard against volatility
• Among the major economies with current account deficit, India is the
second largest foreign exchange reserve holder after Brazil
• RBI intervenes into the forex market through sale of US dollars from
time to time
• Real depreciation (of rupee) is likely to result in a contraction in real
output growth at least in the short run if the import content in the
production is high
• A 1% real depreciation (of rupee) leads to a fall in output growth of an
average firm by 12.5% in chemical industry, 9.8% in rubber, 4.8% in
textile, 5.4% in plastic, 5.1% in metal and metal products industry. The
lowest value is in the footwear industry (0.38%)
• High import-intensity sectors like petroleum products and chemical
and chemical products are more impacted by rupee depreciation as a
weaker rupee increases the value of imported inputs
How to improve the Balance of Payment
position?
• Macro Issues:
Scale: Hurdles to land acquisition, labor regulations, inadequate
power and other infrastructure support and shortages of skilled
labour can be removed to encourage the export sector
Better transportation infrastructure: A World Bank study shows firms
report that it takes lesser number of days for a container to travel
from Shanghai to Mumbai than it takes to travel from Mumbai to
Delhi. Such issues should be addressed
• Micro Issues:
Credit Access: The majority of India's exporters are SMEs with limited
access to external financing. Banks are often reluctant to give them
credits
Simplify the GST: GST export refunds to SMEs are very slow because
of which they may not have enough working capital
Sign a trade agreement with the European Union (EU): Some of
India’s major exports were excluded from the EU's Generalized
System of Preferences (GSP). Negotiations can be done to sign a
preferential trade agreement (PTA)
Tariff: Resist temptations to raise tariff rates in response to temporary
economic pressures such as a sudden increase in imports. As most
exporters use imported inputs, tariffs reduce the competitiveness of
Indian exporters
• Revitalize the textile industry: Our textile industry is lagging behind in
competition from countries like Bangladesh, Sri Lanka and Vietnam
over the last decade. The following are the issues with this industry:
i. Large number of small-scale establishments
ii. Most units use old or obsolete machinery
iii. Shortages of semi-skilled labor with sufficient training to run
modern machinery
iv. Chronic power shortages
v. Land acquisition problems
vi. Onerous clearance requirements that impede the inflow of
imported inputs and export of processed materials
FDI Inflow
• FDI represents longer-term investments made abroad bringing
together with capital and entrepreneurship, technology and
managerial knowhow and sometimes even market access – less
volatile in nature
• FPI has limited potential of contributing to development as they are
short-term and speculative in nature
• Just after the independence, FDI was sought on mutually
advantageous terms even though the majority local ownership was
preferred
• The government adopted a more restrictive attitude towards FDI in
the late 1960s. Restrictions were put on proposals of FDIs
unaccompanied by technology transfer
• In the 1980s, the attitude towards FDI began to change as a part of the
strategy of modernization of industry with liberalized imports of capital
goods and technology, exposing the Indian industry to foreign competition
• With the implementation of the New Industrial Policy (1991), new sectors
such as mining, banking, insurance, telecommunications, construction and
management of ports, harbors, roads and highways, airlines and defense
equipment were opened up for foreign-owned companies subject to
sectoral caps
• In 2012, India allowed FDI in multibrand retail and in civil aviation. Sectoral
caps were revised upwards for telecom, insurance and defense equipment
sectors in 2014
• FDI inflows to India have been growing since 1991, but suddenly in 2006 it
tripled in 2006 but declined in 2008 due to the global financial crisis
• The rise in FDI inflows in 2006 reflects improving investment climate
in India with the acceleration of growth rate since 2003
• Studies show that good industrial performance tends to crowd-in FDI
inflows as well
• With the slowdown of Indian economy since 2011, it declined again
• Studies show that out of the 25 top destinations for FDI Confidence
Index, India ranks 5th in 2013 and China being on the 2nd position
• Earlier the bulk of the FDI flows used to be directed to manufacturing
to the high technology industries through a selective policy. After the
liberalization, a substantial proportion of FDI inflows has directed to
services. Manufacturing has accounted for only about 40% of inflows
in the post-1991 period with services accounting for about 35% share
• The bulk of FDI inflows in India are market-seeking coming for tapping
the domestic market with the share of foreign affiliates in exports
around 10%. The quality of FDI in respect of export orientation is poor
• India has not imposed export obligations on MNE affiliates except for
those entering the products reserved for SMEs. However, in India
some indirect export obligations are there like a foreign enterprise is
obliged to earn the foreign exchange that it wishes to remit abroad as
dividend so that there is no adverse impact on the host country's
balance of payment
• Foreign automobile companies have started export of automobile
components. This export is rapidly growing exceeding the obligations
several times over
• Within the country, foreign firms appear to be spending more on R&D
activity in India than local firms
FDI Outflow
• Like FDI inflows, the major turnaround in their outflows came in 2006
when outflows more than quadrupled in one year
• Indian enterprises started doing more outward investments to
acquire larger companies in the advanced economies
• The past few years have seen several multi-billion dollar acquisitions
of western firms by Indian companies including Tata Steel-Corrus, Tata
Motors-Jaguar/Land Rover, Handalco-Novelis
• During 2012-2013, outward FDI flows declined dramatically as Indian
companies struggled with slowdown of Indian economy
• The emergence of Indian enterprises acquiring much larger
enterprises in the developed world reflects their confidence in
managing the newly acquired entities successfully
Reforms to attract FDI
• Macroeconomic performance: public investment in infrastructure will
improve the growth rate of the economy in the long run which will
work as a good indicator and foreign investors will be more interested
in investing in India
• Better government policies: Effective implementation of policies like
phased manufacturing programmes, export performance
requirements and domestic ownership requirements is required
• Channeling FDI into export-oriented manufacturing through selective
policies and export performance requirements imposed at the time of
entry deserve careful consideration. The export-oriented FDI
minimizes possibilities of crowding-out of domestic investments and
generates favorable spillovers for domestic investments
• FDI into new areas: FDI inflows can be pushed into newer areas where
capabilities do not exist as that minimizes the chances of conflict with
domestic investments
• Knowledge diffusion: The host governments could also consider
employing proactive measures that encourage foreign and local firms
to deepen their local content
• Investment in human capital: Investments made by governments in
building local capabilities for higher education and training in
technical disciplines, centers of excellence, and in other aspects of
national innovation systems have positive impact on FDI inflow