Exports rebound needs structural repairs
Exports have been the biggest underperformer so far this fiscal, the latest gross domestic product (GDP) figures show. At a mere 1.2% year-on-year (y-o-y) in the second quarter—unchanged from the previous quarter—growth in real exports of goods and services was the lowest among demand-side estimates.
In nominal terms, merchandise exports between April and October are up 9.4% y-o-y, compared with 0.2% in the corresponding period last fiscal. That’s above the average of -1.3% for the last five fiscals (FY13-FY17), but much below the 22.5% growth seen in the preceding five (FY08-FY12).
In the past few years, the slowdown in exports could be attributed at least in part to tepid global growth and falling trade intensity. However, this year, the global economy has seen a strong cyclical upturn across geographies and sectors, driven by stronger growth in investment, trade and industrial production.
As per S&P Global estimates, global GDP is expected to reverse a two-year slowdown and grow 3.6% in 2017, higher than the 3.1% logged in 2016. The pickup is expected to be broad-based, across both advanced and emerging market economies. In particular, the US and the euro area—India’s largest export destinations—are expected to grow by 70 basis points (bps) and 30 bps higher than in 2016, at 2.2% and 2.3%, respectively.
The world trade intensity of growth (i.e. ratio of trade to GDP growth), too, is expected to rise for the first time in six years. The International Monetary Fund (IMF) expects global merchandise trade, which was also slowing in the past three years, to grow 4.2% in 2017, 60 bps stronger than GDP growth. Developing economies are expected to outpace developed economies in both export and import trade volume growth.
According to the World Trade Organization, global trade flows grew more than expected in the first half of 2017 due to stronger global growth, particularly in the US and China (which boosted import demand), improving financial conditions in Asia (which improved business and consumer confidence), and rise in oil prices. Revival in global investment, which has a high import content, further helped boost trade.
Clearly, India has not been able to take advantage of the improving global environment, especially compared with its Asian peers. Though export growth has recovered relative to the past few years, at 9.4%, it appears sedate compared with Vietnam’s 23.8%, South Korea’s 18.4% and Indonesia’s 17.8%.
Come to think of it, India’s weak export performance cannot be attributed to global growth, which has trended up. There’s no blaming an unfavourable currency either, for the rupee’s value—both in nominal terms (as gauged by the rupee/US dollar exchange rate) and real terms (as measured by the real effective exchange rate with 36 currencies)—has been fairly stable since the beginning of this fiscal. Indeed, research shows that non-price factors play a greater role in explaining export growth vis-à-vis price factors such as the exchange rate in Brics countries. This is borne out by the Indian experience as well. The fastest growth in exports was achieved when the rupee was strengthening against the dollar. It follows, therefore, that domestic factors have had a greater role in the current export slowdown. And both transitory and structural factors are to blame.
The transitory factors first. The sweeping tax and compliance changes under the goods and services tax (GST) regime, for one, have disrupted many businesses, at least in the short run. Under GST, exporters are supposed to first pay tax on the inputs they buy from suppliers and then claim tax refunds. Delay in refunds has shrunk liquidity, especially for small and medium enterprises (SMEs), which contribute almost 40% to total exports.
The impact shows in the exports of labour-intensive sectors, which mainly comprise SMEs. Gems and jewellery—the largest labour-intensive sector in terms of share in overall exports—has seen exports decline 6.8% in April-October. Among others, ready-made garments, leather products and electronic goods grew 2.5%, 0.6% and 2.8%, respectively, much below the growth in overall exports.
The revealed comparative advantage (RCA)—an indicator of competitiveness, measured by a sector’s share in the country’s exports in relation to its share in world trade—for the labour-intensive sectors mentioned above has declined in the past decade.
Indeed, India’s RCA has been lower than that of Vietnam and Bangladesh, which have been able to occupy a larger share in the low-end manufacturing space being vacated by China as it moves up the sophistication ladder. For instance, Vietnam’s share in global ready-made garment exports has soared from 1.7% to 5.3% in the past decade, and that of Bangladesh from 2.5% to 6.7%, while India saw a mere 0.8% improvement, to 4%. Lower comparative advantage has been a result of infrastructure bottlenecks, rigid land and labour laws, and inferior logistics compared with these economies.
However, the recent improvement in competitiveness rankings offers hope that the RCA too can improve going forward. In 2017, India jumped 30 ranks to 100 in the World Bank’s Ease of Doing Business rankings and by 19 ranks to 35 on the World Bank’s Logistics Performance Index, although concrete steps are yet to be taken in land and labour reforms. So there is a long way to go.
Improving competitiveness will also help manufacturers leverage India’s own big domestic market, currently serviced by imports. India is the third-largest economy in purchasing power parity terms, and in the middle-income phase—when empirical evidence has shown demand to accelerate with every unit increase in income.
Thus, for sustained growth in exports, the government needs to address the structural issues plaguing labour-intensive sectors and iron out the GST-related disruptions that have hurt exports in the short run. This is essential for Make In India to succeed, and can ensure growth that is labour-absorbing.
Dharmakirti Joshi, Adhish Verma and Pankhuri Tandon are, respectively, chief economist and economists at Crisil.
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