The trade landscape is changing structurally to India’s advantage

Photo: Bloomberg
Photo: Bloomberg


The structural changes in India’s trade basket show that our export boom is no more a story of the rising tide lifting all boats

India’s exports boom has often been attributed to commodity price surges, favourable exchange rates and trade diversion from China. Digging deeper, however, we see that the trade boom reflects structural changes in our trade basket. We perform a comparative exercise at the six-digit product level, comparing India’s current trade basket to that of roughly three decades ago in 1993-94. The exercise reveals that India added 628 new products to its export basket by 2022, in addition to the 3800 products since 1994. The new products are highly concentrated in high-tech manufactured goods, chemicals, and electronics and have shown steady growth over the years.

In the three decades between 1994 and 2022, India has not just carved out new markets for over 600 products, but has become the market leader in some of these new product categories. For instance, India is a large net exporter of certain turbojets and defence technology. Similarly, we have also broken into new markets, such as railcars and electrical energy. The growth of the new product basket outpaces the growth of legacy products. Productions such as helicopters, arms and ammunition, and electrical machinery registered some of the highest growth rates. Of course, exports of India’s top-three products, which include petroleum, diamonds, and medicaments, continue to grow. The share of these products, however, is declining.

What does a change in product basket entail for our sensitivity to exchange rate fluctuations? Research shows that as the export baskets shift towards high-value goods, there is a concomitant decline in the sensitivity of exports to real effective exchange rates. Econometric estimates from recent literature pegged exchange rate sensitivity between 1 and 2.5 for the late ’90s and early 2000s to between 0.5 and 1 more recently. Our in-house econometric estimates align with the literature, showing a significant drop in the sensitivity of exports to the exchange rate after the period of the global financial crisis. While the exchange rate sensitivity was as high as 2.5 for 1994-2007, it shows a significant drop to 0.6 for 2008-2022. This means that a percentage appreciation in the rupee currently would result in exports decreasing by less than a per cent, as compared to a drop of 2.5% previously. Thus, going forward, a rise in the value of the rupee is less likely to hurt our exports, unlike in the past.

A part of the explanation for the low exchange rate sensitivity also lies in our rising integration with the global value chains (GVCs). Research confirms the link between GVC participation (both upstream and downstream) and reduced sensitivity to exchange rates. Most of India’s GVC participation has generally remained upstream, emphasising goods such as chemicals, machinery, and metals. Upstream trade involves less value-addition and can be more prone to demand shocks. In this context, policies such as the production-linked incentive scheme (PLI) can prove useful for developing downstream linkages. The PLI scheme can further integrate India into downstream GVCs by incentivising global manufacturers to set up shop in India.

A running critique regarding the PLI scheme centres on how manufacturers tend to use incentives to set up assembly units (which are low in value addition) instead of manufacturing plants. The experience of countries like China and Vietnam shows how assembly, while being low value-added, led to employment generation for a large number of low-skilled workers. The assembly units also helped build backward linkages to domestic sectors in these countries, creating further value-addition. In addition, as firms build their footprint, they will develop into producing more sophisticated components, leading to higher value creation.

Much like manufacturing, some services can also be unbundled into various processes, leading to a global value chain in services. India’s performance in the services value chain has been exemplary. While the early 2000s was a period of BPOs mushrooming to provide cost-cutting back-end information technology (IT) services, India now looks beyond just cost-cutting. Data from the Asian Development Bank shows that India went from providing back-end services in law, IT and management in 2010 to upstream, high-value-added services in these areas by 2020. As a testament to the market power we enjoy, our services exports have also shown a low degree of vulnerability to changes in global income fluctuations. For instance, services exports to the US and Canada (which account for about 60% of total software exports) have shown a low degree of correlation with the gross domestic product (GDP) growth in these countries.

India’s integration into manufacturing GVCs can also increase through exports of services. Intangible services include pre- and post-production activities such as supply chain management know-how, brand management and design. Firms specialising in pre- and post-production activities within a GVC make the largest value additions.

India’s export boom is not just a story of the rising tide lifting all boats. Our export basket is becoming less vulnerable to global fluctuations in demand and exchange rates as we develop high-tech manufacturing goods and services capabilities.

V. Anantha Nageswaran & Meera Unnikrishnan are, respectively, the chief economic adviser and a young professional in the ministry of finance, Government of India. These are the authors’ personal views.

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