Why India's Net Exports Have Fallen While It Fails to Overcome Import Dependence

India’s net exports fell by over 12.7% to $34.66 billion this April. This is one of the steepest declines in the country’s export levels over the last three years and the trend (if it continues) is likely to have major implications for the nation’s already troubled growth story. 

India’s manufacturing sector’s performance, which otherwise contributes to vital exports and private investment growth, has struggled to pick up. This, despite a greater impetus provided by the government’s capex spending aimed at encouraging more private investment in areas of infrastructure, realty, etc. 

The broader economic policy landscape under the current regime seems to be plagued by an environment of intellectual bankruptcy that is adversely affecting its macro-economic policy making and implementation of  governance mechanisms. 

There is neither any evidence of a serious effort to note what’s happening at a macro-level nor does the government seem to have any clear plan for designing a medium-to-long term trade policy. 

The concern

See India’s quarterly trade balance sheet below.

Merchandise imports, that had grown over the last few years, are now seeing a fall. This is distressing for major labour-intensive sectors such as textile, leather, gems and jewellery, as well as other engineering goods. 

However, a positive trend in terms of trade is in services, where India’s service output levels have outperformed that of the US, Europe, and China since late 2022. It has helped narrow India’s current account deficit (CAD) too, which was growing because of a constant rise in merchandise imports (including rise in imports from Russia and China). 

It has therefore been advised that a push towards driving ‘service-based export’ growth may in fact help the Indian macro-growth trajectory and help the government in not just reducing its CAD, but also in creating more jobs in some of the labour-intensive service sectors.  

What about India’s main trade partners?

The US surpassed China to become India’s top trading partner in 2021-22, reflecting a strengthening of ties between the two economic giants. 

A couple of years ago, India’s trade surplus with the US was $32.8 billion. Beyond services, major export items from India to the US include: petroleum-polished pharmaceutical products, jewellery, light oils, and petroleum, frozen shrimp, while major imports from the US include petroleum, rough diamonds, gold, coal, waste and scrap, etc. 

From a trend-pattern perspective, it makes more sense for India to expand its economic and trade relationship with the US going forward. And, some would imagine the US too may see this ‘relationship’ as being vital to finding an effective counter-weight to China while reducing its trade exposure to China. 

However, in April, India saw a 17.6% export share contraction at 5.9$billion with the US alone. This was followed by the UAE with a 22.09% decline in export share from India at 2.23$billion. 

See the chart below for explaining the last year’s trade pattern for India with its main trade partners (where it has a trade exposure of almost 50%). 

Exports to India’s key markets – the US, UAE, China, Singapore, Bangladesh and Germany – witnessed a sharp decline of 12.69% in April 2023. during . Exports to the UAE contracted despite India signing a free trade agreement (FTA) which also raises questions on whether more FTAs can actually result in more trade with a given country. The trade between India and Australia  post an FTA is a case in point. 

When it comes to imports, India’s deep dependence on China has been complemented  over the last year by an increasing import-dependence on Russia.  . 

This trade dynamic isn’t good news for India for the simple reason that US, India’s main trade partner and national security ally remains one of the main political adversaries to both China and Russia. And given India’s multi-aligned trade dependence now pivoting towards China and Russia for  imports and the US for exports, it will be difficult for India to develop a sustained, more cohesive long term foreign policy vision for the years to come. 

If we look at the percentage-change in growth of trade over the last year between India and its key trading partners (in the above figure), one can see a more than 300% rise in import level of goods (primarily crude oil) from Russia alone. 

The higher level of revenue-extraction secured by Russia from its rising imports to India also seems critical for Russia’s Prime Minister Putin to drive his nation’s war-economy and encourage him to continue its escalation of war with Ukraine despite western economic sanctions. It would be interesting to see how the US addresses this issue with India when Prime Minister Modi travels for a state trip to the US soon.

India’s Failed Performance-Linked Incentive Scheme for Driving Manufacturing-Exports

There are two categories where India remains import-dependent. 

The first is the commodity/goods-based dependence for sectors such as pharmaceuticals, electricals, and solar PV cells. The second is country-based dependence for different kinds of goods – whether it is from Chinese electricals, Swissgold, American r capital goods,.

The proposed solutions

To address the first component of import dependence, the Indian government introduced its Production Linked Incentive Scheme or  (PLI) in November 2020 to encourage the domestic production of various electronic parts that it otherwise imports. 

In the Union Budget 2021-22, presented on February 1, 2021, the Union finance minister announced an outlay of Rs 1.97 lakh crore for PLI schemes for 13 key sectors. This means that minimum production in India because of PLI schemes is expected to be over US$ 500 billion in five years.

The PLI schemes have been specifically designed to boost domestic manufacturing in sunrise and strategic sectors, curb cheaper imports and reduce import bills, improve the cost competitiveness of domestically manufactured goods, and enhance domestic capacity and exports.

The scheme, for example, for the automobile sector, proposed financial incentives of up to 18% to boost domestic manufacturing of advanced automotive technology products and attract investments in the automotive manufacturing value chain. But the scheme has had very limited success in achieving what it had set out to do 

For the second category of import dependence, which is more ‘country-based’ than goods-based, there was an effort to reduce India’s imports from China due to the burgeoning trade deficit. 

Numerous efforts to de-link India’s supply chain from China have resulted in India trying to import the same goods at a higher price from countries like the US, Japan and Vietnam, which has made domestic production even more costly and difficult.

Most local manufacturers, including MSMEs, have already been struggling post-pandemic with demand, debt, and credit-sourcing related issues and are more than happy to continue their dependence on cheaper Chinese imports to remain price/cost-competitive in a market where the ‘willingness to pay’ for most consumer goods remains low as consumption-demand has failed to pick up for most income groups.

The ‘illusion’ of Aatmanirbharta

India’s weak growth combined with low domestic private investment has made its overall domestic production weak over the last decade and a half. Foreign direct investment in some sectors might have remained net positive, but depending solely on foreign capital for sustained investment-production always has its limitations.

While the need for more goods and services has continued to expand, a weak domestic economy presents less room for India to grow both domestically and as an external economy. 

Expansive import dependence on other nations means less scope for actualising India’s vision of ‘strategic autonomy’ in its foreign policy, and in negotiating better deals for trade  Other than this, India’s poor trade competitiveness, beyond the reasons cited for its extensive import dependence, is  because of two interplaying factors:

• a weak demonstrable domestic manufacturing strength because of schemes like PLI and ‘Make in India’ that were seen to be vital but yielded limited positive results;
• an uncompetitive currency-pricing mechanism for the Rupee viz-a-viz other emerging export market oriented currencies.

In fact, since the reforms of the early 1990s, India has been facing structural challenges in prioritising both these aspects. On the other hand, countries like Bangladesh, Vietnam, Indonesia and Thailand, to name a few, have done way better in aligning an export-oriented industrial vision with a set of policies that make their products (including their cost) more competitive at a global level.

In the case of an agreement like the Regional Comprehensive Economic Partnership (RCEP) too, one of the key issues that prevented India from coming on board included ‘inadequate’ protection against a surge in imports.

Despite the fact that several countries within the RCEP expressed a desire to include India, India’s own comparative weakness in terms of trade and competitiveness levels triggered a fear about how Chinese commodity products may ‘flood’ Indian markets–a concern that wasn’t entirely misplaced.

Why India Needs Better Trade Deals and A More Service-Oriented Trade Focus

There have been pressing issues involved for India in signing better trade deals: India’s request for added provisions for more trade in services; an assurance for better market access for Indian products in Chinese markets; making 2019 the base year for tariff-reduction calculations – all of which couldn’t happen during the RCEP deal. 

A US-India FTA may almost seem like an ‘unrealisable goal’, in addition to these issues.  

Further, India has also been trying to develop an auto-trigger mechanism that would allow it to raise tariffs on products in instances where a basket of imports from a given nation crosses a certain threshold. This was not accepted by many RCEP members at the time.

What all of this does is make India dependent on signing more FTAs bilaterally – which takes time – and many countries like the US and Japan are not keen on more advanced FTAs as the  production supply-chains in these countries are more globally linked.  (redundant)

A key question therefore arises:How can India focus more on improving its poor performance in trade competitiveness levels?

Enabling competitiveness for Indian products and services across regional and international markets would require a set of both ‘market’ and ‘extra-market’ arrangements.

‘Market-centric’ steps would require a set of liberalising measures with incentives for cross-border trade and reforms in factor markets – land and labour in particular – which allow enterprises to increase production for export. 

Simultaneously, ‘extra-market arrangements’ shall require fiscal and other targeted socio-legal interventions to make the very outlook of Indian businesses – including those entering new markets – more globally aligned.

Weak Rupee Meets Low Domestic Manufacturing

It must be mentioned though that there is little possibility of India experiencing a dynamic export-oriented pattern of industrialisation in its manufacturing sector now, as seen in East Asian economies like South Korea and Taiwan around the 1970s and 1980s. 

Moreover, a tightened labour-market may not produce the same cost-benefit advantages than many other less regulated manufacturing-exporters like Bangladesh have managed to do.

However, there is still a critical need and economic case for the government to continue its focus on stronger manufacturing capacity. This is vital as domestic consumption demand must be met and stronger manufacturing is also able to create more employment, which is the need of the hour. A robust manufacturing sector would have an ability to attract foreign direct investment, which will also boost the economy. 

The auto, pharma, electronic-hardware industry in India, because of the way they grew under a more pro-market sectoral focus since the early 1990s, is a case in point on how things panned out.

Focus more on Service-Based Exports for the future orientation of India’s Trade Focus

On services, India has done well over the last few decades particularly in areas of ICT, travel, financial, banking, insurance, tertiary health services etc. During the last three years, service-based exports have done very well in India’s trade balance. Low cost tech-based exports have huge competitive potential for a relatively service-skilled and educated demographic. Raghuram Rajan has emphasised on this at length.

Building on this, a positive step in this direction would warrant more public-investment and fiscal support on plans or schemes that can help push service-based production, not only for ICT but other key service-based areas like education, healthcare, fintech, outsourcing-based service delivery products, travel, and finance to mention a few. We see a contrarian picture on policy however, with each of these sectors receiving less public (read fiscal) support so far.

From a fiscal perspective, direct tax-based incentives too may help while reducing indirect GST tax rates (or, provide temporal tax holidays) for firms demonstrating greater export potential in services (or those creating more jobs and export-revenue). Technological impetus to start-ups and a whole hearted effort in building India’s digital infrastructure will aid service-based exports to rise, yielding balance of payment dividends.

Why India Must Also Manage the Rupee Better

Further, for greater trade competitiveness, a strong manufacturing capacity requires a competitive Indian Rupee. 

In comparison to the US Dollar and Chinese Yuan over the last two decades, we can observe how India’s exchange rate has appreciated over time till 2012 (primarily due to the influx of foreign capital mobility via FDI). In contrast, China managed to maintain an undervalued Renminbi to make its currency (and its products) cheaper and more competitive in export markets. 

The trend did change post 2013 for India when the Rupee’s value (vs. USD$) saw a gradual erosion-but didn’t  necessarily see a positive effect of this on manufacturing-exports. 

While the underlying factors affecting the volatility of exchange rates may differ from one country to another, it is vital for India via RBI to strategically manage its exchange rates and keep them in alignment with the country’s production patterns (in manufacturing and services), as done more successfully by China in 90s and early 2000s and other export-oriented countries too (including South Korea in east Asia and Bangladesh in South Asia).

Without a competitive Indian rupee, a competitive manufacturing sector enabled through structural reforms guided by market principles and a more export-focused service sector, it is likely that India’s performance in exports and overall current account position may only weaken in the years ahead. 

In a multi-polar political economy landscape, India’s import dependent relationship with China, and Russia also has strategic consequences as it locks its interests deeply with these two and that has the potential to complicate its relationship with other strategic allies (the US-and those allied to the US-led world. This includes other countries economically connected to India, e.g. Japan and UAE, among others. 

In the years to come, this may make India’s own economic policy and its foreign policy scenario appear less multi-aligned, but more exclusionary in nature – where countries with democratically-open macro-political and economic fundamentals may view India as a less trustful and reliable ally.