India: Export for Growth

After inflation levels off, hopefully in the first quarter of the next fiscal year, after the Ukraine crisis becomes dormant, yet again, through exhaustion or accommodation (as in 2014) and thinking beyond the growing domestic political contestation, as India prepares for the quinquennial national electoral contest in April 2024, the problem of low growth is likely to persist. Q1 FY 2023 (April to June) GDP is less than 4 percent above the same quarter in 2019-20- the last normal year before the pandemic. The absence of sustainable, domestic demand growth beyond the surging incomes of the top two quintiles remains a worry.

So, why not export our way out of this downturn (2022-2025) till real incomes improve for the middle two quintiles, which would then sustain the next growth spurt from 2025 till 2030.

Admittedly, it is not the best time to be hanging our hat by the export peg. In the aftermath of the Ukraine crisis the globe is uncomfortably split into three leaky silos. First, the western alliance comprising the US, its allies, and the EU versus the new grouping of Russia and China with their respective allies and finally others who prefer to retain strategic autonomy. India mostly falls in the third category. India’s size, location and political architecture make any other approach unviable.

We are physically most proximate to China. But it rebuffs collegial coexistence in its search for global dominance. We “manage China” at the cost of distancing ourselves from the advantages of participating in the Regional Comprehensive Economic Partnership- the trade pact, governing the world’s fastest growing region.

Exporting past the domestic demand slump

Contrary to the popular conception, India does not do too badly, on export of goods and services with other comparator economies if the potentially large size of our domestic economy is factored in. In 2021, India’s export share in GDP of 20.8 percent was 0.8 percentage points ahead of China at 20 percent. Note however that the 2021 data could also reflect the severe covid-19 supply constraints in China. In 2008, when the share of exports to GDP in China peaked at 31.2 percent, India was 10 percentage points behind with a share of 26 percent.

India needs to step up closer to the world average share of exports in GDP of 29.1 percent. India peaked in 2013 at 25.4 percent. Rewinding to what we were doing right at that time could be one way of recovering export share. Stoking exports is a medium to long term task- reducing logistical cost through better infrastructure and even more importantly, process reform to simplify tax and export controls processes, a sustained branding effort in targeted export markets and active participation in trade and economic cooperation partnerships.

Special Economic Zones

Unlike China, Indian exports are an offshoot of generalized industrial and service sector competitiveness, using the comparative advantage of a low wages, skilled workforce and supply chains developed in the domestic economy over decades.

Attempts to mimic China’s enclaved export promotion have only been moderately successful. Starting in 1980 by 2007 China’s Special Economic Zones, industrial parks and zones accounted for 60 percent of exports, 22 percent of GDP and generated employment for 30 million. The Indian experience is older, starting with Kandla in Gujarat in 1965, but less productive. Successive policy initiatives ending in supportive legislation in 2005 support 268 export only operational enclaves. They accounted for US$ 112.4 billion, or 21 percent of total goods and services exports of US$ 526.6 billion in 2019-20. Around 300 notified SEZs (some not yet operational) are located in 41,970 hectares. Most are industrial clusters rather than entire communities, cities, or regions, as in China.

Politics, parties, and partnerships

There are two significant differences between the Indian and the Chinese strategies. First, and linked to the intense political contestation in India, the Union government often invests in and manages such export facilities. In China, provinces and the cities were encouraged to lead in constituting and managing such enclaves in collaboration with the private sector.

In India, the central political leadership actively nurtures projects and programs closely identified with it, to build public credibility directly with citizens. This is quite similar to the present need of President Xi to carve out a special place for himself in China, versus other leaders. This is one reason decentralized implementation, Chinese style albeit within the overall management of the Communist Party of China, has limited salience the Indian political economy.

Competing macro-economic objectives

Secondly, the framework for macroeconomic stability followed by India, effectively treats exports as a residual, as opposed to being the focal point in China. In India, greater prominence is given to political economy metrics like consumer protection from inflation and quixotically, simultaneously, protection for producers from cheaper imports.

The reappearance of an active industrialization policy – Atma Nirbhar Bharat (self-reliant India), four decades after industrial liberalization, inefficiently subsidizes domestic producers by implicitly transferring to them, the benefits that consumers would have enjoyed from cheap imports – via the ability to charge higher prices in the absence of imported competition.

Higher domestic value addition in individual projects is valued more than cheap imports because it creates jobs quite unmindful of the fact that import constraints generate efficiency loss peculiar to a closed economy ecosystem, unused to imported innovation-based competition. The insistence of TESLA to test-import their cars at reasonable tariff, as a precondition for investment in India, is one such example – although admittedly the idiosyncratic behavior of its owner could not have helped.

Exports, only a residual factor in macroeconomic stability policy

A second draw back for exports is the absence of a level playing field because of the preference for a “strong INR.” India remembers a substantial annual trade deficit just below 7 percent of GDP in 2011 to 2013 resulting in sharp depreciation of the INR. The trade deficit reduced to between 1 to 2 percent of GDP during 2014-17 as the price of imported oil decreased. It reverted to more than 3 percent of GDP in subsequent years till 2019-20 (the last normal, pre-pandemic year) as the price of oil firmed up.

The trade gap is met by capital inflows – either remittances, portfolio, or foreign direct investments. Monetary policy consequently strives to retain enough fat in domestic interest rates to preserve the incentive for inward capital flows to strengthen the INR. One reason Indian stocks remain expensive is because markets expect the RBI not to allow the INR to depreciate. Since 2019, despite around 10 percent depreciation in the nominal exchange rate of the INR, the gap with the real exchange rate of the INR has widened because inflation differentials have not been adequately factored into the nominal rate of the INR.

This strategy helps avoid imported inflation (by partly neutralize the firm trend in global oil and gas prices even before the Ukraine crisis) but it is damaging for exports which become uncompetitive. This fall back, defensive strategy minimizes foreign exchange imbalances through subsidies for capital inflow. But it also acts as a tax on exports, which risks ballooning the trade deficit (the difference between exports and imports) instead.

Making exports competitive is an across the economy, medium term objective which spans the range of providing more subsidy for targeted R&D; targeted subsidy to industry and business for skill, technology and process upgrades and punitive tax for noncompliance with efficiency and quality standards; a friendly business development ecosystem, better infrastructure as evidenced by lower logistical cost and stable macroeconomic conditions.

Charming investors away from their Chinese obsession

In recent times, the possibility of pulling foreign investment away from China and into India by transforming it into a global hub for exports are considered as “low hanging fruit.” This appears naïve. The commercial compulsion to be present in China- the most competitive, large economy with a well-developed playbook for garnering foreign investment, technology and exports is unlikely to disappear overnight. Even if it does, India barely qualifies for “friend-shoring” (friendlier options are available) and not at all for “near-shoring.”

An inward-looking China risks imploding under the weight of its own external and domestic commitments. Despite existing political compulsions, to flex muscle and downsize large business, the Chinese Communist Party remains equally bound to safeguard its legitimacy by delivering the benefits of high economic performance to citizens. Risk that and they risk the social contract on which China works.

Sooner, rather than later, China will be compelled to privilege economic efficiency over political grandstanding. Economic compulsions will revive the premium on the number of mice caught rather than the cat’s color, to misquote Deng Xiaoping- the great strategist. No doubt when this happens, global business will resume profitable collaboration with China.

It is defeatist to sit behind protectionist walls and rely on China self-destructing, to neutralize the threat it poses to continuance of the open economy framework. “Managing China” should include de-hyphenating geopolitics and security from selective trade and investment. Better to be an Angela Merkel than a Volodymyr Zelensky.

Extracted from the authors opinion piece in September 1, 2022

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