FTP 2023: Can it navigate the new world order?

India unveiled its new foreign trade policy (FTP) on March 31, 2023 with the objective of taking exports to $2 trillion by 2030 (from the current level of about $750 billion). This is sought to be achieved through “four pillars”: (i) shifting from incentive-based regime to “remission-based” regime, to make it WTO-compliant (ii) “collaboration” of exporters, states, districts and Indian missions (iii) improving “ease of doing business” and (iv) focus on “emerging areas” like e-commerce, developing districts as export hubs and streamlining SCOMET items (special chemicals, organism, materials, equipment and technologies, which are of dual-use – for civilian applications as well as weapons of mass destruction).

Time will tell how well the FTP 2023 translates into reality. The most glaring gaps seem to be the missing efforts to develop understanding and insights into India’s and global trade trends of the past few years – especially in view of the Russia-Ukraine war leading to global trade re-alignments, sanctions etc. That is essential to identify the challenges and opportunities and also devise appropriate strategic responses. Lack of such analysis means the basis for the policy formulations may not be known. A mere presentation of a wish-list for process improvements and listing of “emerging areas” of trade don’t qualify for a new policy – which is strange given that it is late by two years.

External and internal changes impacting trade

After 2015, when the last FTP came, a lot has changed externally: (i) growing de-globalisation impulses (driven by the Trump administration) (ii) US-China trade conflicts (iii) Russia-Ukraine war leading to supply bottlenecks (high oil, gas and commodity prices), sanctions and re-emergence of two power blocks (iv) new multilateral trade treaties, China-led RCEP of 2019 and US-led IPEF of 2022 – together controlling 70% of global GDP and 53% of global trade – from which India kept itself out (v) China+1 strategy of multinationals seeking second homes in which India doesn’t figure prominently (vi) global high inflation and high interest rates impacting trade and capital flow and (vii) continuing global recessionary threats (caused by pandemic disruptions, war and climate disasters).

A lot has changed internally too: (a) growth is slipping again – the GDP growth fell from 8.3% in FY17 to 3.9% in FY19 and after the pandemic recovered to 9% in FY22 but is slipping again to 7% in FY23 and expected at 6.4% in FY24 (b) import tariffs steadily climbed up since 2014, now to be followed by non-tariff barriers to check import and protect domestic companies from foreign competition – an impulse that also forced India to keep out of RCEP and IPEF and (c) little impact of ‘Make in India’ and production-linked incentive (PLI) in pushing domestic manufacturing and exports. In fact, the manufacturing share has fallen from 17.4% of the GVA in FY12 to 14.7% in FY23 and may fall further as manufacturing growth turned negative in Q2 and Q3 of FY23 (-3.6% and -1.1%, respectively).

The net fallout of all the above developments has brought three new elements into play: (i) massive decline in rupee value against the USD – from average of ₹64 in 2015 to ₹82 during the past 180 days up to March 31, 2023  (ii) Brent prices oscillate between $44.8 and $93 per barrel during FY15-FY23 (PPAC) and (iii) the repo rate climbed down from 7.75% in January 2015 to 4% in May 2020 and then going up to 6.5% in February 2023 (may go up to 6.75% later this week). 

All those factors have a bearing on India’s foreign trade. How these will be negotiated is not known from the FTP document of 2023.

Roller-coaster ride for trade

Official statistics shows a roller-coaster ride for trade since 2015.

Both exports and imports fell from their highs of FY12-FY14 to new lows in FY21 – the pandemic fiscal – and then started climbing up, but imports far outstripped exports, leading to higher trade deficits. This is what the rising import tariff since 2014 aimed to prevent but failed. Now the government is planning non-tariff barriers, in the name of quality control, to check imports. In early March, the government announced that it would be issue 58 “quality control” order to check import.

For illustration, exports fell from 25% of the GDP during FY12-FY14 to 19% in FY21 and went up to 22% each in FY22 and FY23 (AE2) as the economy recovered. Imports follows the same trend – fell from 31% of the GDP during FY12-FY13 to 19% in FY21, but shot up to 24% and 27% in FY22 and FY23, respectively (far higher than exports). Consequently, trade deficits – which fell from -7% during FY12-FY13 to -0.4% in FY21 – went up to -3% and -4.5% in FY22 and FY23, respectively.

Meanwhile, India’s global share of exports, the growth engine, remains stuck below 2% and that of services at 3-4% during the past few years (2015-2020).

The actual trade deficit is likely to be much higher because, in November 2022, the gap between the data on exports provided by China and India was $12 billion (China’s $102 billion to India’s $91 billion) in the first 9 months of FY23. This can only be explained by the under-invoicing of imports by Indian traders. Over-invoicing, for money laundering and round-tripping (to and from other countries), is not unknown in India. The 2018 banking frauds/collapse to Hindenburg’s allegations are prime examples of over-invoicing and money laundering. Despite efforts to reduce imports from China, particularly since the border tension of 2020, it keeps growing and trade deficits with China has jumped from 35% of the total trade deficit in FY15 to 38% in FY22. It is expected to go further up in FY23.

None of these is part of the FTP of 2023.

What goes relatively under-appreciated is that the overall trade deficit is contained by the surplus generated by services export.

For example, during April 2022-February 2023, the deficit in merchandise trade was $247.5 billion (impacted by global trade slowdown), as against the total of $114.6 billion, because services export generated a surplus of $133 billion. The services exports have generated surplus for more than a decade (UNCTAD) while merchandise exports have remained in deficit for several more decades. Besides, growth in export of services was 30.5% in April 2022-February 2023, while that of merchandise was a mere 7.6%.

A detailed analysis of services trade would have identified the sub-sectors doing better to qualify for “emerging areas” of opportunities and targeted policy support. For example, one analysis shows services export is soaring because of business services exports (particularly accountancy and audit), which went up three times in the first nine months of FY23. Neither the Commerce Ministry nor the RBI data give much insights into the composition of business services.

What ails goods export?

Why are merchandise exports falling despite ‘Make in India’ and PLIs?

One obvious factor is global recessionary trend and disruptions caused by the war. The other big factor is persistent import barrier being erected since 2014 in the name of protecting domestic industries – a failed experiment of 1960s and 1970s. Former Chief Economic Advisor (CEA) Arvind Subramanian was the first to raise a red flag in 2020. In a paper co-authored by him pointed out that this was self-defeating as exports served India well for three decades (it also pushed China’s growth) and hurt labour-intensive apparel, textile, leather and footwear sectors.

Viral Acharya, former RBI Deputy Governor, writes in a recent paper that India “undoubtedly” is a contender for “tariff king” of the world as with average tariff rate of 18.3% in 2021 it is the “fourth highest” behind Sudan, Egypt and Venezuela, on par with Brazil, and substantially higher than China and Mexico.

He lists four negative impacts of high import tariff barrier: (i) while India has become self-reliant in agriculture, high import tariff on agriculture (above 35%) with its low efficiency (employing more than 40% workers but generating 15% of the GDP or income) “prevents a market-based rotation of jobs in India from low-skilled agricultural labor to high-skilled services labor” (ii) makes Indian goods costly and globally uncompetitive (iii) makes imported goods costlier in India than other countries (such as iPhones), forcing Indians to go for inferior domestic products, the prices of which are “kept artificially high in spite of global efficiency gains” that could potentially aid disinflation and (iv) protectionism disincentivises investments in efficiency and builds up market concentration by championing “national champions”.

Then there is another fallout.

It is well known that “import intensity of exports” – inputs of imported raw materials and intermediaries for exports producing goods and services for exports – has gone up dramatically since 1991. Therefore, restrictions on imports automatically restricts exports as well. Since high tariff barriers have failed to check imports in the post-pandemic recovery phase, in early March 2023, the government announced that it would issue 58 “quality control orders” in the name of stopping import of sub-standard goods.

Raghuram Rajan, former RBI Governor has already explained the negative fallout of PLIs – uncertainties around continuation of foreign companies after PLIs cease, domestic demand for evergreening PLIs and PLI-induced production may not be globally cost-competitive hurting India's exports in other sectors, like PLI-inducted semiconductor sector would reduce cost-competitiveness of two-wheeler exports that rely on such chips.

The FTP of 2023 is silent on import barriers, PLIs and “national champions”.

So is the case with India unilaterally cancelling 68 bilateral investment treaties (BITs), including that with EU countries (in 2017), which were signed with trading partner nations and has a bearing on India’s FTA negotiations and foreign investments. India is now negotiating bilateral FTAs (with the UAE, Australia, the UK, Canada, EU etc.) but has kept out of mega multilateral trade treaties of RCEP (2019) and IPEF (2022).

The Economic Survey of 2021-22 and the NITI Aayog report of 2018 (“A note on free trade agreements and other costs”) suggested that the government was unhappy with the existing bilateral FTAs for failing to ramp up exports and causing higher trade deficits (with ASEAN, Korea and Japan). But these documents didn’t explain how these trends could be reversed by shunning the RCEP and IPEF, the advantage of individual FTAs over multilateral FTAs and higher import barriers.

It should have been foreseen that shunning RCEP and IPEF would prevent India from joining global value chains that so benefited Bangladesh and Vietnam in their exports of apparel and textile. This is happening now. While multinationals are scouting for a second home under their China+1 strategy, India is not among the top contenders.

A parliamentary panel had revealed this in 2021 too saying “…it is learnt through media reports that most of these companies shifted their base (from China) to Vietnam, Taiwan, Thailand, etc. and only a few came to India” – exposing India’s approach.

Economist Ashoka Mody writes, India shouldn’t read too much into Apple contractors’ investments (iPhones) in India. Investors moving out of China are going mainly to Vietnam and other Southeast Asian countries “which (along with China) are members” of the RCEP and most of the US producers pulling out are “near-shoring” to Mexico and Central America.

In fact, more multinationals are fleeing India and the number of foreign companies registering and “active” are falling. For example, from a high of 3.9% in FY16, growth of registered foreign companies fell to 1.5% in FY21; new registrations fell from a high of 216 in FY14 to 63 in FY21 and “active” foreign companies fell from 80% in FY14 to 66% in FY21.

Another key lesson is that ‘Make in India’, PLIs and “national champions” have proved insufficient to make India a manufacturing and exporting hub like China. Among other factors (market competition, high human development indices) China is vigorously promoting R&D in cutting-edge technologies.

A recent study by a top Australian think tank, Australian Strategic Policy Institute , says China is leading the world in 37 of 44 “crucial technology fields spanning defence, space, robotics, energy, environment, biotechnology, artificial intelligence (AI), advanced materials and key quantum technology areas”. This is because it has established “stunning lead in high-impact research”.

India is neither known for technological breakthroughs nor spending much on R&D.