Future of Indian trade is in services exports

Going by the headlines, India’s exports are booming, creating new records and set to scale new highs. The Ministry of Commerce and Industry has embellished the trade data for FY23 with claims such as India’s overall exports scaled “new heights”; merchandise registered “highest ever annual exports” with 14% growth in FY23; services exports grew at 27% to “lead the overall exports growth”, creating a “new record”; China’s share in import basket declined to 13.8% etc.

These are partial truths and lack perspective. A closer look at the trade data released for the full FY23 on April 13, 2023, shows how the new Foreign Trade Policy (FTP) of 2023, released on March 31, ignored product improvements and services sectors’ potential to boost exports by focusing entirely on process improvements. Some of the key information revealed by the trade data are:

(i) Exports of “core” merchandise (excluding petroleum products and gems and jewellery, which are largely import-dependent) actually fell ($-0.45 billion) but imports of “core” merchandise increased ($62.86 billion). This is a double whammy – indicating a weakening of both external demand and domestic demand.

(ii) Both merchandise exports and imports declined in the second half of FY23 – indicating a progressive weakening of growth globally as well as domestically. Exports decline by $19 billion and imports by $33.6 billion.

(iii) Labour-intensive merchandise exports – apparel and textile, handicraft, carpet, jute etc. – fell in FY23. 

(iv) Trade deficit went up from $83.5 billion in FY22 to $122 billion in FY23.

(v) Imports made new highs – 26% of the GDP, taking it back to pre-tariff hike levels and pushing trade deficit – pointing to the failure of the import substitution policy. China’s share in India’s import basket may have declined in FY23, yet it remains high at 31.2% of the total trade deficit of India and went up in absolute numbers – by $5.7 billion until February 2023.

(vi) Real bright spot is services exports. It generated a trade surplus of $144.78 billion, thereby dramatically reducing deficits generated by merchandise trade. But the ministry provides no details of services exports – as it does assiduously every month and every year for merchandise trade of top 30 “commodities”. It only provides three headline numbers for services trade (exports, imports and trade balance). The RBI database does the same.

Internal challenges: Neglect of services, including its exports

It defies logic that the details and analysis of services exports are not provided by the ministry and the RBI.

Services exports are relatively new but are the main driver of Indian trade in recent years and hence, its neglect is a self-inflicted injury India should treat immediately. India’s trade generated a surplus only twice in 73 years (since 1949-50) – in 1972-73 and 1976-77 (Economic Survey of 2022-23). As per the UNCTAD data available for 2005-2021, serviced exports are delivering a surplus since 2010.

This skewed approach has consequences for domestic production and job creation. It must be kept in mind that the services sector and services exports have grown with little help from the government while manufacturing – the base for goods exports – and merchandise exports have received maximum support but have failed to deliver. Here is how.

(a) Services contributes maximum to national income (GDP) since 1982-83 – when it overtook agriculture – and contributes 60% or more to the GDP since FY13. Manufacturing is stuck at 17-18% since FY07 and at 9-17% in the other fiscals since 1950-51. Manufacturing gets a wide-ranging, long-standing and excruciatingly long list of tax incentives to boost production and exports – tax holidays, refunds and incentives under GST, SEZs, EOUs, Deemed Export Benefit Scheme, Advance Authorization Scheme, Duty Drawback, DFIA, ECGC, MEIS, RoDTEP, RoSCTL, EPCG, PLIs etc. Services have just two – SEIS, and EPCG.

(b) Services sector has always been the Number 2 job provider (since 1950-51); it overtook agriculture only for the year 2018-19, but agriculture has reclaimed its Number 1 position thereafter (EPW, Planning Commission and PLFS).

(c) Services are “more labour intensive than manufacturing or mining” (creating more jobs, even if a big part is informal, low-productive and low-paying), supported by both (i) relatively cheap labour and (ii) English-speaking tertiary-educated workforce. A large body of studies show, the 1991 trade liberalisation “displaced” exports from traditional, labour-intensive sectors to skill and capital-intensive (in manufacturing and to an extent, services). Thus, trade liberalisation has hurt domestic job creation, which neither import substitution nor FTP of 2023 sought to address.

(d) Advantage of English for boosting services exports is likely to end soon for two reasons: (a) shift of focus from English in higher education to 22 “Eighth Schedule” languages (which doesn’t include English) in the New Education Policy (NEP) of 2020, as a result of which the DU colleges, for example, have drastically cut down English teaching and (b) in 2015, the UPSE ended primacy of English in civil services exams, making English skills at par with those of 22 Indian languages for the purpose of qualifying to take the exams, reversing its earlier role for “evaluation” of the exam (or clearing/passing the exam).

(e) Global share of services exports is 3-4% as against less than 2% for that of merchandise exports during 2015-2020.

In short, India needs to put its house in order first by reversing its thinking and FTP of 2023.

External challenges: Geo-economic fragmentation

The falling exports and imports in the second half of FY23, as mentioned earlier, are in line with global developments.

The UNCTAD’s latest report says, global trade “turned negative” in the second half of 2022 with merchandise trade registering a 3% decline in the fourth quarter of 2022 while services trade remained constant. It also says global trade is “set to stagnate in the first half of 2023”. The IMF has also revised global growth for 2023 downward, from 2.9% in January 2023 forecast to 2.8% in April 2023 forecast – which is a huge drop from 3.4% in 2022.

Seven of India’s top 10 exports destination in 2022 are facing a sharp decline in their growth in 2023 –except China, Hong Kong and Bangladesh – as per the IMF’s April 2023 projections. This would mean the worsening of global growth in output and trade would weaken India’s growth prospects further. India’s growth is already slipping from 7% in FY23 to 6.5% in FY24 (RBI). Going by the latest trends in trade, this would only add to the trade deficit and lower merchandise exports.

The threats from the global re-alignments in trade along the power blocs in the post-Russia-Ukraine war and sanctions are huge.

But to understand this better, here is how India has already hurt its cause.

India unilaterally terminated 68 Bilateral Investment Treaties (BITs) – which are signed between trading partner nations and impact investment flows. This would play up more and more as India engages with a series of bilateral FTA negotiations. India also kept itself out of three mega multilateral trade agreements – (i) CPTPP was signed in 2018, after the US pulled out in 2017 but in April 2023, the UK joined it; it contributes 15% to global GDP (ii) China-led RCEP of 2019 and (iii) the US-led IPEF of 2022. The latter two trade blocs contribute 70% of global GDP and 53% of global trade.

The fallout is obvious, most multinationals leaving China under their China+1 strategy are either shifting to RCEP member countries (“friend-shoring”) or going back home to the US and nearby countries (“near-shoring”). India isn’t benefitting much from this shifting of global manufacturing because it is not a part of any of these trade treaties. Such re-alignment also threatens India’s chances of joining global value chains (GVCs) because not just multinationals but the US, European Commission and China are now increasingly looking at strategies to make GVCs more resilient by moving production home or to trusted countries.

More trouble is waiting.

The IMF’s World Economic Outlook of April 2023 describes this phenomenon as “geo-economic fragmentation” and says, the threats from this fragmentation are rising, which would lead to “more trade tensions; less direct investment; and a slower pace of innovation and technology adoption across fragmented ‘blocs’”.

Not just that, an IMF analysis shows the fragmentation of investment, caused by this “geo-economic fragmentation”, may cause “2 percent loss in global output” in the long run. The impact would be more on emerging markets like India which would not only lose out on FDI inflows but also “transfer of better technologies and know-how”.

Will G20 leadership help India’s trade?

India is now heading the G20 and holding a series of conclaves throughout the country (also once at Washington). But the G20 conclaves are more about global political and economic orders – the war, sanctions, monetary, fiscal, financial and structural policies to promote growth and maintain financial stability are on their plates. Besides, these necessarily require long-drawn deliberations and negotiations, over several years, for changes to happen.

After the two rounds of G20 Finance Ministers and Central Bank Governors (FMCBG) last week in Washington, the areas flagged by Finance Minister Nirmala Sitharaman for possible positive outcomes relate to (a) regulating cryptocurrencies (b) strengthening multilateral development banks and (c) resolution of debt crisis faced by many low and middle-income countries.

But these engagements can be leveraged to India’s gains.

Raghuram Rajan and Rohit Lamba have precisely pointed to this recently. They argued, India could persuade G20 leaders to open up to the possibilities of services exports in sectors traditionally considered “non-tradeable”, like health, education, legal and accounting services, by lowering barriers to the globalisation of services. This would, they argued, doubly benefit India – by boosting services exports and improving the domestic education and health standards.