The Hindu Business Line : The nature of the export boom

The recent growth of merchandise exports has been hailed as a sign that the Indian economy is moving beyond relying on success on software services to greater competitiveness in merchandise trade. In this edition of Macroscan, C. P. Chandra sekhar and Jayati Ghosh analyse the recent pattern of export growth.

When the economic liberalisation strategy was launched in the early 1990s, it was generally argued that this would boost India's commodity exports. Two main processes were predicted in this regard:

First, exposure to international competition as a result of trade liberalisation was expected to restructure economic activity in ways that would enhance exports. The share in total production by domestic firms of goods in which India had a competitive advantage globally was expected to rise. And goods actually produced would be delivered through technologies and processes that were internationally competitive. Second, international firms were expected to seek out India as a location for world market production, making India one more hub for manufactured exports. If China could do it, so could India, it was argued, so long as we were more open.

However, for most of the period since 1991, these expectations remained largely unrealised. There were individual years of rapid export growth, but the long-term trend was disappointing. However, more recently, the rapid expansion of merchandise exports has created much greater optimism that this projected processes is finally being realised.

Such optimism is not without basis, even if it is occasionally exaggerated. It stems from the fact that the last five financial years have been characterised by rates of growth in the dollar value of merchandise exports (balance of payments basis) in excess of 20 per cent per annum (Chart 1). Though there was a short period in the early 1990s and a single year thereafter when this had occurred, this is the first sign of a sustained rate of growth of India's merchandise exports since the beginning of the reform period.

Composition of merchandise trade

This shift to what appears to be a higher growth trajectory is also accompanied by a shift in the composition of overall merchandise trade. But this does not seem to be in the expected direction, as evident from Chart 2. Comparing performance on average between the three-year period ending financial year 2000-01 and that ending 2005-06, the shift in fact seems to be away from manufacturing and agriculture towards ores and minerals and petroleum products.

The increase in the share of ores and minerals is explained by enhanced demand for commodities such as iron ore from countries like China. The shift is indicative of changes in international demand conditions rather than major changes in India's competitive position. On the other hand, the exports of petroleum possibly reflect the volume and structure of India's refinery capacity, with India remaining a large net importer of petroleum, oil and lubricants.

Of course, this does not mean that exports of manufactures are not growing — they are, as Chart 3 clearly indicates, even if this growth is at a lower rate than that of aggregate exports. But changes in the overall composition of India's exports during the years of export recovery were not led dominantly by manufacturing exports. So there is not yet any reason to presume any significant shift in India's competitive position in manufactured exports.

Chart 3 identifies the trends in manufacturing exports since 1995-96. Clearly, the real boom in manufacturing export has been only from 2002 onwards. And this has been led by engineering goods and chemicals. The labour-intensive exports that were supposed to be the main beneficiaries of the economic liberalisation process — such as textile products, gems and jewellery and leather products — have not increased that much.

Chart 4 describes the composition of India's manufactured exports itself. It is evident that the share of India's traditional manufactured exports such as textiles, gems and jewellery and leather in the total exports of manufactures has declined, while that of chemicals has risen modestly and that of engineering goods quite sharply.

This recent expansion of chemicals and engineering exports is the feature that gets captured in anecdotes of India's success in global markets in areas such as automobile parts and chemicals and pharmaceuticals. It certainly does point to a diversification of manufactured exports into new areas and markets. As suggested by Chart 5 explores the detailed pattern of engineering exports; within engineering some sub-sectors such as transport equipment and machinery have shown high export growth in recent years.

Exports concentrated

Such diversification is greatly to be welcomed, but even so, has not helped export growth to an extent where it has become the driving force in India's moderate export success. Furthermore, the most recent data from the Directorate of Commercial Intelligences and Statistics (DGCIS) for the first seven months (April-October) of financial year 2006-07 confirm this assessment.

These data also point to a creditable 25 per cent annual increase in India's merchandise exports in dollar terms, compared to the performance in the corresponding period of the previous year. However, this growth in exports appears to be extremely concentrated. If we take the top ten fastest growing exports between these two periods, we find that they account for as much as 55 per cent of the increase in overall merchandise exports. This in itself should give no cause for concern. Success in a few areas of competitive advantage is still success.

The real difficulty lies in the nature of this commodity set. In order of rank in terms of export growth rates, the fastest growing exports are of sugar, molasses, non-ferrous metals, raw cotton, man-made staple fibre, groundnut, petroleum crude, aluminium, dyes and primary and semi-finished iron and steel.

In some of these cases — such as sugar, molasses, raw cotton and groundnut — the recent export growth is likely to reflect specific international conditions, in particular the world commodity boom, and therefore such high rates of growth of export values may not be sustainable over a longer period. In others — such as non-ferrous metals, aluminium, staple fibre, dyes and steel — the export growth indicates India's competitiveness at the lower end of the global value chain.

This may or may not indicate future possibilities of export expansion. The point is that currently, with the global market booming because of demand from countries like China, exports and profits are growing.

In sum, there is certainly evidence of recent export success, but nowhere near the expectations that had been generated by the advocates of liberalisation. India is still to cash-in on the competitive capabilities it built in the commodity producing sectors during the import substitution years.

One consequence of this is that after many years of economic reform, the country is still plagued with a large deficit in its merchandise trade account, with imports growing much faster than exports. This has not mattered as much as it should for two reasons. First, the runaway success the country has recorded in the new area of trade in services, especially software and IT-enabled services, has helped boost foreign exchange earning. Second, the continuing ability of Indian workers to mine available opportunities in the global labour market, has delivered large remittances into the country through the liberalisation years.

Together these flows of foreign exchange have helped financed a large portion of the deficit in the merchandise trade account. This has kept the current account deficit on the balance of payments at reasonable levels and even delivered surpluses in a couple of years.

Downside of the developments

But these developments also have a downside. Success in services and high growth without balance of payments difficulties has made India, with its large domestic market and overtly favourable policies, an attractive destination for foreign investors. The net result has been the large flow of capital into the country and signs of a growing inability of the Reserve Bank of India (RBI) to intervene in India's liberalised foreign exchange markets to limit the appreciation of the rupee.

An appreciating rupee renders India's exports more expensive and reduces the possibility that India would improve on its export success at the lower end of the global commodity value chain. The possibility that India would enter higher-end segments with a higher proportion of final value added being generated within its own geographical boundaries is weakening.

Bigger Indian firms seem to be seeking a way out of this conundrum with new strategies involving acquisitions abroad. Flush with foreign reserves, the RBI has relaxed regulation of capital account transactions and increased the access of Indians and Indian firms to foreign exchange both domestically as well as from abroad.

This has permitted the new experiment. Rather than wait to built domestic capacities at the top end of the value chain that are internationally competitive, Indian firms are seeking to buy into capacities and brands abroad. This would allow them to do the lower end processing in India, export the intermediate to acquired facilities abroad for further processing and then deliver the output to global markets. It appears that Indian firms are seeking to bypass a phase in development with the aid of finance that facilitates acquisition.

This is obviously a high-risk strategy. When the global system is flush with liquidity, acquisitions are the norm — as the ongoing mergers and acquisitions wave across the world proves. Firm values are, therefore, at their peak making acquisitions costly. Integrating or synchronising the activities of existing and acquired units is a problem even within a country and for firms with experience across vertically integrated segments of an industry. They could prove a nightmare for firms without such experience attempting it globally. And betting on brands available for sale is often a gamble. The strategy can easily fail

It is yet to be seen, therefore, if such corporate strategies can be a substitute, however partial, for making India a manufacturing hub for global markets. Experience elsewhere has shown that what is good for a country's corporations need not necessarily be good for the country. And in particular, a strategy of corporate expansion that seeks to use leveraged internal resources for costly acquisitions abroad rather than invest in creating productive assets domestically, is not one that is likely to generate future export competitiveness.

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