The continuous decline in the exports from India over the past more than a year and a half has been one of the major burning issues. A lot of debates and discussions have taken place to find out the real cause of this steady decline. In 2013-14, India’s total export was worth $314 billion and it declined to $310 billion in 2014-15 and further in 2015-16, it declined to $ 261 billion. There are some people who opine that it is the outcome of our exchange rate policy which makes Indian rupee over valued in terms of real effective exchange rate (REER). As a result it is having adverse effect on our exports and our exports are becoming relatively costlier. Banks are not exception to it and their credit portfolio and non interest income is also being adversely affected. Bankers are feeling tremendous pressure on this front and finding it difficult to cope up with the situation of declining export credit, falling foreign exchange earnings and mounting NPAs.
Some might argue that this downfall in exports is the outcome of weak global demand, and claim that everything is going to be perfect as and when world economic conditions improve. According to the data released by the International Monetary Fund, the total volume of global trade has fallen by 0.62 per cent in 2015 and a similar trend is expected to prevail in 2016. For the last few years, the growth in global trade is less than that in global gross domestic product. Let us explore what is the root cause of this decline in exports and what are the remedies available for future sustainable growth?
Exports growth and exchange rate:
Many policy thinkers argue that an overvalued rupee is partially responsible for the recent decline in India’s exports. To understand the relationship between exports and exchange rate, we need to look at the growth of India’s exports and real effective exchange rate (REER) between 2002 and 2015.
Till 2013, the relationship between export growth and REER was mixed (See chart). After this period, it exhibits a clear trend that an overvalued rupee has affected the growth of India’s exports. This corroborates a well-tested hypothesis that “a stronger currency is not good for export outlook”. Many countries in East Asia including China pursued the strategy of relatively undervalued currency to make their exports competitive in global market under their export led industrialisation.
The Finance Minister Arun Jaitley also said that the government would like the rupee to reflect its real value. Raghuram Rajan has been brushing aside the Centre’s allegation by putting forth arguments for what, according to him, are the actual reasons for the sad state of affairs of Indian exports — a slowing of global trade and a shift in importing patterns of global economies.
He explained that the reasons for slower growth in global trade compared to growth in global GDP were threefold. Firstly, as countries get richer, non-traded services constitute a greater fraction of GDP, causing GDP to grow faster than trade. Secondly, with trade-intensive capital goods’ investment muted because of global overcapacity, trade grows more slowly than GDP. Finally, as industrial countries become more competitive, and as China moves up the value chain, more of the inputs going into final products are being sourced from inside a country than from outside. Some global supply chains are, therefore, contracting. He thinks that due to these reasons the heady days when Indian trade in goods and services were expanding at a double digit pace will probably only be a memory for some time and we have to get used to a new normal — a slower growth rate in exports.
He has also made it clear that while rupee depreciation helps one section, there are many others who are hurt by it. Again, a sharp depreciation will stir the road towards internationalising the rupee, which is one of RBI’s long-term goals. The central bank has, rightly, adopted the strategy of intervening only when there is excessive volatility, preferring to stay on the sidelines at other times.
There have been mixed conclusions from various studies on the impact of exchange rates on Indian exports. However, one has to keep in mind that a relatively undervalued currency does not generate additional demand nor is it a permanent solution to all the ills prevailing in the domestic economy. But in a highly complex and competitive world, where countries are competing for their export interest, the value of currency must be fairly placed vis-à-vis competing currencies to make one’s export competitive.
Exports growth and global growth:
Indian exports appear to be highly dependent on global growth. Sharp fall in global growth after the financial crisis led to a corresponding decline in India’s exports. Therefore ignoring global growth while examining the relationship between export growth and exchange rate, does not give the correct picture. While the indirect cause for a slowdown in global trade is a slowing global economy, the breakdown of export numbers shows that it is crude oil that has played a crucial role in exports decline. While the demand for petroleum products was impacted by slowing demand, the sharp cut in crude oil price has also impacted the value of Indian exports.
The other major component of Indian export, gems and jewellery, has been hurt by slowing consumption of discretionary items, and the export of machinery and capital goods is negatively impacted by lower capital expenditure, especially in commodity exporting countries.
Other factors and export growth:
India’s exports are sensitive to relative price competitiveness and global demand. It supports the perception that the current decline in India’s exports is caused by a fall in global demand and loss in price competitiveness. This is particularly true when our exports are supply-driven and not necessarily dependent on their demand in other countries. In addition, some of the following factors may also have some impact on overall Indian export growth and may not be ignored completely.
There is a strong inter-linkage between exports and imports due to increasing dependency of export on imported intermediate inputs, like ‘gems and jewellery’ or ‘oil’ exports. Therefore exporters should discount the benefits available to them by the measures which liberalise intermediate imports in order to boost exports and make it more competitive in the market. In addition, the issues such as lack of reforms in input markets like those in land, labour, capital, logistics, which are hindering our producers to produce goods at competitive rates, should be addressed passionately.
Inadequate infrastructure and capacity building also prevents us from participating in the Global Value Chains (GVC) which plays an important role in developing world class infrastructure to survive in the international markets. There is a need to build the primary infrastructure in terms of better multi modal transportation for improved road connectivity to ports, rail heads, airports and inland waterways, faster throughput at ports and shorter dwell time, faster movement of rakes by railways and quicker air cargo movement with all the related trade facilitation measures in place. In addition, the creation of a supportive infrastructure for exports, including more laboratories for testing, more tool rooms and plant quarantine facilities, larger trade facilitation centers and enhanced cold storage facilities for pharmaceutical and perishable goods.
In addition the rules regarding the movement of goods within the country, from one territory to another, must be more liberal and business friendly. There is need for amendments in the laws, practices, regulations and taxation regimes of various states. It appeals for concerted action from relevant departments at the central and State government levels. The newly passed GST Bill may prove to be of great help in this direction. The role of agencies involved in foreign trade should be more of trade facilitators rather than that of controllers. Therefore equal emphasis should be on domestic reforms in addition to outer measures like various trade agreements, to boost country’s trade ecosystem.
Another factor behind the steep decline in India’s exports could be over-dependence on a few markets such as the US and European Union countries which together account for 40 per cent share in India’s total exports. It is particularly important in view of falling demand, stagnant growth and resultant aggregate demand in these countries. The diversification of export markets is important in the context of future sources of global aggregate demand and the changing dynamics of the global trading through mega regional trade agreements.
On the internal front, India should emphasize on reforming domestic policies and institutions dealing with macroeconomic management (exchange rate, inflation and interest rates), standards, intellectual property rights, trade facilitation, and organisations vis-à-vis operational aspects of trade and investment rules and regulations. On the external front, India should engage with those trade agreements which would help in securing better market access and can diversify our exports and provide greater space for our producers to participate in global production networks.
A way Forward to Banks:
ICICI Bank MD and CEO Chandra Kochhar has expressed her views on free trade pacts saying that there should be “greater thinking” while signing FTAs (Free Trade Agreements) as they have yielded more benefits to India’s partner countries. On analyzing the export performance during the years 2005-12, the FTAs that have been signed with various countries, our imports from those countries have grown more than our exports have grown. So, actually our partner countries have benefited more from us. So while signing the FTAs India should concentrate on our competitive sectors like services and more weightage should be given to those sectors to protect our interests. India has so far implemented FTAs with countries like Japan, South Korea, Singapore and ASEAN. It is negotiating several such pacts with nations like the EU, Australia and New Zealand.
The entire world is slowing down both for exports and imports. India needs to make its exports more competitive amid slowing global demand and depreciating currencies. We have to pick up some sectors where we can make India the global hub in the entire value chain and the most important sector to pick up should be electronics as it being the second largest imported goods in India, if we can just take one of these sectors as champion sector. We will actually produce in the country for consumption in India to start with later of course exports and create huge amount of employment.
Suggesting steps on financing for exports, the entire export credit line in India is still much smaller in terms of scale compared to many other exporting countries. Considering the availability of cheap export credit, today even the pre-shipment credit has entire obligations of SLR and CRR which add to cost of that credit. So if we can even have pre-shipment credit qualify for non-application of CRR and SLR, the cost of funding for the exporters could be much lower. By making the entire export credit part of priority sector lending can incentivise banks to provide more export credit. Today all the export credit that foreign banks do, it qualifies for priority sector classification but the funding of export credit that Indian banks do does not qualify for it. There is a need to make the entire exercise, right from invoice to duty drawback, done digitally. Any how the exports are feeling a sigh of relief by the interest equalization scheme commenced by GOI for the next five years.
Therefore, in view of such external factors, a slight adjustment in exchange rate could serve as an effective instrument to address challenges emanating from relative price competitiveness and can help India’s exports. Exchange rate management alone will not relieve India’s export challenges. The country should make continuous efforts in alleviating supply-side bottlenecks to boost sectoral productivity and export competitiveness. Therefore, India should adopt a progressive approach towards structural reforms to address cyclical as well as structural factors at the external and internal fronts, which are adversely affecting our export performance. In addition we have to be selectively thoughtful about our benefits while finalizing any trade agreement with other countries so that market and product differentiation may help us in attaining a sustainable export growth in line with our core competencies and ongoing reforms.
Most of the factors discussed above are beyond the control of banks; despite they should shift their focus to the financing to more SME units and help them in developing into independent export units as most of them at present supply to the parent exporters who reap the benefits from the trade. There lies a huge opportunity in SME segment as these units constitute more than 40 % of the India’s export manufacturing. Banks should also focus on new market segmentation and shift their area of finance to the sectors and countries which are aligned to the new Foreign Trade Policy 2015-20. Small and Medium Enterprises are not companies which have access to international funds at cheap rates. There are some sectors like automobiles in which Indian SMEs produce at least one or more components. Banks can also extend their support to the SME exporters for the time being by making cheap export credit available to them and offering concessions in service charges particularly to SME units which have been striving hard to make a mark in the international arena and are initially not in a position to negotiate with the banks.
(Faculty Foreign Exchange)
Union Bank of India
Staff College, Bengaluru