A new role for trade?

The new trade policy of the Union government, by offering duty-free imports as an incentive for exports, threatens the viability of the domestic capital goods sector, which has played an important role in India's industrial development.

PARADOXES abound in the figures on India's balance of payments. Two are particularly striking. To start with, while the merchandise trade deficit, or the excess of the imports of goods over their exports, is large and growing, the current account has been in surplus for the last few years. "Invisibles", or foreign exchange flows not matched by movements of goods, have more than made up for the trade deficit.

The trade deficit itself has been widening not because India's export performance has been wanting. Exports valued in dollars have grown by more than 20 per cent in 2002-03 and 2003-04. The trade deficit remains high because the country's import bill has risen from $51.4 billion in 2001-02 to $61.4 billion in 2002-03 to $77 billion in 2003-04. This year, high oil prices would ensure that the figure is much higher.

However, these high import figures have not posed a problem because of huge inflows on account of software and IT-enabled services (totalling $11.7 billion in 2003-04) and on account of private transfers or remittances, which stood at a staggering $18.9 billion last financial year.

In the event, the current account on India's balance of payments has been in surplus, leading to the second paradox. While a surplus on the current account implies that India did not require capital inflows to finance its balance of payments, such inflows stood at a net figure of $22.2 billion in 2003-04, largely because of a huge $11.4 billion of net portfolio flows. The result has been an embarrassment of riches, reflected in rising foreign exchange reserves.

These two paradoxes provide the background to assess the new trade policy released by the Commerce Minister. Clearly at the moment, earning foreign exchange to finance the current account is not what concerns the government. This has resulted in the view expressed by the Minister that he is seeking to project exports as an "engine of growth". "Exports, as many look at it, is not merely a dollar generating activity. It is an incremental economic activity," he has said. This perception has been embodied in the objective that India needs to double its exports to take its share of the world total to 1.5 per cent in the coming five years.

This emphasis on a medium-term strategy is positive, inasmuch as it implicitly recognises that India should not rely on potentially volatile financial flows on the capital account to meet its foreign exchange requirements. Unfortunately, the same emphasis does not appear to be reflected in the government's policies with regard to financial flows themselves, leading to the unusually large inflows of portfolio funds referred to earlier.

A second positive feature of the trade policy is that it seeks to realise a quantum jump in exports by emphasising merchandise exports. While seeking to build on India's strengths through new concession for services exporters (including individuals) under the "Served from India" scheme, the policy statement pays much attention to the merchandise exports area. The questions that remain therefore are: What are the means being used by the government in its effort to boost merchandise exports? And which are the areas of focus when it comes to realising its goal of doubling India's global export share?

There are four ways in which the target of doubling India's merchandise exports in world trade is sought to be achieved. The first is by adopting the attitude that we need not "export our taxes" and therefore should neutralise the disadvantage that domestic taxation of inputs creates for exporters through tax drawbacks or duty-free imports.

The second is by adopting promotional policies such as providing infrastructural support, revamping and revitalising the Board of Trade, launching special schemes in key export areas, and so on.

The third is through strengthening the export processing zones and export-oriented unit schemes, which provide special concessions for specialised exporting units.

And the fourth is to provide economic incentives in the form of duty-free import concessions, some of which are in the form of unrelated imports, to exporters. In particular, the Export Promotion Capital Goods (EPCG) scheme, which allows duty free or concessional duty-based imports of capital goods in return for a commitment to meet pre-specified targets with regard to exports over a certain time period, has been emphasised.

MOST of these are a mere continuation or reiteration of pre-existing schemes. To the extent that they strengthen such schemes they are welcome. But there are a couple of features of the policy that are disconcerting. One is the use of access to duty-free imports as a means of providing export incentives. This not merely reduces the net foreign exchange earning derived from exports, but can serve as the means through which even the dwindling protection for crucial sectors of Indian manufacturing can be further eroded with damaging consequences for domestic growth and employment. R.K. Dhawan, a former Additional Director-General of the Directorate General of Foreign Trade, who should know, has dismissed the view that the new trade policy will help generate employment. In his view: "Industry will be crippled by free imports of new and second-hand capital goods under the EPCG scheme."

It needs to be noted that with the liberalisation of imports and reduction of import duties, the strength of this incentive has been substantially eroded. Considering that such incentives did not help deliver export buoyancy even in the period when imports where strictly controlled, it is unlikely that Indian manufacturers would take to exporting because of the possibility of accessing duty-free imports. To the extent they do, they would focus on areas of import where duties are still relatively high to protect domestic industry, and the impact on domestic production would only be adverse.

The point to note is that liberalisation has increased the tendency among domestic producers to import freely without bothering about the foreign exchange implications. Thus the export policy should have included a component that seeks to discipline domestic producers to target global markets, in return for the access to imports they are being offered in any case. What the policy does is to say that access to imports would be even better if these firms contribute to export revenues. Even if at the moment India's foreign exchange situation is comfortable, the fundamental principle that those who absorb large amounts of foreign exchange from the national kitty have a responsibility to earn some foreign exchange needs to be emphasised. That is, the issue is not to offer access to easy imports to those who export, but to ensure that those who resort to imports also earn some foreign exchange through exports. Unfortunately, by declaring that exports are now required more from the point of view of growth rather than the earning of foreign exchange the trade policy statement has departed from this principle.

There is evidence that duty-free import incentives encourage foreign exchange profligacy. In fact, in the past some of these schemes, such as the export promotion capital goods scheme have been misused. The benefit of the scheme is availed of, but the quid pro quo commitment to meet pre-specified export targets is not met. Despite this the government has carried forward and strengthened the scheme in the new policy. Besides encouraging foreign exchange profligacy, this amounts to removing all protection for and threatening the viability of the domestic capital goods sector, which has played an important role in India's industrial development.

In terms of sectoral priorities too the trade policy statement reflects some lack of innovativeness and an unwillingness to depart from past trends. There is still an overemphasis on traditional exports such as agricultural products, handloom, handicraft and gems and jewellery. Some of these areas already have a large presence in India's export basket: textiles contributed 18.8 per cent of the dollar value of India's exports in 2003-04, gems and jewellery accounted for 16.6 per cent, and agricultural products for 11.7 per cent. To push these shares even higher would be difficult. On the other hand, handicrafts' contribution of 0.7 per cent is too small to make any difference.

The emphasis on traditional exports has been defended on the grounds that the export policy seeks to further the employment generation objectives of the government. The employment objective is indeed laudable, but to expect export growth in traditional areas to contribute significantly is not. Domestic policies, including public works programmes backed by a law guaranteeing employment, are required to realise those objectives. Exports really matter from the point of view of financing imports. And for this purpose, it is time India focussed on diversifying its exports much more into non-traditional areas of manufacturing, which is where world markets are expanding fast.

In fact, there is some danger that export incentives would be seen as a substitute for the domestic support needed for sectors that have traditionally been an important source of livelihood for the poor. The emphasis on exports of agricultural, handloom and handicraft products - all sectors faced with crises of one kind or the other - suggests that this is a soft option that the government may be toying with. That is an option that cannot work and cannot be an alternative for dealing with these crises. The responsibility for earning foreign exchange through merchandise exports must rest with large, non-traditional manufacturing firms. And growth and buoyancy in the traditional sectors must be delivered through support in the domestic market. Unfortunately, the trade policy statement seems to have reversed these priorities. Whether this has been done consciously or unwittingly is, however, not clear as yet.