The removal in 2005 of quotas on textiles and clothing (T&C) presents important opportunities for India, but is also exposing key structural impediments to growth. India had been constrained by quotas, which suggests that it should benefit from their lifting in January 2005, under the Agreement on Textiles and Clothing (ATC). On the other hand, India now faces increased global competition, including from China. The Indian government is optimistic about export prospects—the National Textile Policy targets T&C exports to rise fourfold, to $50 billion by 2010—but the key question is: are policies in place to allow for such success?

The removal in 2005 of quotas on textiles and clothing (T&C) presents important opportunities for India, but is also exposing key structural impediments to growth. India had been constrained by quotas, which suggests that it should benefit from their lifting in January 2005, under the Agreement on Textiles and Clothing (ATC). On the other hand, India now faces increased global competition, including from China. The Indian government is optimistic about export prospects—the National Textile Policy targets T&C exports to rise fourfold, to $50 billion by 2010—but the key question is: are policies in place to allow for such success?

Despite significant advantages, the Indian textile industry faces considerable constraints to reaching its potential. India has a competitive advantage stemming from its large and relatively low-cost labor force, a large domestic supply of fabrics, and the industry’s ability to manufacture a wide range of products (United States International Trade Commission, 2004). India also has a strong and diverse raw material base for manufacturing natural and artificial fibers. Furthermore, India has large capacity in textiles and spinning, and India’s textile industry spans the entire supply chain. However, whether India can benefit from the quota elimination will depend on the degree to which the existing constraints are removed. These include stringent labor market regulation, poor infrastructure, inadequate investment, and a legacy of unfavorable government policies.

This chapter examines the impact of the elimination of quotas on India. It first looks at how India has fared in the T&C industry over the last 10 years. Then it provides evidence, including from previous rounds of liberalization as well as economic modeling, of the likely impact of quota elimination on India. In the following section, we utilize a general equilibrium model to examine the impact of the elimination of the ATC quotas on India. Next, we focus on the specific constraints facing the Indian T&C sector, and conclude by discussing possible options for overcoming weakness.

Where Does India Stand in the Global Textile Industry?

The T&C sector is an important one for India. Textiles and clothing are significant items in India’s export basket, accounting for nearly a quarter of Indian exports and around 3 percent of world T&C exports in 2003. In addition, this sector is the second largest generator of employment, providing jobs for 35 million people or around 10 percent of the work force. Thus, the T&C sector will need to play a key role as India looks to create jobs for its rapidly growing work force. Textiles and clothing exports are also a significant earner of foreign exchange, and contribute 4 percent and 14 percent to GDP and value added in manufacturing, respectively (Ministry of Textiles, Annual Report, 2003–04).

While India’s market share of exports of both textiles and clothing has increased in recent years, it has lost ground to China in certain markets (Table 11.1). India has done reasonably well in the United States and Canada since 1995, but has lost ground in Europe, and plays a negligible role in the Japanese market. China, meanwhile, continues to surpass India as world leader in exports of T&C. A study by the United States International Trade Commission (2004) predicts that China will become the “supplier of choice” for most U.S. importers (the large apparel companies and retailers) because of its “ability to make almost any type of textile and apparel product at any quality level at a competitive price.”

Table 11.1.

Market Shares in Textiles and Clothing

(In percent)

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Source: World Trade Organization.

Competing in the Post-Quota World: Initial Indications

The example of Japan can provide an early glimpse at how India might fare in a post-quota world—as Japan did not impose quotas in the pre-2005 period—and the picture that emerges provides some cause for concern. In particular, China accounted for nearly half and 80 percent, respectively, of Japan’s T&C imports in 2003. Recently, imports from India have fallen, while those from Vietnam, Indonesia, and other member countries of the Association of South East Asian Nations (ASEAN) have risen notably.

Another indication of the possible impact after the abolition of quotas in 2005 comes from previous rounds of liberalization. Since 2002, when the so-called “Phase III” liberalization took place, Indian exports of products for which quotas were eliminated grew by a respectable 20 percent, but Chinese exports tripled (Table 11.2). A number of other countries, such as Bangladesh, Korea, Indonesia, the Philippines, and Thailand saw their T&C exports fall by 50 percent on average. So, while India has been able to maintain its place, previous liberalizations have hardly been a boon for its T&C industry.

Table 11.2.

Impact of Liberalization of Textiles and Clothing on Exports to the United States

(In percent)

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Sources: U.S. International Trade Commission; and U.S. Department of Commerce, Office of Textiles and Apparel.

Change in exports to the United States of textile and clothing items liberalized during Phase III (2002–04).

Change in the value of exports to the United States of Phase IV textile and clothing items since end-2004 (January–June 2005).

Change in the value of exports to the United States of all textile and clothing items since end-2004 (January–June 2005).

Change in the volume of exports to the United States of all textile and clothing items since end-2004 (January–June 2005).

Early data on the impact of the recent elimination of quotas paint a broadly similar picture. U.S. data for the first half of 2005 confirm that exports of T&C from China have surged, India has held its ground, and some other exporters have faced sharp declines. As expected, China has tripled its T&C exports of liberalized product lines and saw a sharp increase in total textile exports (see Table 11.2). Export volumes from China rose by almost 50 percent in the first half of 2005. At the same time, prices of these liberalized goods fell sharply:1 apparel prices fell by almost 8 percent; wool products by 30 percent; cotton coats, dresses, and knit shirts by more than 60 percent; and cotton trousers, skirts, and sweaters by almost 50 percent. India’s textile exports to the United States grew robustly, faster than all major exporters with the exception of China. These trends are mirrored in member countries of the European Union (EU). Total EU imports from China grew three times as fast as those from India (in value terms) during January–May 2005 (Table 11.3). For products liberalized in January 2005, China’s exports surged by 80 percent, while India posted a moderate growth of 10 percent. Surprisingly, while the prices of exports of most countries fell, Indian export prices rose.

Table 11.3.

Imports of Textile and Clothing in the First Half of 2005 into the European Union

(In percent)

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Source: European Commission.

Change in total imports in January–May 2005, relative to 2004.

Change in imports of products liberalized on January 1, 2005, during January–May 2005 relative to the corresponding period in 2004.

Another way of understanding how India will fare in the new global environment for T&C is to use economic models. Here, results are mixed. While the literature mostly suggests that India stands to gain substantially from the liberalization, a few recent studies draw more negative conclusions. Differences in results reflect the methodologies used, including partial versus general equilibrium modeling, different base years for the data, differences in the sectoral and regional aggregations used, and the absence of preference schemes from the Global Trade Analysis Project (GTAP) database until recently (Table 11.4 contains a summary of the literature). We turn now to the GTAP model.

Table 11.4.

Summary of the Literature on the Effects of the Quota Elimination on India

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Modeling India’s Potential in Textiles

The elimination of quotas on T&C is expected to have a significant impact on the production, exports, and employment in exporting countries and a positive impact on the welfare of consumers in importing countries. The quota-imposing countries—the United States, EU countries, and Canada—are expected to experience gains in welfare, despite a decline in production of T&C, through reduced consumer prices and increased efficiency following enhanced specialization. For developing countries the net effect will depend on two factors: while the terms of trade will deteriorate, quota-constrained exporters will experience an increase in efficiency as the distortionary trade regime is removed. Therefore, the elimination of quotas is widely expected to lead to winners and losers.

We use the computable general equilibrium model from the Global Trade Analysis Project (GTAP version 6) to simulate the impact of the elimination of quotas in the T&C sector. We simulate two scenarios to estimate the impact of the elimination of quotas on India. The first is a complete removal of the quotas, by eliminating the export tax equivalents (ETEs) of quotas under the Multifiber Arrangement (MFA) and the ATC.2 The second scenario includes a 50 percent reduction of quotas on China, and a full removal of quotas (or equivalently ETEs) imposed on other countries.3 This scenario aims to estimate the impact of the liberalization keeping in mind the somewhat more limited liberalization vis-à-vis China.

In 2005, quotas were imposed on Chinese exports of T&C using the textile-specific safeguard provision contained in China’s protocol of accession to the World Trade Organization (WTO). Moreover, in June 2005, under the Shanghai Agreement between the EU and China, annual import restrictions were set for 10 categories of Chinese textile and clothing products, limits for many of which were reached early in the year. The United States has similarly placed restrictions on imports of about 30 T&C categories from China for the next three years. A key contribution of this chapter is to analyze incomplete liberalization in the presence of quotas on China and a focus on the impact on India.

Key results are as follows.4

  • With full liberalization (Scenario I) textile exports from India are expected to grow by 6 percent (value terms), whereas clothing exports are expected to fall by 4 percent relative to the base year 2001 (Table 11.5). In the case of incomplete liberalization (Scenario II), both textiles and clothing exports from India are projected to grow, by 13 percent and 11 percent, respectively. Thus India, along with some other exporting countries, benefits from the temporary restrictions imposed on China.

  • The fall in export values in the first scenario is explained by the fall in prices rather than export volumes. In both scenarios, volumes of textile and clothing exports grow.

  • As expected, prices of T&C exports fall with the lifting of the quotas. With the complete liberalization of the sector, Chinese exports are much more competitive as can be seen by a sharper fall in export prices.

  • The impact on GDP is generally insignificant, except for China, where GDP rises by 2 percentage points due to tremendous gains in efficiency (Table 11.6). In the second scenario, India’s GDP is projected to rise by ½ percentage point, while that of China’s by 1 percentage point.

  • World welfare would increase but India’s welfare would drop, as a negative terms of trade effect would outweigh a rise in allocative efficiency effect (Table 11.7).5 The negative effect on India is in contrast to a number of previous studies based on earlier versions of the GTAP database. The main welfare gains would accrue to consumers in the EU and the United States via reduced prices. Of the exporting countries, China would gain, despite a negative terms of trade effect, due to massive increases in efficiency. In the pre-2005 world, Chinese exports were severely restricted and faced binding quotas in many product categories. In Scenario II, we see a smaller increase in world welfare due to incomplete liberalization, and a smaller increase in the welfare of the United States, EU, and China. On the other hand, we see a smaller negative welfare effect on other exporting countries such as India, Mexico, and Bangladesh.

Table 11.5.

Summary Table on the Impact of the Elimination of ATC Quotas on Exports

(In percent)

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Source: Simulations using GTAP 6.0.

This scenario assumes a complete elimination of quotas for all countries except China. For China, it assumes a 50 percent reduction in quotas.

Table 11.6.

Impact of the Elimination of ATC Quotas on GDP

(In percent)

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Source: Simulations using GTAP 6.0.

This scenario assumes a complete elimination of quotas for all countries except China. For China, it assumes a 50 percent reduction in quotas.

Table 11.7.

Impact of the Elimination of ATC Quotas on Welfare

(In 2001 constant U.S. dollars)

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Source: Simulations using GTAP 6.0.

The breakdown of the terms of trade effect for India is food: 10; textiles: -325; clothing: -251; manufacturing: -10; and services: 20.

This scenario assumes a complete elimination of quotas for all countries except China. For China, it assumes a 50 percent reduction in quotas.

These results should not, however, be interpreted to mean that India will be unable to benefit from the quota elimination. In particular, GTAP does not model the potential for India to strengthen its textile industry via domestic structural reforms. Furthermore, the simulations do not capture dynamic effects of, for instance, the impact of greater competition on productivity. Thus, the results should be seen as providing a warning that India may not do as well in the post-quota world as some expect if needed reforms are not pursued aggressively. In that regard, the results suggest also that the temporary quotas on Chinese exports provide a small window of opportunity to prepare for completely liberalized trade in 2008, when all quotas on China are to be lifted. We turn now to examine more closely the key constraints on India’s textile industry and how they may be overcome.

What Is Constraining India’s Potential in Textiles and Clothing?

Significant constraints facing the Indian T&C industry may be preventing it from realizing its export potential. The opportunities unleashed by the removal of the quotas are tempered in India by domestic policy constraints and a problematic business environment.

The absence of labor market flexibility and the legacy of reservation for small-scale industry are obstacles to achieving economies of scale.6 Until recently, a number of T&C subsectors had been set aside for small-scale industry which has, perversely, precluded much-needed investment and modernization. Moreover, Indian manufacturers often set up several small plants instead of a single large one, to remain exempt from certain restrictive labor laws and onerous regulatory requirements. It should not be surprising, then, that India’s T&C sector is dominated by small producers with little vertical integration in the apparel industry (United States International Trade Commission, 2004).

The failure to reap economies of scale—together with a generally difficult business environment—has limited investment and productivity gains. Investment in the textile industry has remained low and stagnant, varying between $1 billion and $1.5 billion annually during 2000–03. Moreover, foreign direct investment (FDI) in this sector has been insignificant, although the government has allowed foreign equity participation up to 100 percent in much of the sector. (See Chapter 5 for a discussion of constraints on FDI more generally.) Perhaps even more important than the funding that such investment could have generated is the fact that India has missed out on the associated technology transfer. Largely as a result of limited investment, productivity is low and, despite wages that are among the lowest in the world, labor costs per unit of production are relatively high. A study by the Reserve Bank of India (2004) finds a decline in total factor productivity growth in the textile sector in the 1990s. While capital intensity increased during the decade, growth in capital productivity in the textile sector slowed vis-à-vis the previous decade. Growth in labor productivity rose during the same period, but does not compare favorably with other countries. A lack of investment and innovation may also be constraining the quality of Indian T&C products. A recent study (World Bank, 2004) points to perceptions about the low quality and quality inconsistency for India’s T&C products as a key problem for exporters.

Until recently, the excise tax regime for the textile sector was not conducive to new investment, although recent changes are a step in the right direction. The 2005/06 budget (Government of India, 2005) reduced excise duties for yarn and fiber, although blended and noncotton textiles continued to be subject to a higher tax regime. With the man-made fiber sector accounting for a large share of trade, rationalizing the taxation structure for this sector may strengthen competitiveness. In addition, the implementation of a value-added tax in most states in 2005/06 has made the tax system more export friendly (see Chapter 9).

Inadequate infrastructure and bureaucratic delays have contributed to long turnaround times in India. This is critical in today’s world of global competition in which production can and does shift quickly to different locations. Poor roads, ports, and airports contribute to delivery times that are longer than for key competitors. Transportation times from India are long (see Chapter 4), and it is estimated that each additional day in transport is equivalent to an extra 0.8 percentage point increase in applied tariff rates (Hummels, 2001). The efficiency of customs processing is lower in India than in many other countries. Moreover, the price of industrial power in India is among the highest in the world, reflecting inadequate investment in the power sector as well as distortionary pricing, with large cross-subsidies from industry to consumers.

The Way Ahead

How can the Indian government ensure that its T&C industry is well prepared to deal with the new global environment? In general, the government should focus on creating an enabling environment—including via the provision of an adequate infrastructure—and on removing obstacles to investment, innovation, and job creation. By doing so, Indian enterprises will be empowered to enhance their productivity, increase product quality, and reduce delivery times. Goldman Sachs (2004) surveyed about 30 major wholesalers, manufacturers, and retailers globally to examine the impact of the elimination of textiles and apparel import quotas in 2005. Both U.S. and EU respondents cited product quality as the top consideration in sourcing decisions post quota elimination, followed by product cost, production speed, working conditions, access to inputs, and transportation speed. Most, if not all, of these issues can be addressed by improving the policy environment in which Indian textile firms operate.

  • Increased labor market flexibility is key to achieving economies of scale and much-needed flexibility in production. A move to U.S.-style “hire and fire” policies is not in the cards in India and may not be desirable. However, raising the firm size threshold for exemption from various labor laws and regulatory requirements may lessen the incentive for Indian firms to remain inefficiently small. Special economic zones, if properly designed, could also help firms work around the restrictive labor laws and could enable the setting up of mega production plants similar in scale to those in China. Finally, a relaxation in contract labor law would be helpful in allowing businesses to respond to the rapid changes in demand that are typical in T&C, for example, by hiring temporary workers.

  • Steps to increase investment are needed to raise productivity. In large part this will require broad changes in the business environment and economic infrastructure that are not specific to T&C. More specifically, India is considering allowing FDI in the retail segment, which could play an important role in improving distribution services for textiles and clothing.7 In addition, technology will increasingly have a dominant influence in what was traditionally a labor-intensive industry. There may be a role for government to support the import of existing technology, investment in research and development, and technology transfer and diffusion both globally and domestically.

  • Continued efforts to enhance infrastructure and reduce customs red tape would have a large payoff. Indian port capacities need to be increased. And the same applies for its airports. More firms internationally are expected to use air freight to tighten inventory and shorten delivery time, even if transport costs are higher, and the apparel industry is estimated to become one of the fastest growing air freight markets between 2004 and 2009. A policy of setting up textile clusters, linked to airports with emphasis on freight and business traffic, could be an option at least until ports and other capacities are enlarged. Increasing the efficiency in customs procedures, including by streamlining the administrative requirements to clear customs, expedite the customs procedures, and computerizing customs, would also be important in this regard. Moreover, power sector reforms—as contemplated in the 2003 Electricity Act—are needed to bring electricity costs down to internationally competitive levels. More specifically, in the T&C sector, use might be made of dedicated power delinked from State Electricity Boards, and better quality power in textile parks.

With the proper enabling environment, the private sector would be well placed to improve its capacity to compete in a market where prices are falling and more players are entering. In doing so, the following considerations will be critical:

  • To minimize lead times, firms should aim at integrating the supply chain and developing strong textile clusters, capable of handling all stages of production in a coordinated manner. In particular, the weaving and fabric processing sector—considered to be the weakest link in the supply chain because of inadequate investment and lack of technology—should be strengthened. There needs to be integration from weaving to garment making to reduce lead times, cut costs, and improve quality. There is also a need to forge business contacts between domestic clusters and retail groups.

  • Greater emphasis should be placed on quality certification and branding to boost the quality of Indian fabric and garments.

  • Developing expertise in designing, marketing, retailing, financing, and the gathering of market intelligence on foreign markets is important. To this end, FDI flows should be encouraged.

  • Greater inroads need to be made into the area of upscale high-fashion and customized clothing segment. Extensive use of computer-aided design and manufacturing systems will aid innovation and reduce lead times. Greater emphasis is also needed on training to offer service-related skills and integrated solutions to prospective buyers. Some state governments are planning to set up training institutes to upgrade skills of personnel.

  • Diversifying product bases—including moving into rapidly growing areas such as technical textile fabrics for packaging, sports textiles, medical and hygiene-related textiles, and military textiles—will also need to be part of the overall industry approach.


The dismantling of the MFA quota regime presents an opportunity for India to increase its market share in the world and to “go global”. However, success is not guaranteed. The results of the simulations undertaken in this chapter do not present an especially optimistic scenario for India in terms of export growth of T&C in a quota-free world, as the decrease in prices will offset gains from higher export volumes. However, the presence of the safeguards on China provides India with a rare window of opportunity to undertake important reforms in labor markets, investment, and infrastructure, so it can realize its potential. If successful, such reforms will allow India to emerge much stronger and expand its share in world textiles and apparel markets at a much faster pace.

Appendix. Methodology and Data

The Global Trade Analysis Project (GTAP) database contains the bilateral trade, transport, and protection matrices that link all regions of the world. In turn, the regional matrices are derived from individual country input-output tables. The GTAP relates trade policy shocks to the medium-term changes in global production and trade flows. We use the standard general equilibrium closure for the simulations.

We present a regional aggregation model with 13 regions or countries and the major exporters and importers (as per the World Trade Organization data) of textiles and clothing. The countries or regions included are Bangladesh, China, EU15, Hong Kong SAR, India, Indonesia, Korea, Mexico, the Philippines, South Asia (other), Taiwan Province of China, the United States, and the rest of the world.8 We use a five-sector aggregation for the simulations, focusing on textiles, clothing, food, manufacturing, and services, and a five-factor general equilibrium model. The detailed results of these simulations are reported in Ananthakrishnan and Jain-Chandra (2005).

India Goes Global: Its Expanding Role in the World Economy

In the last several years, India has emerged as a global economic power. It has become one of the world’s fastest growing economies, the world’s leading outsourcing destination, and a favorite of international investors. And Indian corporates are emerging as key global players in their own right. This rapid development has gone hand-in-hand with a gradual, but unmistakable, opening of its economy. Tariff rates have come down significantly, capital account restrictions have been steadily eased, and broad structural reforms have increased the flexibility and competitiveness of the economy.

Even with India’s impressive recent achievements, it continues to face considerable challenges as it seeks to sustain rapid growth and extend its benefits to all it citizens. Good jobs need to be created for the 100 million labor force entrants expected over the next decade. India’s infrastructure must be dramatically enhanced to cope with its booming economy. Large fiscal deficits and debt must be brought under control. And India must continue to open itself to the world, to fully reap the potential benefits of globalization.

This book, then, appears at an opportune time. Is India entering into a “Golden Age” or simply experiencing a period of rapid but ultimately unsustainable growth of the sort it has seen several times before? The studies in this book examine in detail what lies behind India’s recent economic rise and considers the steps needed to build on this success over the medium term.

India Goes Global: Its Expanding Role in the World Economy


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Prices have fallen in the most competitive segments for which the quotas were binding. In other words, the quota premium was keeping the prices artificially high and these started falling once the quotas were removed.


The ETE measures the degree of restrictiveness of a quota. Exporters in countries where the quotas are binding need to buy the quota. Since the market clearing supply of quotas is not available, they sell at a premium imposing, in effect, a tax on exports. Therefore, increasing restrictiveness leads to rising ETEs. However, the removal of all ETEs may overestimate the impact of liberalization, since the GTAP model does not permit the elimination of simply those export taxes that are related to the MFA/ATC quota elimination.


The simulated 50 percent reduction in China’s export quotas is aimed at analyzing in a general sense the sensitivity of Scenario I to the presence of safeguards in general. The model is not sufficiently detailed to capture the precise impact of the current EU and U.S. limits on imports on specific Chinese T&C products.


Results are in 2001 constant dollar terms. The regression results are relative to the base year 2001. The impact on welfare is measured by the change in equivalent variation. The equivalent variation is the income change, which at current prices would be equivalent to the proposed price change, that is, the income change needed to keep the utility of the consumer unchanged.


The negative welfare effect for India is derived after taking into account the possible positive effect on domestic consumers because of the reduction in prices.


Small-scale industry is defined as one in which investment in fixed assets does not exceed Rs 10 million (about $0.2 million). Qualifying firms receive preferential treatment in a number of areas, including access to bank credit and lower tax rates.


In China, foreign retailers will have the right to set up distribution networks through wholly foreign-owned enterprises, without any geographical or quantitative restrictions.


In this chapter, we present the results for India and China.