This Selected Issues paper presents an analysis of trends in growth and investment in India in the 1990s, with a focus on the slowdown in growth during the second half of the 1990s. The paper discusses the fiscal situation, outlining the key reasons for the deterioration in fiscal balances, how the fiscal situation compares with other developing countries, and the key lessons from countries that managed successful fiscal consolidation. The paper also contains an assessment of India’s opening to global trade and factors that may be affecting India’s export performance.

Abstract

This Selected Issues paper presents an analysis of trends in growth and investment in India in the 1990s, with a focus on the slowdown in growth during the second half of the 1990s. The paper discusses the fiscal situation, outlining the key reasons for the deterioration in fiscal balances, how the fiscal situation compares with other developing countries, and the key lessons from countries that managed successful fiscal consolidation. The paper also contains an assessment of India’s opening to global trade and factors that may be affecting India’s export performance.

IV. Where is India in Terms of Globalization?1

A. Introduction

1. There is an acute awareness in India that more needs to be done to fully realize India’s potential and to reap the full benefit of globalization. Proponents of this view point to the example of other developing countries in East Asia, which were able to achieve higher rates of economic growth over extended periods and to reduce poverty faster than India. In the words of the Governor of the Reserve Bank of India (RBI):

“… Despite all the talk, we are nowhere even close to being globalized in terms of any commonly used indicator of globalization. In fact, we are still one of the least globalized among major countries—however we look at it…” (RBI (2002)).

This assessment was also shared by the Prime Minister’s Economic Advisory Council (EAC), which made the point that

“… there is no divine dispensation that gives India alone the power to survive and prosper as an isolationist island in a globalized world. The truth is that if we do not reform rapidly, and position ourselves to compete, we will be marginalized…” (Government of India (2002)).

2. This chapter examines the extent of India’s integration with the global economy through international trade in goods. The paper is structured as follows. A first section summarizes India’s trade policies and trade performance over the last few decades. The second section compares India’s trade performance to that of its main economic competitors, in particular China, and discusses the extent to which India may be under-trading. A third section offers a number of explanations for India’s lack of globalization. Finally, a concluding section discusses the authorities’ roadmap for future trade liberalization.

B. Trade Policies and Trade Performance

3. India’s trade policy since independence can be divided into three main phases. In the years until the mid-1980s, import-substitution policies kept the economy closed and inward-looking. However, these policies did not prevent a major balance of payments crisis in 1990/91. As part of the wide ranging structural reforms launched in the aftermath of the crisis, the authorities implemented trade and capital account liberalization. These policies resulted in strong trade and growth performance, with the period 1992–96 registering the highest growth rates (Table IV.1, also see Chapter II). Since 1997, however, against the background of the Asian crisis and other emerging markets crises, the pace of reform has slowed.

Table IV. 1.

Trade Performance and Other Selected Indicators, 1977–2001

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Source: World Economic Outlook database.

Pre-Reform Years (1970–91)

4. For most of the post-independence period, India’s trade policy was largely geared toward self-reliance through import-substitution. In the early stages of this policy, imports of most goods were banned, except of goods not produced domestically such as raw materials and some components and machinery items. Quantitative import restrictions (QRs) and other non-tariff barriers (NTBs) were pervasive, and import tariffs were extremely high.2 Direct restrictions on exports, a protected domestic market with a high cost structure, and restricted access to inputs for export production and to foreign direct investment resulted in a strong anti-export bias.

5. The contribution of external trade in goods to growth was negative during most of the period. Reflecting the pervasive trade restrictions, India’s real GDP grew on average by almost 4½ percent annually during 1977–86, but the volume of exports increased by only 2 percent on average. The growth of imports exceeded that of exports. Consequently, India’s trade openness (measured as the ratio of imports and exports of goods to GDP) declined during most of the 1980s, from 13 percent in 1979 to 11½ percent in 1986. Starting in 1987, a gradual depreciation of the rupee allowed for a pick up in exports and a small opening up of the economy.

Reform Years (1991–96)

6. Trade reforms were an essential part of the economic reforms adopted following the balance of payments crisis in 1990/91. The levels and dispersion of tariffs were cut sharply and quantitative restrictions and some other nontariff barriers were eased (Box IV.1).

Key Trade Policy Reforms 1991–961/

Tariff reduction. The statutory peak rate2/ was lowered from 400 percent in 1990 to 110 percent in 1993 and further to 50 percent in 1996. The simple average tariff was lowered by half from 80 percent in 1991 to around 40 percent in 1996.

Removal of QRs. Most quantitative restrictions on import of capital and intermediate goods were eliminated and a single negative list established. With the elimination of import licensing requirements for intermediate and capital goods, the share of value added subject to quantitative restrictions in the manufacturing sector decreased from about 90 percent in the pre-reform period to 51 percent in 1995. However, imports of all remaining goods, comprising mostly agricultural and consumer goods, remained severely restricted and quantitative restrictions on imports remained pervasive, covering over 90 percent of value added in 1995. In 1996, the inclusion of more consumer goods in the open general license list started to lower this figure.

Elimination of export restrictions. Restrictions on exports, including on goods with large export potential, were relaxed with the number of restricted items falling from 440 in 1990 to 150 in 1994 (mainly mass-consumed agricultural products and some minerals). Along with the elimination of most export restrictions, various export incentives scheme were revamped to streamline procedures and reduce distortions, while sector-specific direct export subsidies were largely eliminated. Export taxes were largely abolished in 1992, except for a few selected items, including tea.

1/ A description of India’s trade policy reform during 1991–96 is included in IMF (1997).2/ The statutory peak rate refers to the highest standard rate, although higher tariff rates apply to a number of goods.

7. This major trade liberalization, together with the real depreciation of the rupee, contributed to strong export and import growth during 1992–96. The volume of both exports and imports grew at a double digit rate during the period and India’s trade openness jumped to 22 percent of GDP by 1996. While export growth was mainly driven by lower input costs, quality improvements, and expansion of export industries, imports responded to buoyant domestic industrial production and investment. Also, the regime for foreign investment began to be liberalized gradually.3 By 1996, the inflows of foreign direct investment (FDI) amounted to about US$2.4 billion or the equivalent of ½ percent of GDP.

Removal of Quantitative Import Restrictions (1997–2001)

8. Since 1996, the trade liberalization effort shifted from tariff reduction to the gradual removal of QRs. While the statutory peak rate was reduced from 40 percent in 1998/99 to 35 percent 2000/01, higher duties continued to apply to a number of items and the rates on certain tariff lines were increased, including on goods such as sugar, edible oil, rice, and wheat. At the same time, a special import surcharge of 2 percent was introduced with the 1996/97 budget and subsequently increased to 5 percent in 1997/98 and further to 10 percent in the 1999/00 budget. A special additional customs duty of 4 percent was introduced in 1998. Including the various additional surcharges, it is estimated that the average tariff has remained broadly unchanged during 1997–2001. Following the 1997 World Trade Organization (WTO) decision that India’s QRs were not justified for balance of payments purposes, the remaining QRs were removed in two steps during 2000 and 2001. However, new NTBs were imposed in 2001 on imports, including on agricultural products, petroleum products, urea, and new and secondhand vehicles (Box IV.2).

9. The slowdown in the trade liberalization process together with adverse regional and global developments contributed to a stagnation of India’s trade expansion. During 1997–2001, the average annual growth rate of both exports and imports slowed to below 10 percent compared to, respectively, 11 percent and 15 percent during 1992–96. The trade openness of the economy, which increased sharply during 1992–96, stayed flat at around 22 percent of GDP. Also, the inflow of FDI remained broadly constant at about ½ percent of GDP. However, an important factor mitigating the slowdown in goods exports was the sharp expansion of services exports, especially software, communications, and management services. Since 1997, services exports have grown at the average annual rate of 25 percent, representing, by 2001, a third of total exports of goods and services (Figure IV. I).4 This success reflected India’s supply of high-skilled and relatively low-cost labor and the fact that, compared with other sectors, the services industry has been relatively free of barriers to trade and investment. In particular, the software industry has benefited from substantial government support, including through tax and tariff exemptions and the establishment of technology parks.

Figure IV.l.
Figure IV.l.

Volume or Exports, 1970–2001

Citation: IMF Staff Country Reports 2002, 193; 10.5089/9781451818567.002.A004

Source: WEO.

Trade Policy Reforms in Recent Years (1997–2001)1/

Progress at trade liberalization since 1997 has been mixed. While further steps were taken to eliminate QRs and other nontariff barriers, the overall level of protection has remained broadly unchanged and a number of protectionist measures were taken.

Tariff changes. The statutory peak rate was reduced from 40 in 1997/98 to 35 percent in 2000/01 and the 10 percent import surcharge (on the basic duty rate) introduced in 1997 was eliminated. A special additional customs duty of 4 percent was introduced in 1998. A minimum tariff rate of 5 percent was imposed on a number of exempted items in 1999. Some tariff rates were increased with the 2000/01 budget including on (i) secondhand automobiles (180 percent); (ii) tea, coffee, copra, and coconut (70 percent); and (iii) crude and refined edible oil.

Removal of QRs. The remaining quantitative restrictions were phased out in two steps in April 2000 and April 2001. However, a number of nontariff barriers were retained and in some cases enhanced:

  • Restrictions to import a number of sensitive commodities, such as wheat, rice, maize, petrol, diesel, and urea, only through state trading enterprises.

  • Introduction of (i) an import ban on automobiles older than three years; (ii) restrictions to import secondhand automobiles only through the port of Mumbai; and (iii) certification requirements for the import of secondhand vehicles.

  • Establishment of an early warning system for monitoring imports of 300 sensitive items.

  • In addition, special rules were applied to certain imports, such as the requirement to submit all imports of plant and animal primary products to import permits based on sanitary measures and provisions, and all imports of liquor and processed food to the health and hygiene regulations.

1/ For a more detailed description of India’s trade policy reform during 1997–2001 see IMF (2000) and IMF (2001a).

C. India’s Integration in the World Economy

10. Notwithstanding increased outward orientation since the 1990s, India’s share of world trade has remained unchanged. This section turns to the question of how India’s trade performance compares with its neighbors and more generally with the overall development of world trade during this period. Based on traditional indicators of trade openness, while India was able to open up, it could not significantly increase its share of world trade in merchandise goods, nor reap the full benefits of its fast growing regional environment. According to a statistical model of trade integration, India continued to under-trade during the 1990s.

Comparative Indicators of External Openness

11. The simplest approach to measuring trade integration is to look at indicators of trade openness. While India trade openness (defined as the ratio of imports and exports of goods to GDP) doubled during the 1990s, it continued to lag behind that of the rest of Asia, in particular China (Figure IV.2). Between 1980 and 2000, China’s index of trade openness increased by 150 percent while that of India increased by less than 50 percent. A similar pattern emerges in terms of shares of world trade (Figure IV.3). While India’s share of world merchandise exports has increased from 0.5 percent to less than 0.7 percent over the last 20 years, China’s share has more than tripled to almost 4 percent.5 In other words, if India had opened up like China since the late 1970s, its exports of goods would be on the order of US$200 billion instead of the current US$45 billion. India’s share of global trade is similar to that of the Philippines, an economy six times smaller. However, as noted above, thanks to India’s competitive edge in the IT sector, India’s trade performance looks more favorable when trade in services is included.

Figure IV.2.
Figure IV.2.

Index of Trade Openness, 1982–2001

(1982=100)

Citation: IMF Staff Country Reports 2002, 193; 10.5089/9781451818567.002.A004

Source: IFS and staff estimates.
Figure IV.3.
Figure IV.3.

Index of Share of World Trade, 1982–2000

(1982=100)

Citation: IMF Staff Country Reports 2002, 193; 10.5089/9781451818567.002.A004

Source: IFS and staff estimates.

12. FDI inflows to India remains very low in comparison to some other emerging countries. This occurs despite the fact that India is one of the largest domestic markets in the world and has a large labor force available at relatively low cost.6 FDI inflows to India amounted to a mere US$2.3 billion (½ percent of GDP) in 2000 compared to US$38 billion in China (4 percent of GDP) or US$33 billion in Brazil (5½ percent of GDP).

Statistical Model of Trade Integration

13. A second, more analytical, approach to measuring openness to trade is to use a statistical model of trade. One such model—the so-called gravity model—that explains bilateral trade in terms of countries’ characteristics such as, economic mass, distance apart, geographical contiguity, common language, or free trade agreements (Box IV.3). The model can be used to estimate a benchmark of what trade of a given country might be expected to be, given the bilateral trade performance and country characteristics of all other countries. One can then evaluate the degree to which actual trade patterns deviate from this benchmark and thus whether a country over-trades or under-trades.7

14. According to the model estimates, India under-trades when compared to the trade performance (benchmarks) of other countries (Table IV.2). For example, in the period 1995–98, India’s trade was estimated to be about 70–80 percent less than what would be expected given its income and geography.8 Furthermore, the degree to which India under-trades seems to have risen in the 1990s, notwithstanding the trade liberalization measures. This suggests that the benefits of the gradual tariff reductions could have been limited by the persistence of nontariff barriers, even though QRs were gradually dismantled. In addition, other emerging and developing countries, in particular in Asia, also liberalized their trade regime, so that India’s relative performance in trade liberalization may not have improved.

Table IV.2.

Estimates of the Gravity Model and Country Specific Dummies 1/

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* Indicates bias-corrected significance at the 5 percent level.

15. The newly industrializing economies in Asia seem to have over-performed the rest of Asia in trade integration. In particular, the country specific dummies for Hong Kong SAR, Singapore, and Taiwan POC are all highly positive and significant. In contrast, China is estimated to be trading about as much as would be predicted by the model. Most industrialized countries, including the United States and Japan, are also estimated to trade as predicted by the model.

D. Explaining India’s Low Degree of Integration

16. There are at least four factors that could explain India’s relatively low degree of trade integration. The first is the continuing high degree of restrictiveness of the trade regime. Second, the process of trade liberalization itself, whereby tariffs on inputs and intermediate goods have been lowered at a faster pace than tariffs on outputs, may have also contributed to increase India’s effective protection and the anti-export bias. Third, the existence of various domestic impediments to investment and growth has impacted both the tradable and non-tradable sectors of the economy. Finally, India, like other developing and emerging markets, is facing a number of market access or trade barriers in industrial countries that impede the full exploitation of comparative advantage.

A Gravity Model of India’s Trade Integration

Gravity models of bilateral trade are well-suited for testing the extent to which countries under-trade or over-trade, after controlling for their size (proxied by GDP), income (proxied by GDP per capita), and costs of trade (proxied by the distance between them and their degree of remoteness) and other fixed factors, such geographical contiguity, common language, and free trade agreements.1/ The use of country-specific dummy variables allow to determine whether a country under- or over-trades compared to other countries and whether its trading performance have changed over time.

In the specification of the gravity model used in this section, the bilateral merchandise trade between two countries is modeled as follows:2/
(1)TRADEijt=(YitYjt)α(Yij/PitYjt/Pjt)θDijβeμijt,

where TRADEij is bilateral trade (exports plus imports) between countries i and j, Yi and Yj are nominal gross domestic product (GDP) in countries i and j, respectively; Pi and Pj are population in the two countries, Dij is the geographic distance between countries i and j, and t is a time subscript.

Priors about the key variables are as follows. The economic size is expected to augment trade (α> 0) in line with the theory of trade in differentiated products. The level of per capita income is expected to be positively related to trade (θ> 0), given that more developed countries—countries with a higher level of GDP for a given population size—tend to specialize and trade more. Distance could be interpreted as a proxy for transportation and communication costs, and is negatively related to trade (β<0).

The parameter μijt controls for other factors that could augment or diminish trade:

(2)μijt=γκ+φλt+ijt,

where γκ reflects other potential determinants of trade (for example, membership in preferential trading arrangements, common land borders, a common language, participation in military conflicts, and oil trade) and ϵijt is a well-behaved error term. The parameter φλ identifies the country specific effect; i.e., the extent and the significance of the country’s under-trading or over-trading from the average trade as predicted by the model. The model is estimated by nonlinear least squares (in order to deal with zero-valued observations) on cross sectional data for five-year periods from 1980 to 1998.3/

1/ A short survey of literature on gravity model is presented in Subramanian and Tamirisa (2001). A brief history of the gravity model is given in Frankel and Rose (2000).2/ The empirical work in this section draws on the ongoing work by Subramanian, Tamirisa, and Bhavnani (2002).3/ For a comprehensive description of the methodology and data, see Subramanian and Tamirisa (2001).

Trade Restrictiveness

17. Notwithstanding the reforms of the 1990s, India’s trade regime remains highly restrictive. India’s average tariff remains one of the highest in the world (Table IV.3). While a large number of QRs were eliminated in 2000–01, other non-tariff barriers continue to be in use. India has also become one of the major users of anti-dumping measures. Overall, India’s index of trade restrictiveness measures 8 on a scale of 1 to 10 in 2001.

Table IV.3.

Measures of Trade Policy Regimes in India and Other Regions: IMF’s Trade Restrictiveness Index, 2001

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Source: IMF. For details on the methodology used in constructing this index, see Appendix I in Sharer (1998).

Includes other discriminatory duties and charges.

18. India’s tariff rates remains high by Asian and international standards (Table IV.4). With the 2002/03 budget bill, the statutory peak rate was reduced from 35 percent to 30 percent, but about 300 products with a zero tariff rate were moved into the 5 percent tariff category.9 Despite some consolidation, India’s tariff dispersion remains relatively high,10 and the tariff shows substantial escalation in some sectors, especially for paper and printing, textiles and clothing, and food, beverage, and tobacco. As a result of additional bindings taken by India in the WTO, the share of tariff lines that are bound has increased since 1998, from 67 percent to 72 percent; new bindings were made primarily in textile and clothing; and India also renegotiated bindings in some agricultural items.11 As a consequence, a number of items, mostly agricultural products, have much higher tariff rates than the statutory peak rate of 30 percent.12 A further complication with the current tariff structure is that, at the 6-digit level, some sub-categories of a particular product could have different tariff rates (concessional rate or zero rate).

Table IV.4.

Summary of Standard Customs Duty Rates, 2000–031/

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Source: Indian authorities and staff calculations.

Includes only the standard customs duties and the ad valorem portion of mixed duty rates.

As submitted in the 2002/03 draft budget law to Parliament.

19. In addition to the standard customs duties, imports can be subject to various additional duties. These include (i) an additional customs duty, also known as countervailing duties, corresponding to the equivalent of the local excise duties (domestic tax); (ii) a special additional customs duty; (iii) possible safeguard duties, in case of import surges; and (iv) anti-dumping duties. Including all such duties and charges, India’s average tariff was estimated at about 36 percent in 2001/02 and 33 percent in 2002/03, compared with an average of 12½ percent for Asia, 1773½ percent for sub-Saharan Africa, and 12 percent for the countries of the Western Hemisphere.

20. Almost all QRs have been removed, but imports are still subject to various other nontariff restrictions.13 These include some import bans (rice, wheat, beef, etc.), import restrictions through state trading monopolies (canalization), and standards or certification requirements. Also, a list of 133 items are subject to domestic standards established by the Bureau of Indian Standards (BIS).14 Other particular standards are also in place outside this list (e.g., sanitary and phytosanitary regulations, and the safety standards on automobiles, which prevent the importation of used cars more than three-year old). Delays in customs procedures are also due to the complexity of the tariff structure and exemptions, which may vary according to product, user, or specific export-promotion programs. In an effort to improve the classification of products and to reduce red tape, a new 8-digit customs harmonization system has been proposed (see below). Also, the authorities stated that import licenses could now be granted within a day if the request was made on line.

21. India is one of the most active users of anti-dumping measures and safeguards duties (Table IV.5). While these are allowed under WTO rules, the Government of India (2002) noted that:

Table IV.5.

Top Ten Users of Anti-Dumping Measures, 1995–2001 1/

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Source: WTO.

As measured by initiations by reporting party.

“…not all cases of competitive imports are dumping. In many cases, the items being imported may be more competitive imports than domestically produced items simply because domestic competitiveness is constrained by restrictions on scale of production.”

Based on notifications of anti-dumping actions made to the WTO, India initiated some 250 actions during 1995–2001, of which a large number were against imports from the European Union and China (about 19 percent each). Moreover, the number of anti-dumping measures in force has risen steadily from 19 in 1997 to 131 in 2001. The majority of the initiations have been made for chemical and related products (47 percent). Since 1998, safeguard duties were imposed on eight chemical products.

Effective Protection

22. India’s effective protection rate is likely to be much higher that the average nominal tariff rate. An exact calculation of effective protection would require detailed information on India’s input-output matrix. However, with a nominal tariff of 35 percent on output, effective protection could vary from 35 percent to 350 percent depending on the sectoral input-output ratio and the average tariff on inputs, making protection quite arbitrary and random.15

23. The situation in India is exacerbated by the existence of numerous tariff exemptions16 and escalation clauses, with average tariffs rising from 29½ percent for unprocessed products to 32⅓ percent and 33 percent for semi-processed and processed products, respectively.17 Only a single uniform rate of import duty could ensure that all producers of all goods have the same and transparent rate of protection, thus promoting efficiency and competitiveness while eliminating administrative problems, legal disputes, tax evasion, and corruption.

24. Ad hoc tariff changes that tend to accompany each years’ budget add to the complexity of India’s tariff regime and risk increasing effective protection. For example, the 2002/03 budget lowered the statutory peak rate from 35 percent to 30 percent and reduced tariff rates on a number of inputs, while increasing tariffs on some agricultural products (tea and coffee) and certain finished goods (such as steel) above the statutory peak rate (Box IV.4).

Selected Tariff Measures in the 2002/03 Budget

The following main tariff changes were announced in the 2002/03 budget speech.

Tariff Cuts

  • The statutory peak rate was lowered from 35 percent to 30 percent. By 2004/05, there will be only two basic rates of customs duties, 10 percent covering generally raw materials, intermediates and components, and 20 percent covering generally final products, with some exceptions on account of WTO bindings or higher tariffs for agricultural products.

  • The customs duty on cement and clinkers was reduced from 25 percent to 20 percent; on copper, zinc, and lead from 35 percent to 25 percent and, on aluminum and tin from 25 percent to 15 percent.

  • To encourage the development of infrastructure facilities, the customs duty on specified equipment for ports and airports was reduced to 10 percent.

  • The flat duty rate of 35 percent applicable to certain items of personal use of passengers returning from abroad on transfer of residence was reduced to 30 percent, while a few more items like lap top computers, portable photocopy machines, digital video disc players, and video cassette disc players were added to the eligible list of items.

  • The customs duty on imported liquors was reduced from 210 percent to the WTO binding rate of 182 percent. The rates of CVD applicable to liquors and wines were revised to 75 percent for value up to US$25 per case and 50 percent for others.

Tariff Increases

  • To support the steel industry, it was decided that the basic customs duty on seconds and defectives of steel would be increased to the bound rate of 40 percent. To reduce the disparity between rolled products produced by the steel plants and cheaper products produced from ship breaking, the basic custom duty rate on ships for breaking was increased to 15 percent.

  • To protect the interest of the farmers, (i) the customs duty on tea and coffee was increased further to 100 percent, that on natural rubber, poppy seeds, pepper, cloves and cardamom to 70 percent, and the duty on pulses from 5 percent to 10 percent; and (ii) the customs duty on agricultural machinery and implements was reduced from 25 percent to 15 percent.

  • A nominal customs duty of 5 percent was imposed on some of the items that were previously exempted.

  • Notwithstanding India’s commitment under the Information Technology Agreement to apply zero duty regime on IT products by 2003, the government responded favorably to the request by local manufacturers to make it effective only from the year 2005. As a further measure of assistance to domestic industry, customs duties on a number of hardware inputs and certain capital goods were reduced to 5 percent and 15 percent, respectively.

  • To provide incentive to the domestic manufacturers of drugs, a basic customs duty of 5 percent on drugs was introduced.

Domestic Impediments

25. India’s trade performance reflects not only its trade regime but also domestic structural bottlenecks affecting both the tradable and nontradable sectors. These include (i) a relatively restrictive foreign investment regime; (ii) the reservation policy for small-scale industries; (iii) the poor quality of public infrastructure, such as transportation and power; (iv) the slow pace of industrial restructuring, and (v) efficiency costs associated with red tape.

26. India’s foreign investment regime remains relatively restrictive. Notwithstanding the recent steps aimed at liberalizing and simplifying FDI approval,18 foreign equity restrictions in the form of bans or limits still apply to a number of sectors. In addition to sensitive sectors such as defense, strict FDI restrictions remain in place for agriculture (including plantation), retail trading, railways, print media, and some real estate operations. FDI limits are still in place in the banking sector, insurance, and some service sectors. Also, in many instances, FDI proposals need to be considered and approved by various government agencies based on a number of guidelines including on export or value-added requirements. In particular, such requirements would apply to industries that require an industrial license, to equity participation higher than the prescribed foreign equity limits, or to foreign investors who have no previous ventures in the proposed sector.19

27. The policy of reserving certain products exclusively for small scale production (reservation policy) may have had a detrimental impact on export performance. A number of sectors subject to reservation (e.g., leather products, toys, and until recently garments), which are widely seen as having the maximum export potential, could not benefit from economies of scale in production to compete internationally.20 As recommended by the EAC, in case outright abolition of reservation is not feasible, reservation should at least be abolished for selected products in which India has a strong export potential.

28. Poor physical infrastructure contributes to making India’s industry less competitive in international markets. According to a recent World Bank/Confederation of Indian Industry (CII) study on the competitiveness of Indian manufacturing, in the area of physical and financial infrastructure, India’s performance is clearly behind many East Asian and Latin American countries, and the gap between China and India is rapidly widening in favor of the former.21 In particular, access to reliable power at reasonable cost is a prime concern for most manufacturing firms. Also, transportation is seen as an area where India falls short of its neighbors.22

29. Industrial restructuring has faced several impediments. First, protection from international competition through tariff and non-tariff barriers has prevented the necessary restructuring of non-profitable enterprises. Second, restructuring has been complicated by labor legislation that constrains labor mobility, which in turn has not allowed India to reap adequately the benefits of its comparative advantage in labor intensive technologies. For instance, the dismissal of workers or restructuring of workforce requires government approval for companies with more than 100 employees.23 Third, restructuring has been complicated by cumbersome legal procedures to liquidate loss-making enterprises.

30. Efficiency costs associated with administrative hurdles and red tape have also affected the investment climate. According to the World Economic Forum, after labor regulations, customs administration and cumbersome procedures for entry and exit are major constraints in doing business in India. Customs administration is tedious and time-consuming.24 Also, India requires more permits and it takes much longer to start a firm than almost all countries included in the Global Competitiveness Report. There are, however, large differences in the incidence of red tape and provision of infrastructure across states in India. Not surprisingly, firms operating in Indian states with relatively good investment climates post consistently better performance than those in other states. Restrictions and high regulatory burdens also apply to the use and transfer of land.25

Trade Barriers Faced by Indian Exports

31. India also faces trade barriers in its exports to industrial countries, in particular the United States and the European Union. While these economies are generally fairly open, they have barriers that apply to imports of a number of products in which India and other developing countries have a comparative advantage. For example, in the United States customs duties on a number of items for which India has a comparative advantage are significantly higher than the U.S. average tariff on imports.26 Table IV.6 shows the tariff barriers that apply to the top 20 product categories exported by India to the U.S. by value in 2001, including under the preferential access of the Generalized System of Preferences (GSP). While the simple average tariff on India’s merchandise imports is less than 5 percent, the tariff rates on a number of textile products, which represented almost 20 percent of the total value of U.S. imports from India, were in excess of 10 percent in 2001. For instance, India’s exports of articles of apparel and clothing accessories to the United States faced a tariff barrier in the order of 11–13 percent. Footwear articles have an import tariff duty of 14 percent. High tariff rates also apply to tobacco and manufactured tobacco substitutes (74 percent), manmade staple fibers and filaments (12 percent), and dairy products (12 percent).

Table IV.6.

Top 20 U.S. Imports From India, 2001

(In millions of U.S. dollars)

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Sources: WTO, U.S.’s International Trade Commission, and staff estimates.

32. In addition to tariffs, many of India’s exports face nontariff barriers (quantitative restrictions) and other forms of protection in industrial countries. According to the WTO, exports from India are also currently subject to 40 anti-dumping and 13 countervailing measures, mainly for agricultural products, textile and clothing products, and chemical and related products. One of the most notable trade restrictions facing India is on its exports of textile and clothing under the Multi Fibre Arrangement (MFA) and the Agreement on Textile and Clothing (ATC). However, it was observed that Indian exporters’ utilization of quotas in these two markets has in some instances been low, possibly reflecting India’s high production costs.27 This in turn indicates that India may not necessarily be in a position to expand exports when the quotas under the ATC are relaxed (Panagariya (2002)), although both the phasing out of the ATC and China’s accession to the WTO could theoretically benefit India (François and Spinanger (2002)). Another important trade restriction faced by India is the large trade distorting agricultural subsidies in industrial countries.

E. Roadmap for the Future

33. In early 2002, the government presented its medium-term export strategy together with its new export and import (EXIM) policy for 2002–07 (Box IV.5). Recognizing the limits of past export strategies,28 the new strategy aims at identifying potential markets and new areas of comparative advantage in order to increase India’s share of world exports to 1 percent by 2007 (from 0.67 percent at present).29 About 220 items at the 4−digit level were identified for special focus, with the three E’s—electronics, electrical, and engineering goods—figuring prominently in the list of items with the greatest export potential. Other sectors include textiles, gems and jewelry, chemicals, agriculture, and leather and footwear items. For each of these sectors, various sector-specific strategies are expected to be put in place. For instance, the strategies for the electronics, electrical, and engineering sector include support to small and medium-sized enterprises (SMEs) for research-development, accreditation of testing laboratories in India by overseas agencies, and encouraging joint ventures and FDI.

34. At the macroeconomic level, a number of policies have been established to improve the overall export competitiveness. These include the establishment of new private sector run special economic zones (SEZs), steps to make labor regulation more flexible, in particular regarding exit policy, the pursuit of the dereservation policy, the reduction of transaction costs and red tape through automation and simplification of procedures, and the upgrading of export infrastructure. As a complement to this environment, the real effective exchange rate of the rupee would be maintained at a level appropriate for ensuring price competitiveness of exports.

Some Key Highlights of EXIM Policy, 2002–07

In support of the medium term export strategy, the EXIM policy for 2002–07 introduced a number of specific measures to facilitate exports through price and regulatory incentives, including (i) the further liberalization of the trade and exchange regime; (ii) widening the eligibility to use export schemes; and (iii) other measures to simplify procedures and cut transaction costs.

Liberalization of the Trade and Exchange Regime

  • Eliminating all quantitative restrictions and packaging restrictions on exports, in particular on agro and agro based products, except for a few sensitive items.

  • Establishing offshore banking units (OBUs) in the special economic zones (SEZs). These units would be permitted to undertake hedging of commodity price risks, provided such transactions are undertaken by the units on stand-alone basis. Also, external commercial borrowings for a tenure of less than three years will be permitted in SEZs.

  • Improving the special facilities for status holders, in particular (i) allowing the license, certificate, and permissions and customs clearances for both imports and exports on self-declaration basis; (ii) granting priority finance for medium and long term capital requirement as per conditions notified by RBI; (iii) allowing the retention of 100 percent of foreign exchange in exchange earners’ foreign currency accounts; and (iv) lengthening the normal repatriation period from 180 days to 360 days.

Enlarging Access to Export Schemes

  • Promoting cottage sector and handicrafts exports through greater access to exports schemes, such as the market access initiative (MAI) and export promotion capital goods (EPCG), and enlarging the list of duty free items for imports.

  • Encouraging further development of centers of economic and export excellence and making the benefits of the above mentioned export schemes available to small scale industry (SSI).

  • Broadening the duty free and customs exemption regime in the leather and textile industry.

  • Promoting the gem and jewelry industry through (i) the elimination of customs duty on import of rough diamonds; (ii) the abolishment of the licensing regime for rough diamond; and (iii) relaxing the value addition norms for export of plain jewelry.

  • The Electronic Hardware Technology Park scheme is being modified to enable the sector to face the zero duty regime under the Information Technology Agreement.

  • To enhance the cost competitiveness of export products, fuel costs are to be rebated for all export products. Special transport subsidies for exports originating from units far from ports were added.

Other Measures to Simplify Procedures and Reduce Transaction Costs

  • Adoption of a new and clear 8 digit commodity classification for imports.

  • Same day licensing introduced in all regional offices.

  • Reduction in the percentage of export cargo undergoing physical examination.

  • Simplification of the customs procedures and duty schemes, such as the Duty Exemption Entitlement Certificate, the Advance License for Annual Requirement, the Duty Free Replenishment Certificate, the Duty Entitlement Passbook, and the Export Promotion Capital Goods scheme.

  • Setting up of Business Centers in Indian missions abroad for visiting Indian exporters.

35. In order to achieve the authorities’ objective for trade integration, more efforts are needed to eliminate the anti-export bias of the Indian economy. This would require:

  • Significantly reducing the statutory peak rate and lowering the average tariff rate to at least the “Asian level” of 12 percent.30 In this context, the pace of tariff reduction could be accelerated in view of the current strong external position.

  • Simplifying the tariff regime by removing or reducing the exemptions and introducing a lower and more uniform duty structure. Specifically, there is a need to avoid complex and biased tax incentive systems, in particular in the SEZs, that could lead to substantial revenue losses and thus complicate further the process of tariff reduction.

  • Removing the remaining nontariff and administrative barriers on imports and exports, while both domestic production and imports should be made subject to the same safety and quality standards.

  • Along with trade reforms, further liberalizing and simplifying the foreign investment regime.

  • Finally, allowing a more flexible exchange rate regime to reflect changing fundamentals resulting from trade and capital account liberalization.

36. Pari passu with these steps, the various export promotion schemes should be streamlined and phased-out. As noted in WTO (2002), while the share of exports qualifying for these schemes has risen steadily, from around 37 percent in 1997/98 to 71 percent in 1999/00, it is not clear whether these schemes have been successful in boosting Indian exports. Instead, it has been suggested that India’s opening up may be due more to the liberalization policies pursued since 1991 rather than to the export promotion schemes themselves.

37. Finally, there is an urgent need to unshackle Indian industry to enable it to compete globally. Thanks to its high-skilled and relatively low-cost labor force, particularly in areas of engineering and science, Indian industry has great growth and export potential. However, this potential is greatly undermined by the disadvantages that industries face in terms of structural, regulatory, and infrastructure impediments. The SEZs are being planned with a view to providing world-class facilities for export-oriented manufacturing and to attract FDI. However, experience from other countries suggests that they would be of more benefits to the whole economy if enterprises in SEZs develop close links with domestic enterprises to maximize productivity spillovers. And domestic enterprises can benefit more from these spillovers if there is a major overhaul of the investment climate at both the center and states levels.

References

  • A.T. Kearney,FDI Confidence Audit—India,February 2001.

  • Chopra, Ajai, Charles Collyns, Richard Hemming, and Karen Parker, 1995, “India: Economic Reform and Growth,” IMF Occasional Paper 134 (December).

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  • François, Joseph, and Spinanger Dean, 2002, “Market Access in Textiles and Clothing,Egyptian Center for Economic Studies, (May).

  • Frankel, Jeffrey, and Andrew Rose, 2000, “Estimating the Effect of Currency Unions on Trade and Output,CEPR Discussion Paper No. 2631.

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  • Goswami, Omkar, David Dollar, and others, 2002, “Competitiveness of Indian Manufacturing: Results from a Firm-Level Survey,Confederation of Indian Industry and the World Bank, (January).

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  • International Monetary Fund, 2000, India—Recent Economic Developments, IMF Staff Country Paper (December).

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  • Panagariya, A., 2002, “India at Doha: Retrospect and Prospect” in Economic and Political Weekly, (January 26).

  • Sharer, Robert, 1998, “Trade Liberalization in IMF-supported Programs”, IMF World Economic and Financial Surveys.

  • Subramanian, Arvind, and Natalia Tamirisa, 2001, “Africa’s Trade Revisited,IMF Working Paper No. 01/33.

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1

Prepared by Jean-Pierre Chauffour (x38826), who is available to answer questions.

2

For a comprehensive description of India’s trade regime prior to 1991, see Chopra, et al. (1995).

3

The most significant measure of liberalization was the allowing of foreign majority participation in 35 high-priority industries on an automatic approval basis, with the possibility of approval to 100 percent on a case-by-case basis.

4

Another notable aspect of India’s composition of trade in goods and services is the trend decline in the share of agriculture goods.

5

It has been argued, however, that China’s rising export share in world markets is overstated because a significant portion of China’s exports reflect processing trade.

6

If local market size and labor costs were the only determinants, India should be very successful at attracting FDI. According to A.T. Kearney, which publishes an index of FDI competitiveness with emphasis on these elements, India ranks near the top of the list at number 7 (A.T. Kearney (2001)).

7

This approach has been used in a number of recent IMF publications, including IMF (2001b) and Subramanian and Tamirisa (2001).

8

Country dummies in Table IV.2 are expressed in logarithm terms.

9

However, a large number of items remains exempted from customs duties. Most are product specific but many are also based on industrial or end-use.

10

The bulk of imports falls into four major standard tariff rates: 5, 15, 25, and 35 percent (now 30 percent), although higher tariff rates apply to a number of goods.

11

According to the WTO, India bound all agricultural lines (under the WTO definition of agriculture) and 68.2 percent of lines for non-agricultural products, WTO (2002).

12

It is estimated that some 2 percent of the tariff lines have rates exceeding the statutory peak rate of 30 percent.

13

Some 600 items at the 8-digit level out of a total of 35,000 items (i.e., 1.7 percent of the total) are still subject to WTO-compatible quantitative restrictions or bans (mainly for security reasons).

14

A comprehensive description of India’s NTBs is available at www.nic.in/eximpol.

15

The effective rate of protection that a producer gets on his value-added depends on the value added per unit, the average import duty rate on inputs, and the tariff on the output.

16

According to the Planning Commission, in any standard publication of the custom tariff, containing 1,150 pages, it is estimated that 400 pages are devoted to exemptions (cited in WTO (2002)).

17

According to WTO (2002), escalation is especially pronounced in food, beverages, and tobacco, wood and furniture, textiles and leather, and basic metals.

18

FDI limit in private banks was recently raised from 40 to 49 percent, excluding investments by foreign institutional investors (FII). According to a proposed measure in the 2002/03 budget, portfolio investments by FIIs will no longer be subject to sectoral limits for FDI, except in specified sectors.

19

In other cases, the FDI could be automatically approved with only the RBI being informed within 30 days of receipts of funds or issuance of shares to the foreign investor.

20

About 750 sectors are still reserved for the small scale industry (SSI).

22

According to the World Bank/CII survey, the total container volume handled at all the Indian ports combined is lower than that passing through Shanghai. Furthermore, shipping a container (continued…) container of textiles or garments from Bangkok to the United States eastern seaboard is almost 18 percent cheaper compared to Mumbai or Chennai despite a longer route.

23

A draft law to increase the employee threshold to 1,000 has been approved by Cabinet but is yet to be tabled in Parliament.

24

According to the World Bank/CII survey, the time needed to clear customs is 50 percent longer in India than in Korea or Thailand and triple what many OECD countries report.

25

Land market distortions are estimated to account for about 1.3 percent of lost growth per year (World Bank and CH (2002)).

26

The focus on the United States is because U.S. custom tariff data are more readily available than those of other industrial countries. India’s exports to the EU and Japan are also reported by the Indian authorities to face substantial barriers.

27

According to the above mentioned World Bank and CII (2002), while India’s value added per unit of labor costs in the garments and textiles industry compares favorably with other Asian countries, such as Thailand, Malaysia or the Philippines, the value added per worker compares unfavorably. This is mainly because of the unfavorable investment climate, including the regulatory burden on firms, delays at customs, energy cost disadvantage, and relatively high interest costs.

28

Past export strategies such as the Extreme Focus Product Strategy (1992), the 15x15 Matrix Strategy (1995), or the Focus on Latin American Countries (LAC, 1997) have been too static, focusing essentially on India’s existing export products and markets.

29

This would require exports to double to around US$80 billion in five years, at a compound annual rate of 12 percent per annum.

30

The EAC’s recommendation to lower the maximum rate to 12 percent by 2005 was not retained by the government, which instead announced that, by 2004/05, there would be only two basic rates of customs duties, 10 percent covering generally raw materials, intermediates and components, and 20 percent covering generally final products, with some exceptions on account of WTO bindings or higher tariffs for agricultural products.

India: Selected Issues and Statistical Appendix
Author: International Monetary Fund