7.1 The external sector has exhibited a marked transformation since the balance of payments crisis in 1991. The crisis was overcome by a series of stringent measures with an overriding objective to honour all external obligations without resorting to rescheduling of any external payment obligation. While successfully dealing with the crisis through an adjustment programme, it was decided to launch simultaneously a comprehensive programme of structural reforms in which the external sector was accorded a special emphasis.

7.2 After the 1991 crisis, the broad approach to reform in the external sector was laid out in the Report of the High Level Committee on Balance of Payments, 1993 (Chairman: C. Rangarajan). The objectives of reform in the external sector were conditioned by the need to correct the deficiencies that led to the payment imbalances of 1991. Recognising that an inappropriate exchange rate regime, unsustainable current account deficit and a rise in short-term debt in relation to the official reserves were the key contributing factors to the crisis, a series of reform measures was put in place. A swift transition to a market determined exchange rate regime was felt necessary so as to deal effectively with the uncertain response to reforms introduced in other areas of the external sector at that time. It may be recalled that other reforms initiated in the external sector included dismantling trade restrictions, moving towards current account convertibility, liberal inflows of private capital, removal of restrictions on all inflows and related outflows, as also, gradual liberalisation of certain restrictions on outflows. The overall objective of the reform process was to achieve higher growth and efficiency without exposing the system to greater vulnerability. Consumer welfare was sought to be improved by making available better quality products at globally competitive prices and by providing greater freedom of choice to residents to undertake current transactions on a global scale.

7.3 Responding to the reform process, the external sector has gained considerable strength, resilience and stability. This is evident from an unprecedented accretion to reserves, modest current account deficit (of late, a surplus), larger non-debt creating capital inflows, orderly exchange rate movements and containment of external debt within sustainable levels. Notwithstanding these comforts, there are areas of concern and challenges, arising primarily from the growing openness of the economy, the need for accelerating growth in the medium-term and also the need to meet the Tenth Plan growth target through higher capital flows for investment. In this context, while it is important to review and assess the impact of various reform programmes and policies relating to the external sector, there is also a need to examine a range of emerging issues. These include: current account sustainability in the wake of increased openness, the possibility of a 'Dutch disease' type effect (on account of strong performance of software exports and remittances), more open capital account and cost of accretion to reserves, including its implications for monetary management.

7.4 Against this backdrop, this Chapter attempts to profile the changes in the external sector and its implications for macroeconomic management. Section I analyses the developments relating to trade liberalisation in terms of tariff rationalisation and dismantling of quantitative restrictions, institutional arrangements, strengthening of regional groupings and India’s position in the World Trade Organisation (WTO). Section II discusses the changing structure of foreign trade, changing role of invisibles in the current account, and the current account balance in the post reform period. Section III presents an overview of the capital account developments and outlines the capital account liberalisation process in India. This section also offers an assessment of the external debt scenario in India and the exchange rate developments. Section IV examines the range of issues relating to adequacy of foreign exchange reserves and the associated implications for monetary management and growth Concluding observations are set out in Section V.

7.5 Trade reforms formed an integral part of the overall structural reform process. An open trade regime has been viewed as the least vulnerable form of globalisation with enormous opportunities for higher growth emanating from higher exports and higher welfare resulting from the possibility to make available better quality products at globally competitive prices under competition from liberalised imports (Krueger, 1998). This has been the rationale and the guiding principle for the trade reforms in India. As has been brought out by a number of individual and cross-country studies, trade restrictions reduce real economic growth by distorting the pattern of resource allocation, and by discouraging innovation and technical progress. Import substitution inflicts static costs on the economy by way of resource misallocation as also dynamic costs by raising the incremental capital-output ratios and exclusion from new technology. While the traditional argument for free trade in terms of allocative efficiency is made under the assumption of perfect competition, it is also argued that in imperfectly competitive markets, increased competition through trade would bring about welfare gains by reducing the dead-weight losses engendered by domestic monopolies and oligopolies (Helpman and Krugman, 1989). Beneficial impact of trade liberalisation on economic growth is also envisaged through the international production networks which spread the sequential production processes across national boundaries. Some of the channels through which trade liberalisation would affect the welfare of the people are: the access to imported goods, relative prices of tradable goods, relative wages of skilled and unskilled labour, impact on government revenue, incentives for investment and innovation affecting economic growth, and the vulnerability of the economy to external shocks (Bannister and Thugge, 2001). In the debate on the sequencing of different channels of globalisation, the general view has favoured sequencing driven by trade liberalisation (Edwards and van Wijnbergen, 1986; Rodrik, 1987; Mussa, 1984). Box VII.1 sets out the cross-country experience on trade liberalisation.

7.6 In the post-war period, several developing countries pursued import substitution-led development strategies. Poor growth resulting from such strategies, however, led to policy reorientation in the early 1960s. While one set of countries started giving more incentives for the export sector even while persisting with a moderate form of import substitution (for instance, Brazil, Argentina and Mexico), another set of countries made a more fundamental shift in favour of outward orientation (for instance Korea, Singapore and Taiwan) (Balassa, 1989). The Indian development strategy recognised the significance of liberal trade policy in the early 1980s, which was manifested in the form of a number of important recommendations made at that time by several Committees. The notable ones focused on a shift in emphasis from control to deregulation through simplification in import licensing system (Alexander Committee, 1978), clear recognition of dynamic comparative advantages associated with export growth (Tandon Committee, 1980), the need to harmonise foreign trade policies with other macroeconomic policies, advantages of an export-led growth strategy, a phased reduction in effective protection (Abid Hussain Committee, 1984) and the need to discourage inefficient import substitution (Narasimham Committee, 1985). Notwithstanding these concerns, the trade regime continued to be characterised by a licensing system which together with a high tariff structure protected the economy from external competition. In addition, the trade performance was constrained by restrictive foreign investment policies (RBI, 1999).

7.7 The process of trade liberalisation, however, gathered momentum only during the 1990s in the aftermath of the external payments crisis. The policy measures undertaken aimed at making domestic industry cost-efficient by enhancing efficiency in resource use under international competition, which was expected to derive a better export performance in the long-run. The major trade policy changes in the post-1991 period included simplification of procedures, removal of quantitative restrictions, and substantial reduction in the tariff rates as also their dispersion as recommended by the Tax Reforms Committee, 1992 (Chairman: Raja J. Chelliah). Furthermore, the reach of the export incentives was broadened, extending the benefits of various export-promotion schemes to a large number of non-traditional and non-manufactured exports. Following the announcements in the Export Import (EXIM) policies, various changes were effected such as the removal of quantitative restrictions, strengthening the export production base, removal of procedural bottlenecks, technological upgradation and improvement of product quality. Various steps were also taken to promote exports through multilateral and bilateral initiatives, including identification of thrust areas and focus regions. The policy stance also marked a move away from the provision of direct export subsidy to indirect promotional measures. India also took several policy initiatives at the multilateral levels for tariffication of the non-tariff barriers. As per India’s commitment to the World Trade Organisation (WTO), India agreed to the phased removal of all balance-of-payments (BoP) related quantitative restrictions by end-March 2001.

7.8 The tariff rates have undergone considerable rationalisation during the 1990s. Prior to the 1990s, the maximum import duty rates on certain items were over 300 per cent. The peak rate of import duty on non-agricultural imports was gradually reduced from as high as 150 per cent in 1991-92 to 25 per cent (excluding agriculture and dairy products) by 2003-04 (Chart VII.1) The weighted average import duties on various goods, even though reduced from the high levels prevailing earlier, are still higher than that of some of the East Asian countries (Table 7.1). The rate for China is expected to be phased down to less than 10 per cent in the coming years as part of China’s agreement in connection with its WTO entry (Government of India, 2001).

7.9 The weighted average tariff rates of India for various broad import groups are set out in Table 7.2. It is observed that although the average tariff rate declined steadily from 1991-92 to 1996-97, thereafter, it edged up again, inter alia, due to the imposition of various surcharges. The increase in the weighted average tariff rates since 1998-99 has been predominantly in agriculture and consumer goods sectors.

7.10 The Government, however, is committed to reducing tariffs to levels comparable with those prevailing in East Asian economies. The Finance Minister in the Union Budget for 2001-02, had stated that there would be a progressive move within three years to reduce the number of rates to the minimum with a peak rate of 20 per cent. This was reiterated in the Union Budget for 2002-03, wherein it was stated that by 2004-05, there would be only two basic rates of customs duties, namely 10 per cent covering raw materials, intermediates and components and 20 per cent covering final products. Keeping in line with these announcements, the Union Budget for 2003-04 while reducing the customs duties on several products, brought down the peak tariff rate to 25 per cent (excluding agriculture and dairy products).

7.11 India has been following a consistent policy for gradual removal of import restrictions since 1991, when the economic reforms were initiated. India began removing BoP related Quantitative Restrictions (QRs) unilaterally since 1996. QRs were removed on 488 items in 1996, 391 items in 1997 and 894 items in 1998. As per India’s commitments to the WTO, out of the remaining 1,429 items for which QRs were maintained on BoP grounds under the General Agreement on Tariffs and Trade (GATT) provisions, QRs on 714 items were removed on March 31, 2000 and the balance QRs on 715 items were removed on March 31, 2001. With this progressive removal of QRs maintained on BoP considerations, restrictions, still in force only relate to those items as permissible under Articles XX and XXI of the GATT on grounds such as security, health, safety, or moral conduct. While removing QRs, the Government has taken several safeguard measures (adjustment of tariffs, imposition of temporary QRs, safeguard duties, anti-dumping duties and restricting the import of certain agricultural products) in order to guard against any surge in imports on account of dumping. A high-powered Standing Group functions on a war footing for tracking, collating and analysing data on 300 sensitive items of importance to the public.

7.12 Reflecting the relaxation of quantitative restrictions, the proportion of canalised items in total imports in value terms declined from 27 per cent to 19 per cent between the ten-year period from 1988-89 to 1997-98. With effect from April 1998, 340 items were shifted from the ‘Restricted list’ to the ‘Open General Licence (OGL) list’. With effect from March 31, 1999, the convention of publishing a negative list for imports and exports was discontinued. The share of tariff lines without restrictions has now gradually increased to around 95 per cent since April 1, 2001 from a level of 61 per cent as on April 1, 1996.

7.13 The policy thrust on exports during the 1980s and 1990s was promoted through several schemes. These schemes have been refined further during the 1990s and new schemes have also been introduced.

• Export Processing Zones (EPZs) were set up as enclaves separated from the Domestic Tariff Area (DTA) by fiscal barriers and intended to provide an internationally competitive duty free environment for export production at low cost. Eight of the EPZs have since been converted into Special Economic Zones (SEZs).

• The Export Oriented Units (EOUs) Scheme, which is complementary to the EPZ scheme, was set up in 1981 under which a unit can be set up in any of the seven EPZs or at any other location in the country and be eligible for a host of liberal package of incentives which include same entitlements as given to EPZs.

• In order to fully exploit the potential in the Information Technology (IT) sector and to promote IT related exports, the Central Government has set up Software Technology Parks (100 per cent EOUs) since 1991.

• To build a strong and efficient electronics industry with good export potential, Electronic Hardware Technology Parks (EHTPs) were also set up.

• The SEZ Scheme was announced in March 2000 in order to promote export production in a hassle-free atmosphere (Box VII.2).

• The proposal to set up Agriculture Economic Zones (AEZs) was announced in March 2001 to promote the export of agro and agro-based products, and 45 AEZs have been sanctioned so far. The Central Government would assist the State Governments in the development of necessary infrastructure, flow of credit and other facilities for promoting agro exports.

7.14 In addition, schemes were put in place for imports undertaken by exporters so as to neutralise the impact of any duties on those imports. Such schemes are Export Promotion Capital Goods (EPCG), Duty Free Replenishment Certificate (DFRC), Duty Remission Scheme and the Duty Entitlement Passbook (DEPB) Scheme. The issue of multiplicity in these schemes is being addressed.

7.15 Steps have also been taken to simplify the rules and procedures and improve the speed of transactions in the Directorate General of Foreign Trade (DGFT) with the help of information technology aimed at reducing transactions costs. A common commodity classification for imports and exports has been adopted by both, the Directorate General of Commercial Intelligence and Statistics (DGCI&S) and the Central Board of Excise and Customs (CBEC) to eliminate the classification disputes. In the area of customs, the percentage of physical examination of export cargo has already been reduced substantially except for few sensitive destinations while a major push is being given to Electronic Data Interchange (EDI) and ‘System based Appraisal’. Export Promotion Councils have been set up to function as a conduit between the exporters and the Government and to provide essential services required by the exporters.

7.16 Trade finance is a crucial element in the design of trade policies. From time to time, the Reserve Bank has undertaken several measures to ensure adequate and timely availability of credit for exports at competitive interest rates. The Reserve Bank’s export credit refinance schemes have played a pivotal role in this area. Commercial banks have been providing credit to exporters at pre-shipment and post-shipment stages, both in rupees as well as foreign currency. The rupee export credit has been generally available at rate of interest linked to the Prime Lending Rate (PLR). The export credit in foreign currency is provided at internationally competitive interest rates linked to London Inter-Bank Offer Rate (LIBOR) or similar interest rates. The Reserve Bank has been adjusting interest rates on rupee export credit from time to utime taking into account the need to maintain competitiveness by looking at interest rate differentials, as also other factors like inflation and developments in financial markets. The Reserve Bank has also taken measures to support institutional arrangements for export promotion, such as policy initiatives to provide a liberalised environment for the operations of SEZ units. These measures include: (i) exemption from interest rate surcharge on import finance; (ii) release of foreign exchange to DTA units for buying goods from EOU/EPZ/SEZ units; (iii) permitting 100 per cent retention of foreign exchange in Exchange Earners Foreign Currency (EEFC) accounts; (iv) permitting overseas investment by SEZ units from the EEFC accounts through the automatic route, write-off of unrealised export bills and (v) permitting SEZ units to enter into a contract in overseas commodity exchanges or markets to hedge the price risk in the commodity on export/import provided that the contract is made on a ‘stand alone’ basis.

7.17 India is one of the founding members of the GATT (1947) and the WTO (1995) and favours the multilateral approach to trade relations. India grants Most Favoured Nation (MFN) treatment to all its trading partners. As a member of the WTO, India is committed to ensure that the sectors in which developing countries enjoy a comparative advantage are adequately opened up to international trade. India is also committed to ensure that the Special and Differential Treatment Provisions for developing countries under different WTO Agreements are translated into specific enforceable dispensations. Notwithstanding its commitments, India has maintained that the multilateral system would gain even more if it adequately reflected the concerns of the developing countries. At the Fourth Ministerial Conference at Doha in 2001 India forcefully presented her concerns, which are reflected in the Doha Declaration (Box VII.3). On the four 'Singapore Issues', viz., trade and investment, trade and competition, transparency in Government procurement and trade facilitation, raised at the first Ministerial held in Singapore in 1996, no decision was reached either at this Ministerial or the subsequent two Ministerials held in Geneva and Seattle. However, Working Groups were established to examine each of these four issues in detail. The Doha Declaration states that the study process on these issues would continue until the fifth Ministerial Conference to be held in Mexico and decision regarding any negotiation would be based on explicit consensus. On issues of crucial relevance to India, the Declaration reaffirms that the International Labour Organisation (ILO) is the appropriate forum to address the core labour standards.

7.18 The relationship between regionalism and globalisation is an important issue of contemporary interest. Regional Trade Agreements can be trade-creating or trade-diverting and can lead to welfare improvement or deterioration. Arguments exist in theory on both sides on whether unilateral tariff reductions are superior or inferior to granting regional preferential treatment. Some observers believe that the proliferation of regional arrangements in recent years threatens or even undermines the multilateral system while others hold the view that regional trade agreements provide a necessary spur to global liberalisation in the present era (Bhagwati, 1994; Frankel, 1997; Yeung et al, 1999).

7.19 India is a member of a few regional trading agreements within Asia such as the SAARC Preferential Trading Arrangement (SAPTA), the Indian Ocean Rim Association for Regional Cooperation and the BIMST-EC (Bangladesh, India, Myanmar, Sri Lanka, Thailand - Economic Cooperation). Of these, SAARC has been the relatively effective trading arrangement with regard to trading interests. Being a member of SAPTA (SAARC) does not seem to have spurred trade between India and other member countries to the extent that NAFTA benefited Mexico, Mercosur benefited Argentina and ASEAN benefited Malaysia and Thailand. These countries have benefited from the dominant country within the arrangement (e.g., USA in NAFTA) and also from the growing economic growth of the member countries. In the case of regional trading agreements, India has been the dominant member. Moreover, economic performance of the other members in these agreements has also not been conducive to providing significant benefits to India. India’s exports to the SAARC increased marginally during the 1990s and were only 4.6 per cent of total exports in 2001-02 as against 19.0 per cent to other Asian developing countries comprising inter alia Hong Kong, Singapore, Malaysia and South Korea with whom India does not have any trading agreement (Table 7.3). In fact, OECD continues to be the largest market and source for India’s exports and imports, respectively.

7.20 Going beyond trade reforms, India moved to full convertibility on current account in August 1994 by liberalising various transactions relating to merchandise trade and invisibles. This has been in consonance with the global trend. Out of 186 IMF member countries, 152 countries had accepted obligations under Article VIII of the IMF, according to which 'no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions'.

7.21 With the broad approach of growing trade openness and shift in competitiveness towards services exports, India’s current account transactions resulted in a modest current account deficit throughout the 1990s and a surplus in the recent past. A component-wise analysis on merchandise trade and invisibles is presented in this Section with a view to assess the broad approach of policy reforms in this area. As an emerging issue, the issue of current account sustainability has also been analysed.

7.22 The impact of trade reforms is evident from the changing structure of India’s foreign trade in terms of diversity of markets and products and also in the form of higher degree of trade openness (resulting from higher export growth and the associated increase in the capacity to import).¹ Following the various policy initiatives taken by the Government, there was a perceptible improvement in India’s export performance in the initial phase of the reform period - both at the overall level and across commodities. The commodity composition of India’s export basket has changed in favour of technology intensive and industrial products such as, engineering goods, besides high-value agricultural products. The destination profile of India’s exports shows that the developing countries have gained considerable prominence over the years. The commodity composition of imports is affected by various factors such as impact of trade policy, domestic demand and international prices. The sourcing pattern of imports has also changed, mostly in favour of the developing countries.

7.23 Benefits and costs of trade liberalisation are difficult to quantify and attempts to do so yield results that are contingent on the methodology and its pitfalls. However, the benefits of trade liberalisation undertaken during the 1990s are evident in the higher average growth rate of exports during the 1990s at 9.7 per cent as against 8.1 per cent in the 1980s.² The other benefits were lower commodity price inflation (in the latter half of the 1990s) and higher consumer welfare. The latter in turn, emanated from product quality improvement as well as wider choice in range of most products. The notable feature is that there was remarkable export growth during the first half of the reform period, in particular during the years 1993-94 to 1995-96 with a deceleration in the subsequent years (Chart VII.2). This behaviour can be attributed partly to sluggishness in external demand precipitated by financial crises in some parts of the world and the subsequent weakening of overall world demand and world trade volume (RBI, 1999). Weak exports also reflect growing domination of China in labour intensive manufactured exports, high infrastructure costs, unusually rigid labour laws, reservation for small-scale sector and relatively high regulatory problems (Acharya, 2002).

7.24 Due to higher annual average growth of exports in the 1990s (12.9 per cent) in relation to the average GDP growth of about 6.1 per cent, the contribution of exports to growth in GDP increased modestly. Results of micro-level studies that are based on information collected through sample surveys yield different results with some of them giving a much higher contribution of exports to GDP growth. The results of a study conducted by the Reserve Bank, however, indicate that the contribution of exports to GDP may be much lower when adjusted for imports of raw materials. Such findings need to be asessed in the context of the selection of firms in the sample surveys (Box VII.4).

7.25 The export performance of the East Asian countries has been much better than that of India (Table 7.4). What is remarkable is that these countries maintained continued export growth despite being hit by the Asian crisis. The high average export growth rate in these countries during 1990s was facilitated by the transformation of these countries from producing cheap labour-intensive goods to technology intensive goods, like electronic parts in the case of Malaysia and electrical components in the case of Korea.

7.26 The average import growth in India which was 7.2 per cent (in US dollar terms) during the 1980s increased to 12.9 per cent during the 1990s. Imports during the period 1990-91 to 1995-96 (excluding 1991-92) experienced an average growth rate of 16.7 per cent, reflecting largely the strong industrial growth during the period (Chart VII.2). Subsequently, in the remainder of the 1990s the average growth rate fell drastically to 8.0 per cent and further to 1.7 per cent during both 2000-01 and 2001-02, due to the slowdown in economic activity (RBI, 2002). The slow growth in imports is a cause for concern as it has a direct bearing on the exports of capital-intensive goods. Interestingly, India’s import growth during the 1990s was lower than that of China but higher than that of the other East Asian countries (Table 7.5).

7.27 The ratio of exports to GDP increased from an average of 4.6 per cent during the 1980s to 8.0 per cent during the 1990s (excluding the year 1991-92) which represents an increase in export orientation of the economy by 3.4 percentage points of GDP over one decade. Similarly, imports as a proportion of GDP increased from 7.2 per cent during the 1980s to 9.5 per cent during the 1990s. India’s total merchandise trade, an indicator of the degree of openness of an economy, increased from about 11.8 per cent of GDP in the 1980s to 17.4 per cent during the 1990s (Table 7.6 and Chart VII.3).

7.28 The average export-import ratio, an indicator of the import financing capacity of exports, improved sharply from 64.0 per cent to 84.1 per cent, between the 1980s and 1990s and further increased to 85.2 per cent in 2001-02 (Table 7.6 and Chart VII.4). During the 1980s, the export-import ratio was as high as 115.5 per cent for Malaysia and 93.4 per cent for China. During the 1990s, the ratio for these countries – at 112.0 per cent for China and 106.8 per cent for Malaysia – was still higher than that for India. The exports of these countries thus, more than compensated for higher imports.

7.29 India’s net terms of trade, which measure the relative change in export and import prices have been generally fluctuating during the 1990s. Import purchasing power of exports as measured by the income terms of trade have consistently improved during the 1990s on account of strong export, growth in volume terms.³ The income terms of trade, increased on an average from 141.5 in the 1980s to 439.4 in the 1990s and further to 743.2 in 2001-02 (Chart VII.5).

7.30 Diversification of exports constitutes an important element of India’s export promotion strategy. Reflecting the policy thrust as also the evolving pattern of industrial development, India has gradually transformed from a predominantly primary products exporting country into an exporter of manufactured goods. However, it may be noted that this was more prominent in the 1970s. The progress has, however, stalled thereafter. Aided by various export promotion measures, the share of ‘manufactured goods’ in India’s total exports increased from 70.7 per cent during 1987-90 to 75.3 per cent during 1992-97 and further to 77.4 per cent during 1997-2002.⁴ Exports of petroleum products have also increased in the recent years (Chart VII.6). The commodity composition within the major groups has also undergone a considerable transformation. Within the ‘primary products’ group, the share of ‘ores and minerals’ in total exports has declined while the share of ‘agricultural and allied products’ remained almost unchanged at around 18 per cent between 1990-91 and 1998-99 but declined thereafter to 13.4 per cent in 2000-01. The falling share of ‘ores and minerals’ has been offset by the increase in share of ‘engineering goods’ within the manufactured products group - an indication of upward movement of India’s exports in the value-addition chain. Similarly, exports of processed agricultural products also showed marked improvement in the post-reform years whereas the shares of traditional export items such as tea, coffee, cereals, handicrafts and carpets declined. Among other major manufactured products, the share of ‘chemicals and allied products’ has improved while that of ‘leather and manufactures’ has declined between the years 1990-91 and 2001-02 (Table 7.7 and Chart VII.6).

7.31 The areas in which South-East Asian countries have achieved their highest export growth during the 1980s have been typically labour intensive, relatively low technology products such as textiles, clothing, shoes, toys, sport goods and the like. Subsequently, during the 1990s they have graduated up to somewhat higher technology consumer goods and then even higher technology and capital-intensive sectors such as capital goods and petro-chemicals. Over the same period, the Indian export pattern has remained stationary with persistent dominance of labour-intensive low technology products such as clothing, textiles, shoes and other leather goods. Adequate quality upgradation has been absent and unit prices have stagnated. The attainment of both higher volume growth and of higher unit value realisation will require both larger scale of operation and higher quality. It is, therefore, essential to loosen constraints in these sectors so that they can grow freely in volume, utilise better machinery, graduate up to higher technology levels, and utilise better international marketing channels. What is observed in other countries in Asia is that production of such consumer goods may be achieved through final assembly operations that are large in scale, but where a great deal of out-sourcing to small enterprises is undertaken to preserve their competitiveness. Consequently, freeing of restrictions on the size of small-scale industries through de-reservation is likely to lead to the growth of many more small-scale enterprises than is currently the case, along with a much higher potential for growth in manufacturing employment (Mohan, 2002).

7.32 Destination-wise analysis of the Indian exports indicates an unchanged position in respect of the Organisation for Economic Cooperation and Development (OECD) group being the largest market, increasing prominence of the Organisation of Petroleum Exporting Countries (OPEC) and the developing countries (Asia, Africa and Latin America), and a steep erosion in the relative position of the Eastern Europe. With the break-up of the Soviet Union, the share of the East European countries fell dramatically from 17.9 per cent in 1990-91 to just 2.9 per cent in 2001-02, primarily on account of the termination of Rupee trade and its adverse impact on exports of agricultural products such as tea, tobacco and spices to this region. The loss of this market share was, however, made up by increasing the shares in developing countries and the OPEC region, both of which doubled between the years 1987-88 and 2001-02 (Table 7.8 and Chart VII.7).

7.33 India’s export share in world trade has increased perceptibly during the recent period. India’s exports as a percentage of world exports improved to 0.56 per cent during 1991-96 and further to 0.65 per cent during 1996-2002 from 0.48 per cent in the 1980s. The ratio was 0.71 per cent in 2000-01, the highest achieved so far since the 1970s. Nonetheless, India’s share in world exports is still very low and appears unimpressive when compared with the other major trading Asian countries, such as, China and other East Asian economies like Malaysia, Thailand, Singapore, Korea and Indonesia (Table 7.9 and Chart VII.8). China demonstrated the most dramatic change as its share in world exports more than doubled in a decade from 2.0 per cent in 1991 to 4.4 per cent in 2001. Group-wise, India’s share in the imports of industrialised countries in the 1990s declined as compared to that in 1986. In respect of the developing countries as a group, however, it has increased from 0.5 per cent in 1986 to 1.1 per cent during 1996-2000 (Table 7.10).

7.34 The commodity-structure of India’s imports has also shown marked changes, reflecting, inter alia, the impact of trade policy, the movements in international prices and the pattern of domestic demand. The share of oil imports in India’s total imports increased from 17.1 per cent during 1987-90 to 23.9 per cent during 1992-97 and further to 27.2 per cent in 2001-02 (Chart VII.9). While the share and absolute value of these imports showed sharp fluctuations over the years mainly on account of the large movements in international crude prices, the volume of such imports has grown significantly on account of increase in domestic consumption and the stagnation in domestic crude oil production. Given the large swings in international crude prices, as also a trend rise in the oil import bill, there is a need for a comprehensive review of energy policy of the country covering the demand-supply aspects, as well as the price policy. Renewed efforts to improve energy supply from domestic sources by encouraging explorations, and stepping up of production and refining capacities are necessary to bring about a structural change in this area.

7.35 Reflecting the impact of a series of policy measures undertaken in the post-reform years starting with the repeal of the Gold Control Order in 1991 for liberalising the imports of gold and silver, these imports showed a sharp pick-up from 1992-93. The imports of gold and silver (including passenger baggage) rose from a meagre US $ 6 million in 1991-92 to US $ 1.3 billion in 1992-93 and further to US $ 5.9 billion in 1997-98. A large part of the increase in these imports could be due to a switchover from the unofficial channel to the official channel, initially through the Non-Resident Indian (NRI) baggage route and subsequently through the OGL route.⁵ In the subsequent years, however, these imports have stabilised and, in fact, declined to US $ 4.6 billion in 2001-02.

7.36 Imports of capital goods registered sharp increases in the initial reform years from US $ 4.5 billion in 1992-93 to US $ 10.3 billion in 1995-96, but exhibited a declining trend thereafter. The share of these imports, which had declined from 29.5 per cent in 1987-88 to 24.2 per cent in 1990-91, rose in the post-reform period to 28.2 per cent in 1995-96 but dropped to 18.1 per cent in 2001-02, reflecting the lack of investment demand associated with the sluggish pace of domestic industrial activity (Chart VII.9). Among other import items, the relative shares of fertilisers, non-ferrous metals, ‘metalliferrous ores and metal scrap’ and ‘iron and steel’ generally showed a declining trend.

7.37 There are noticeable changes in the sources of India’s imports and in country shares.⁶ The share of the OECD countries and the Eastern Europe in India’s imports declined between the years 1987-88 and 1999-2000 while that of the developing countries and the OPEC group increased during the same period. The share of India’s imports from the OPEC region rose significantly to 25.9 per cent in 1999-2000 from 16.3 per cent in 1990-91, mainly on account of the increase in the oil imports (Chart VII.10).

7.38 The Ministry of Commerce and Industry, Government of India has set an export target of 1 per cent share of world exports by 2006-07 for the medium-term which would be co-terminus with the Tenth Five Year Plan. This target is based on historical trends, current prospects and the requirement of a compound annual growth rate of about 12 per cent for exports till the year 2006-07 (Government of India, 2002a). The export performance is known to depend on price competitiveness, as well as non-price factors. As regards the price competitiveness, a number of earlier studies have emphasised that real exchange rate may be an important variable influencing the price competitiveness of India’s exports. In India, large exchange rate misalignment has not occured in the last one decade as the market itself has corrected the misalignment gradually over different episodes. The strong performance of the software exports, however, has created concerns about a possible 'Dutch disease' effect which may erode the competitiveness of traditional exports.⁷ The export performance across commodity groups shows that most of the export groups have performed well so far, and apparently have not been affected by any 'Dutch disease' effect. In a market determined exchange rate regime, exchange rate cannot be used as an instrument of export promotion, even though, at times, nominal appreciation could be prevented consistent with the overall exchange rate policy of the country. If the exporters retain the depreciation induced profits, they cannot improve their price competitiveness and therefore, exports may not increase despite a depreciation. In the Indian context, studies show that there has been an upward movement in exchange rate pass-through for India’s exports.⁸ While Patra and Pattanaik (1994) estimate the co-efficient (during 1970-71 to 1992-93) at 43 per cent, Dholakia and Saradhi (2000) placed this figure at 30 per cent prior to 1991 and at 70 per cent after 1991.

7.39 Some of the recent studies have analysed the role of non-price factors vis-à-vis the price factors. Studies analysing the factors contributing to the competitiveness of India’s exports have observed that non-price factors play a more important role (Marjit and Raychaudhuri, 1997). Another study observed an inverse relationship between depreciation of exchange rate of rupee and trade competitiveness, and also emphasised the role of other factors like quality, product design, reliability and after sales service in raising trade competitiveness (Bhatt, 2000).

7.40 India’s export performance is affected by domestic as well as external impediments. The domestic factors inhibiting India’s export growth, as mentioned earlier, inter alia are infrastructure constraints, high transactions cost, small-scale industry reservations, inflexibilities in labour laws, lack of quality consciousness and constraints in attracting FDI in the export sector. High levels of protection in relation to other countries also explain why FDI in India has been much more oriented to the protected domestic market, rather than as a base for exports (Ahluwalia, 2002). The exports of developing countries like India are facing increasing difficulties by emerging protectionist sentiments in some sectors in the form of technical standards, environmental and social concerns besides non-trade barriers like anti-dumping duties, countervailing duties, safeguard measures and sanitary and phyto-sanitary measures. Indian products which have been affected by such barriers include floriculture products, textiles, pharmaceuticals, marine products and basmati rice exports to the European Union and mushroom and steel exports to USA and also grapes, egg products, gherkins, honey, meat products, milk products, tea, and spices. Differential tariffs against developing countries have also adversely affected market access into these countries (Government of India, 2002b; WTO, 2002). According to the WTO, exports from India are currently subject to 40 anti-dumping and 13 countervailing measures mainly for agricultural products, textiles and clothing products and chemicals and related products. This brings into focus the importance of non-price factors like quality, packaging and the like mentioned earlier, where India still seems to be lacking as compared to the international standards. This has adversely affected India’s export performance vis-à-vis other developing countries which may have an improved standing in these non-price factors.

7.41 To sum up, India’s external trade reforms have been quite comprehensive. The protection given to domestic industries has been reduced by way of the reduction in tariff levels. However, the pace of tariff reduction needs to be accelerated (subject to revenue constraints). The tariff levels in India are still among the highest in the world. The evidence from 1991-97 and 2001-2003 suggests that faster tariff reduction is good for industry. India has completely dismantled its quantitative restrictions except for a few items. Various export promotion schemes have been put in place. In the area of multilateral commitments the progress has been satisfactory. The concerns of developing countries as voiced by India in the WTO are being considered. India is making progress on the negotiations on Services and on several issues which are in the process of study. Reforms in the trade sector have also been notable as clearly seen from the increase in India’s trade-GDP ratio. There has been a steady increase in the growth rate of exports and imports as compared with the 1980s. The export-GDP ratio has almost doubled from that in the 1980s. The rising export-import ratio is indicative of the improvement in financing capacity of exports. India’s share in world exports has been rising and in 2001, this ratio was the highest achieved so far since the 1970s. There has been a discernible shift in India’s composition of exports with overall diversification of exports. The share of manufactured goods has shown an improvement driven by the increasing share of chemical and allied products, engineering goods, textiles and handicrafts including gems and jewellery. Imports have been driven by an increase in the imports of mainly export-related items like pearls, precious and semi-precious stones and electronic goods. India has also been successful in diversifying its export market increasingly to the developing countries alongwith the OECD emerging as the largest market for India’s exports. A notable feature is that despite the loss of the East European market after the break-up of the Soviet Union, India made a safe transition to other markets like developing countries of Asia and to the OPEC.

7.42 One of the most significant developments in the current account of balance of payments in the 1990s was the remarkable growth in services transactions with the rest of the world, which was made possible by the revolution in information and communication technology. The information and communication related services (services relating to computer software, hardware, internet, e-commerce and telecommunication sector) experienced unprecedented growth during the last decade, outstripping the growth in merchandise trade. Reflecting the growing importance of trade in services, the General Agreement on Trade in Services (GATS) was adopted in 1993 to extend multilateral rules and discipline to services trade, with particular emphasis on non-discrimination and prohibition of quantitative restrictions. The Reserve Bank has undertaken several measures to relax payments restrictions on transactions pertaining to trade in services and other invisible transactions.

7.43 With the shift in the competitiveness towards services, in particular the technology related services, India has emerged as one of the fastest growing exporters of services in the world outstripping the growth rate of industrial countries as well as all countries taken together (Chart VII.11) (RBI, 2002a). Reflecting this, gross invisible receipts (comprising services, transfers and income) increased from US $ 7.5 billion (29 per cent of total current receipts) in 1990-91 to US $ 35.6 billion (44 per cent of total current receipts) in 2001-02. Among the various items of invisible receipts, services increased from US $ 4.6 billion (18 per cent of total current receipts) in 1990-91 to US $ 20.3 billion (25 per cent of total current receipts) in 2001-02. Within services, miscellaneous services receipts, which encompasses communication services, construction services, financial services, software services, news-agency services, royalties, copyright and license fees, management services and others, increased from US $ 2.0 billion in 1990-91 to US $ 14.7 billion in 2001-02, representing 41.2 per cent of invisible receipts in 2001-02. Software services have shown spectacular growth while also emerging as the most important source of miscellaneous services earnings. Software exports increased from US $ 0.3 billion in 1993-94 to US $ 1.8 billion in 1997-98 and further to US $ 7.2 billion in 2001-02, with its share rising from 2.9 per cent to 20.1 per cent of total invisibles receipts during this period. Reflecting the strong growth emanating from software exports, the traditional sources of services exports, viz., travel and transportation have declined in relative importance. Following the heavy inflow of invisibles receipts, India’s current account deficit narrowed down considerably during the decade of the 1990s. The receipts and payments on account of various categories of current account transactions as a percentage of GDP are presented in Table 7.11.

7.44 One of the factors underlying the external payments crisis of 1991 was the high levels of current account deficit (CAD) maintained during the 1980s which at the time of the crisis had reached 3.1 per cent of GDP, well above the sustainable level for India (Cerra and Saxena, 2002). Concerted efforts directed at imparting strength and stability to the external sector emphasised a policy of maintaining the CAD within a sustainable level of about 2 per cent.⁹ This is broadly in line with the recommendations of the High Level Committee on Balance of Payments (RBI, 1993), which recommended that CAD-GDP ratio could be sustainable at 1.6 per cent. The current account deficit averaged only about 1.0 per cent of GDP during the last decade (1992-2002), as compared with 1.8 per cent in the 1980s, and recorded a surplus in 2001-02 after a period of 23 years. Among the components of current account, while the trade deficit (BoP basis) declined marginally from 3.2 per cent of GDP during the 1980s to 3.0 per cent during 1992-2002, the invisibles surplus increased significantly from 1.4 per cent of GDP to 2.1 per cent over the same period(Chart VII.12). With the narrowing of the current account deficit in the recent years, there is a need for revisiting the issue of sustainability of current account in the Indian context.