1. Column: Recharging services exports

Column: Recharging services exports

Firms, especially software exporting ones, could look at real wage adjustment as a short-term market fix

By: | Updated: July 30, 2015 5:23 AM

About a fortnight ago, we highlighted an emerging macro policy concern in these pages, viz. a threat to current account balances from decelerating services’ exports (Imported stabilisation, July 2, goo.gl/DR3NLN). The column noted that any coincidence between the trend declines in exports of services with that of goods could open new faultlines in the current account, potentially creating new pressure points in sustaining macroeconomic stability. The sharp fall in services exports—nearly 15% in May 2015—corroborates apprehensions of a fresh bout of uncertainties on the external account. Along with a similar fall in merchandise exports of magnitude, the near-term CAD projections could surprise on the upside in the quarters ahead.

A worrying policy concern

Analysts figure the CAD will widen to about 2% of the GDP in April-June 2015, from 0.3% the previous quarter. But it is the context that is more significant here—the seven-fold expansion within one quarter occurs at a point when import payments for oil and other commodities are down sharply, while demand for non-oil, non-metal imports is quite weak. If developments in the first quarter alone have caused the full-year CAD forecasts to be revised up to a region of 1.6-1.7% of GDP from a 1.5% range previously, it isn’t hard to imagine the CAD touching 2% of the GDP or thereabout if services exports continue to fall at the current rate. A 10% fall, for instance, would translate into a 40bps expansion of the current account for the whole year.

services-exports

A bastion of India’s current account balance, services exports have long given rock-solid support, including accommodation of a five-fold expansion in the merchandise trade deficit in a matter of one decade. Therefore, from an external balance perspective, any slippage into contraction territory is of serious concern, particularly as this downward drift coincides with a robust recovery in the US economy, its key market.

This does raise questions that deeper forces may underlie the deceleration. Is the faltering growth in services exports underpinned by fundamental shifts? Are relative price changes, i.e., exchange rate adjustments, eroding market shares? Or, is the sector losing competitiveness due to other, internal factors affecting productivity? According to the WTO, India’s rank in world services exports also slipped two places, to 8th, in 2014, from the previous year. While reasons are delved into and answers sought, the point is that having steadily lost competitiveness in manufacturing from the mid-1990s, India can ill-afford to do the same with services.

What ails services exports?

Are services exports facing external demand constraints like their merchandise counterparts? There isn’t a straightforward answer. Although it is tempting to attribute the slowdown to the weak growth of world output, there is a fundamental difference in the two kinds of exports. While goods’ exports are fairly diversified by destination, the market for services’ trade tend to be concentrated in the US and a few European countries. This is where the disturbing signals arise: the US economy has been growing at a robust pace since the last several quarters while growth in three leading economies of the European region, i.e. Germany, France and UK has picked up in recent months.

Alternatively, how to regain this lost position? The obvious response is to recoup productivity. Two important sources of productivity gains can be identified. One is increasing competitiveness through exchange rate adjustments. This element, however, is subject to the constraints of overall dynamics of the macroeconomy. Another way through which individual firms can recoup competitiveness and protect market shares is to increase efficiency in production by scaling up the value-chain. But this is more of an issue for medium- to long-term attention, by which time markets can get lost permanently as better, more efficient competitors enter in replacement.

Looking for a quick fix

Unlike its merchandise export equivalent, where fingers are pointed at policy inaction on various fronts, exporters of services do not have much to complain about! Therefore, the solution has to be within; a kind of quick-fix that can respond in the short-run. This can come from nowhere else other than real wage adjustments, the quickest and most common means deployed across the globe in responding to competition pressures and market-protection.

How are Indian firms, particularly the software exporters, doing on this front? The two accompanying tables present a set of trends in real wages’ growth in the sector. Table 1, which has annual nominal salary increases for the IT sector, indicates these to be around 11% each year since 2012. Adjusting for inflation (Column 3), this works out to a 5% increase in 2014 and this year so far. Table 2 contains trends in staff costs, a not so clean variable, but one that gives some indication nonetheless. This too shows a continuous increase in real wages in the sector that is somewhat surprising, though admittedly the data includes employee numbers. In particular, an average 5% growth in real wages for the IT/ITeS sector as whole, when export revenues are seriously falling seems incredible.

Some short-run adjustments of the part of exporting firms might be inevitable in this light. While the steady deceleration in their exports merits deeper scrutiny and analysis that are the eventual guide to lasting remedies, the sector as a whole can take action to recover productivity growth by adjusting real wages. Markets once lost are very hard to regain, particularly as there is a likely interplay of structural changes in the US that could be one of the factors.

On their part, policy makers shouldn’t get sanguine about the external balances in an environment of falling import prices. A scenario of complementary deterioration in exports of both goods and services can possibly tilt the current account balance into vulnerable zones. Indeed, if 2013 was a year in which gold imports exposed the current account deficit, in 2015-16 it well might be the hand-in-hand tumbling of service and merchandise exports.

The author is a New Delhi-based macroeconomist

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