India?s loss of manufacturing competitiveness needs to be reversed if the structurally higher CAD is to be mitigated

Finance minister P Chidambaram has repeatedly said he is far more worried about the growing current account deficit (CAD)?projected at over 5% of GDP?than the fiscal deficit. The question everyone is asking these days is whether India?s CAD has structurally moved to a much higher ?new normal?. No one expected the CAD to worsen so much as it had remained under 2.5 % of GDP in recent years until 2010-11. So what has gone wrong now?

There are problems on both sides of the equation?imports and exports. In my view, the contribution to higher CAD from the import side is less structural and possibly temporary in nature. For instance, the massive amount of additional gold imports, roughly $30 billion, seen in 2011-12 would gradually correct itself as the attractiveness of gold as a superior hedge against inflation wanes. The current gold rush, as it were, is a short-term phenomenon. The shale gas revolution in the US and the consequent expectation of a decline in oil and coal prices should also help India shrink its energy import bill in the medium term. India?s total coal import in 2007-08 was about $6 billion and this grew nearly 200% to about $17 billion in 2011-12, when the CAD had breached the 4% mark. Of course, if our vast coal reserves are reasonably exploited over the next five years, the steep growth in coal imports could be arrested. Currently, excess energy and gold imports could be contributing a good extra 1% of GDP to the CAD. Full correction in diesel prices may to some extent mitigate the excess import of crude.

However, slowing exports and a lack of competitiveness in the global marketplace would appear to be a more serious structural problem for India. The Economic Survey pitches this issue upfront and puts on the cover a telling graph that shows that India?s export growth has not shown a significant breakout even after some 20 years of reasonably high GDP growth, next only to China. In the same period, India?s Asian peers such as South Korea and China have grabbed a much larger share of the global export market. This largely has to do with manufacturing competitiveness, where India has lagged considerably. For instance, even in these trying global economic conditions, some other Asian economies are showing positive export growth whereas India has registered negative export growth for much of 2012. This is particularly puzzling as India has experienced a 49% depreciation relative to the Chinese yuan since 2007. The yuan has grown stronger against the dollar and the rupee has weakened in the same period, making Indian goods very competitive vis a vis Chinese merchandise in the global marketplace. Yet India has not been able to exploit this in the western markets, which still account for a substantial share of India?s exports. Why has India not been able to increase its share of world manufacture exports? This question needs to be debated afresh to understand the structural dimension of a high CAD.

India abandoned its policy of import substitution within a protectionist framework some decades ago. Through WTO, India moved to a substantially open trade regime over the past 15 years. However, we are yet to meaningfully exploit an open global trade regime to boost our manufacturing exports and gain a significantly higher share of world trade. Unlike other successful exporting economies in Asia who have established global competitiveness in manufacturing exports, India is still struggling to create its own niche in the export market for manufactures. In a global economic slowdown, such as the one being faced now, the men get separated from the boys.

A study by Sudip Chaudhuri of IIM Kolkata, published in EPW (February 23, 2013), gives some interesting insights into why India?s manufactured exports could be stagnating over the past decade. The study goes into the plausible reasons why the manufacturing trade balance, which was a surplus of 2.1% in 2001, started deteriorating in the subsequent years, until 2008. Mind you, these were also the boom years for the Indian economy. The deteriorating manufacturing trade balance is attributed to the failure of the economic reforms to promote new industries.

The trade balance for about 45 key manufacturing sectors improved between 1986 to 2001 and ended in surplus. Among the major industries that contributed to the surpluses were apparel and clothing, textiles, iron and steel, non-metallic minerals and pharmaceuticals.

However, the period from 2001 to 2008 saw manufactured trade experience deficits as imports grew rapidly in areas where India had little or no competitiveness. These include chemicals other than pharmaceuticals, specialised industrial machinery, aircraft, electronics and telecommunications.

India saw a revolution in telecom services between 2001 and 2008 but had virtually no presence in the manufacture of hardware. Much of the telecom equipment was imported at zero duty after a duty free regime was ushered in by the WTO. India also lost its traditional competitiveness in textile and garments as the elimination of the quota system in the developed markets created new exporting nations like Bangladesh, Pakistan, Vietnam, etc, who grabbed higher incremental market share. So India kept losing out in its traditional export strongholds even as it opened up imports in new areas like telecom, electronics and specialised capital goods. The incremental import of power equipment from China is a prime example of how India is losing its competitiveness in the manufacturing sector.

This needs to be reversed if the structurally higher CAD is to be mitigated over the longer term. India needs a new strategy of import substitution wherein it exploits the open economy architecture?flow of foreign technology, etc?to create competitive domestic manufacturing niches.

mk.venu@expressindia.com