But it is harder to correct certain structural changes that have been taking place in both India’s imports and exports. A consequence of demonetisation was perhaps the fact that many Indians used a smartphone for the first time to make cashless payments. Indeed, electronics is among India’s fastest growing import categories since then. To the extent this is leading to digitisation and financial inclusion, it is a good thing. While efforts to produce more at home should be undertaken, import substitution can take a while.
The bigger structural problem, however, is the fall in India’s core exports. Over the past four years, they have fallen by a whopping 4 per cent of GDP. About 0.5ppt of this can be attributed to the combination of demonetisation and the goods and services tax, and could be reversed (in fact there has been some buoyancy in exports so far this year). But the remaining 3.5ppt of slowdown still needs a closer look. To put it in context, over the same time electronics imports have risen by less than 1 per cent of the GDP; so they are not the main problem.
So, what’s gone wrong with core exports, and how can it be fixed?
We find that three things explain a bulk of India’s exports misfortune. Domestic bottlenecks explain 50 per cent of the slowdown, world growth 33 per cent and the exchange rate less than 20 per cent. But broad aggregates can hide finer points. So, we drilled deeper. We broke down exports into goods and services.
We found that the strengthening of the rupee between 2014 and 2017 impacted services exports more than goods exports. Understandable, given that goods exports tend to use a higher proportion of imported inputs than do services exports. (The loss arising from a stronger rupee in goods exports is to some extent offset by gains from cheaper imports.) And yet, the rupee was still not the main factor affecting service exports. It explained only a quarter of the slowdown.
Once we saw clear evidence that disaggregated data conveys more nuanced information than aggregates, we modelled low, medium and high technology exports separately. And the results were eye-opening. While the three main drivers continued to matter, sector specific factors played an increasingly important role (for the statistically minded, they raised the average r-squared of our regressions from 60 per cent to 75 per cent).
To cite a few examples, we found that volatility in cotton availability and a disproportionate policy focus on cotton when world demand has moved towards man-made fibres have inhibited the growth of textile exports. Similarly, irrigation infrastructure matters for agricultural exports, foreign direct investment (FDI) and tariff rates matter for engineering goods (which include automobiles), and human capital and the global banking sector matter for software exports.
Our findings suggested several dos and don’ts for reviving India’s export fortunes.
First, easing domestic bottlenecks could reverse half the downturn. Infrastructure investment and steps to improve the business environment can go a long way. For instance, focused infrastructure spending on irrigation can increase agricultural exports. More investment in education can boost software services over time. And steps to attract more FDI could have sizeable results. We found that more FDI in both medium technology (gems, jewellery and oil products) and high technology sectors (engineering products) can boost exports.
Second, sector specific factors can make a meaningful difference. For instance, reviving textile exports can be helped by better implementing productivity enhancing technology (such as genetically-modified BT cotton) in order to dampen price volatility. Equal support for cotton and man-made fibres can create a better balance to India’s export basket. Trade negotiations to lower tariffs that India’s exports face abroad can boost textile and engineering goods exports.
Third, the limits of the exchange rate as a driver of exports need to be understood. At most, the strengthening rupee explains a quarter of the slowdown in exports over the last few years. And conversely, the ongoing rupee depreciation will likely raise exports by only a limited extent.
Other things matter more, and hoping that the recent rupee depreciation will solve India’s exports problem may just be wishful thinking. Obsessing about the rupee is akin to missing the wood for the trees.
The author is chief India economist, HSBC