The boom in India’s exports has often been attributed to rising commodity prices, favorable exchange rates and trade diversion from China. However, digging deeper, we see that the boom in trade reflects structural changes in our trade basket. We conduct a comparative exercise at the six-digit product level, comparing India’s current trade basket with that of roughly three decades ago in 1993-94. The exercise shows that India added 628 new products to its export basket by 2022, in addition to 3800 products since 1994. New products are highly concentrated in high-tech manufactured goods, chemicals and electronics and have been showing steady growth over the years. ,
In the three decades between 1994 and 2022, India has not only created new markets for over 600 products, but has also become a market leader in some of these new product categories. For example, India is a large net exporter of some turbojet and defense technology. Similarly, we have also entered new markets like railcars and electric power. The growth of the new product basket outpaces the growth of the old products. Manufactures such as helicopters, arms and ammunition, and electrical machinery registered the highest growth rates. Of course, exports of India’s top-three products, which include petroleum, diamonds and pharmaceuticals, continue to grow. However, the share of these products is declining.
What does a change in the product basket do to our sensitivity to exchange rate fluctuations? Research shows that as export baskets shift toward higher-value goods, there is a concomitant decline in the sensitivity of exports to real effective exchange rates. Econometric estimates from recent literature peg the exchange rate sensitivity between 1 and 2.5 in the late 90s and early 2000s, and more recently between 0.5 and 1. Our internal econometric estimates align with the literature, showing a significant decline in the sensitivity of exports to the exchange rate following the global financial crisis period. While exchange rate sensitivity was as high as 2.5 for 1994–2007, it shows a significant decline to 0.6 for 2008–2022. This means that a 1 per cent appreciation in the rupee at present would result in less than 1 per cent decline in exports, as against a decline of 2.5 per cent earlier. Thus going forward, unlike in the past, appreciation of the rupee is less likely to hurt our exports.
Part of the explanation for lower exchange rate sensitivity also lies in our increasing integration with global value chains (GVCs). Research confirms the relationship between GVC participation (both upstream and downstream) and less sensitivity to exchange rates. Most of India’s GVC participation remains generally upward, with an emphasis on goods such as chemicals, machinery and metals. Upstream trade involves less value-addition and may be more vulnerable to demand shocks. In this context, policies such as Production Linked Incentive Scheme (PLI) can prove useful for developing downstream linkages. The PLI scheme can integrate India into downstream GVCs by encouraging global manufacturers to set up shop in India.
Ongoing criticism about the PLI scheme centers on how manufacturers use incentives to set up assembly units (which are low in value addition) rather than manufacturing plants. The experience of countries such as China and Vietnam shows that assembly, despite low value-added, led to job creation for a large number of low-skilled workers. The assembly units also helped create backward linkages to domestic sectors in these countries, leading to further value addition. Furthermore, as firms build up their footprint, they will evolve into producing more sophisticated components, leading to higher value creation.
Like manufacturing, some services can also be incorporated into various processes, forming a global value chain in services. India’s performance in the service value chain has been exemplary. While the early 2000s was the period of BPOs for providing cost-cutting back-end information technology (IT) services, India now looks beyond mere cost-cutting. Data from the Asian Development Bank shows that India moved from providing back-end services in law, IT and management in 2010 to upstream, high-value-added services in these sectors by 2020. Services exports have also shown less vulnerability to changes in global income volatility. For example, service exports to the US and Canada (which account for about 60% of total software exports) have shown a low degree of correlation with gross domestic product (GDP) growth in these countries.
India’s integration into the creation of GVCs can also increase through export of services. Intangible services include pre- and post-production activities such as supply chain management information, brand management and design. Within the GVC, companies specializing in pre- and post-production activities provide the greatest value addition.
India’s export boom is not a story of a rising tide that lifts all boats. Our export basket is becoming less sensitive to global fluctuations in demand and exchange rates as we develop capabilities to manufacture high-tech goods and services.
V. Ananth Nageswaran and Meera Unnikrishnan are respectively Chief Economic Adviser and a Young Professional in the Ministry of Finance, Government of India. These are the personal views of the authors.
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Updated: June 08, 2023, 12:22 AM IST