A Decade of Economic Reforms - Review by RBI
[Source: RBI Report on Currency and Finance 2001-2002 dated March 31, 2003]

Module: 5 - External Sector

Current Account: Approach, Developments and Issues

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"

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.

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) 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.

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. 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).

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.

The export performance of the East Asian countries has been much better than that of India. 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.

In order to examine the contribution of the export sector to overall growth of the industrial sector, an internal study was undertaken by the Reserve Bank using the data from the RBI studies on ‘Finances of Public Limited Companies for the period 1975 to 2001’. The study was based on balance sheets of around 1,720-2,131 companies of which 786 to 1,036 companies had reported exports data. For analytical purposes, the companies were grouped into two broad sets:

1. Set I covered companies having exports but may or may not have imports (used mainly to analyse their export potential and net foreign exchange contribution) and

2. Set II covered companies having both exports and imports (used mainly for analysing contribution of exports adjusted for imports of raw material (value added) to overall sales growth).

The analysis of exports contribution to growth for these companies was done in terms of a number of ratios. For example, for the first Set of companies two ratios:

1. exports to sales ratio, and

2. net foreign exchange earning of industries having exports to total foreign exchange reserves of the country were calculated;

the analysis of the second Set of companies was based on three ratios, viz.,

1. exports to sales ratio,

2. imports to sales ratio, and

3. exports adjusted for imports of raw material to sales ratio.

The standard industrial classification was adopted for grouping the companies. During 1975-76 to 2000-01, the share of exports of the companies covered in the study amounted to 17-20 per cent while their share of imports varied from 10.6 – 25.6 per cent of the total non-oil imports of the country during the period. The limitations of the data set used for the study are non-comparability of companies used for each year, annualisation of income and expenditure for some companies due to change in the accounting year and change in industrial classification of a company from year to year depending on the share of a product in total sales. Furthermore, most of these companies are from the manufacturing sector. The results of the study are thus subject to these limitations of data-base.

At the macro level, the performance of companies in Set I in terms of the exports to sales ratio declined from 8.1 per cent in 1975-76 to 6.8 per cent in 1988-89, but at 11.2 per cent witnessed a turnaround in 1994-95 and stood at 15.7 per cent in 2000-01. The net foreign exchange earnings of these companies to total foreign exchange reserves of the country accounted for, on an average basis 10.6 per cent during the 1970s, 2.0 per cent during the 1980s and 1.3 per cent during the 1990s. This declining trend in the net contribution of these companies to country’s foreign exchange reserves was mainly on account of increase in their imports. Industry-wise analysis revealed that within the manufacturing sector the highest contribution was made by the mining and quarrying industry with exports to sales ratio ranging between 10.0 – 79.5 per cent during 1975-76 to 2000-01. The exports to sales ratio of industrial sector, other than manufacturing sector, varied between 16.0 – 31.0 per cent, processing and manufacturing of agriculture and allied activities 11.0 – 27.0 per cent and manufacturing of foodstuffs, tobacco, textiles, etc., 10.7 – 40.9 per cent. Using the revised National Industrial Classification (NIC), 1998 it was observed that the exports to sales ratio of manufacturing of wearing apparels, dressing and dyeing of fur industry was 58 – 80 per cent during the period 1998-99 to 2000-01, while manufacture of furniture was 78 – 81 per cent and tanning and dressing of leathers, manufacture of luggage, handbags, etc. contributed 56 – 63 per cent.

The exports to sales ratio of companies having both exports and imports revealed a more or less similar trend to those of companies having exports (Set I) and varied between 6.6 – 15.6 per cent. The imports to sales ratio, however, increased steadily from 4.6 per cent in 1975-76 to 14.7 per cent in 1996-97, but declined to 12.4 per cent in 2000-01. Consequently, when exports adjusted for imports of raw material are used for calculating exports to sales ratio, the contribution of this group in terms of sales ratio was meagre and ranged between a negative 0.4 per cent to 6.4 per cent during 1975-76 to 2000-01. Thus, contrary to the perception in the industrial circle of export sector’s contribution to overall growth of the economy of 25 per cent during the last decade, the exports adjusted for imports of raw material to sales ratio was far less. The country’s exports at a macro level, including re-exports not adjusted for value added, contributed around 18.4 per cent to GDP growth in nominal dollar terms during the 1990s. However, when the exports of the industries covered in the study are anlysed with due adjustments for imports of raw material (value added), the exports to sales ratio was much less at 3.7 per cent on an annual average basis during the 1990s.

Industry-wise analysis revealed that ratio of exports to sales of manufacturing of mining and quarrying was the highest (10 - 77 per cent during 1975-76 to 2000-01), while the ratio for processing and manufacturing of foodstuffs, tobacco and textiles ranged between 9- 41 per cent and that of other industrial group fluctuated between 13 - 26 per cent. The ratio in respect of processing and manufacturing of agriculture and allied activities ranged between 7- 30 per cent and was 6 - 19 per cent for manufacturing of metals, chemicals and products.

Overall export contribution of the industries to their sales growth for Set I companies stood at 5.7 per cent during the 1970s, increased to 8.9 per cent during the 1980s and increased further significantly to 18.7 per cent during the 1990s. During 1975-76 to 2000-01, the export contribution of these industries to their overall sales growth stood at 16.0 per cent. The contribution of exports to sales growth during the last two years was substantially higher at 23.1 per cent for these industries.

The contribution of exports adjusted for imports of raw materials to their sales growth depicted a dismal picture at a negative 0.3 per cent during the 1970s which increased marginally to 1.5 per cent during the 1980s. However, during the 1990s, the exports adjusted for imports of raw materials to sales growth of these industries stood at 8.4 per cent, which was mainly due to higher exports contribution of 12.0 per cent during the last two years.

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. 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.

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.

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.

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.

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. 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.