India's exports

10110 INDIARS EXPORTS MARTIN WOLF A WORLD BANK PUBLICATION fSt torYt   India's Exports A WORLD BANK PUBLICATION   India's Exports MARTIN WOLF Putblished I' rT ThA W rLl Bunk OXFORD UTNIVERSITY PRESS  Oxford L'nitersirt Press NEW YORK LONDON GLASGOWt TORONTO MELBOURNE WELLINGTON HO.N(G KO\G TOKYO KUALA LUMPUR SINGAPORE JAKARTA DELHI BOMBAY CALCUTTA MADRAS KARACHI NAIROBI DAR ES SALAAM CAPE TOWN Copyright C) 1982 by the Intemational Bank for Reconstruction and Development / THE WORLD BANK 1818 H Street, N.W., Washington. D.C. 20433 U.S.A. All rights reserved. No part of this publication mav be reproduced, stored in a retrieval svstem, or transmitted in anv form or by an\ mean-. electronic, mechanical, photocopvinE. recordlng- or otherwise, without the prior permission ot Oxford Universitv Press. Manufactured in the United States of America. The views and interpretations in this book are the authors' and should not be attributed to the World Bank, to its affiliated organizations, or to an\ individual acting in their behalf. Editor Virginia deHaven Hitchcock Charts S. A. D. Subasinghe Book design Brian J. Svikhart Binding design Joyce C. Eisen Library of Congress Cataloging in Publication Data Wolf, Martin, 1946- India's exports. Bibliography: p. Includes index. 1. India-Commerce. 2. India-Commercial policy. 1. Title. HF3786.5.W64 382'.6'0954 82-6309 ISBN 0-19-520211-2 AACR2  CONTENTS Preface ix Exports as a Separate Area for Analysis ix Available Literature on Exports x Contributions of the Book x Shortcomings of the Book xi Acknowledgments xi Abbreviations and Acronyms xiii Currency Equivalents xiv 1. Introduction and Summary 3 The Role of Exports 4 A Temporary Glut of Foreign Exchange 6 The Renewed Foreign Exchange Crisis 12 Conclusions 12 Outline of the Book 13 2. Past Performance of Exports 15 Overview of the Economy and the Industrial Sector 15 Overall Export Trends 17 The Pattern of Growth 32 The Role of Exports in Output 46 Summary and Conclusions 50 3. Domestic and International Constraints 55 Hypotheses about Exporte Performance 55 Unacceptable Hypotheses about Poor Performance 56 The Role of the Public and Private Sectors 59 Domestic Constraints on India's Exports 60 External Constraints on India's Exports 73 Conclusions 75 4. Export Policies and Programs 79 The Export Incentive System 79 Export Taxation and Controls 102 Export Processing Zones 110 The Evolution of Export Policy from the Mid-1970s 112 Incentives and Performance: An Evaluation 121 v  vi Contents 5. Strategic Issues 131 Developments in the Second Half of the 1970s-An Assessment of a Liberalization Episode 132 Long-run Options 136 The International Environment 142 Implications of Export Policy for Industrialization 146 Future Policy Reform 147 Appendix. Statistical Tables 153 Bibliography 193 Index 199 TABLES 1-1. Balance of Payments. 1972/73 to 1975/76 4 1-2. Quantum Indexes of Main Import Categories, Contrasted with GDP and Manu- facturing Output 5 1-3. Development of India's Import Capacity 8 1-4. Development of the Purchasing Power of India's Foreign Exchange Receipts 10 1-5. Quantity Indexes of Key Imports I1 2-1. Relative Size of Sectoral Expenditures for India and Major Developed Countries, 1973 16 2-2. India's Share of World Exports, 1948 to 1979 18 2-3. Growth Rates of Export Volume and the Purchasing Power of Exports for India and Groups of Market Economies, 1960161 to 1978/79 20 2-4. Decomposition of Changes in the Purchasing Power of India's Exports, 1960/61 to 1978/79 22 2-5. Export Volume and Purchasing Power for India and Selected Developing Econo- mies, 1960 to 1979 25 2-6. Structure and Growth of Exports for India and All Developing Economies, 1960 to 1978 26 2-7. Indexes of Fluctuations of Constant Dollar Export and Import Unit Value Indexes, and of the Terms of Trade, 1960/61 to 1978/79 31 2-8. Value and Growth of Major Exports, Ranked by Their Importance in 1950/51 33 2-9. Value and Growth of Major Exports, Ranked by Their Importance in 1978/79 34 2-10. Volume Growth Rates of Rapidly Growing Exports, 1968/69 to 1978/79 34 2-11. Manufactured Exports of Selected Developing Economies, 1965 to 1978 36 2-12. Manufactured Exports of India and Leading Developing Economies in Selected Commodity Groups, 1972 and 1978 38 2-13. Direction of Exports, 1960 to 1978 40 2-14. Value and Growth of Total Exports of Selected Developing Economies, 1972 to 1978 42  Contents vii 2-15. Growth in Main Export Categories in 1976/77 Prices, 1973/74 to 1978/79 44 2-16. Output, Absorption, and the Role of Trade for Some Products, 1970, 1973, and 1976 48 3-1. Purchasing Power Parity Effective Exchange Rates, 1950 to 1971 61 3-2. Purchasing Power Parity Effective Exchange Rates, 1971/72 to 1979/80 62 4-1. Indexes of India's Exchange Rate, 1970 to 1979 80 4-2. Cash Assistance Rates, 1970171 to 1976/77 82 4-3. Shares in Cash Assistance, 1970171 to 1979/80 84 4-4. Shares in Import Replenishment Licenses, 1973/74 to 1979/80 86 4-5. Duty Drawback in Detail, 1974/75 and 1975/76 88 4-6. Value of Export Taxes and Incentives, 1974/75 94 4-7. Trade lncentives and Taxes, 1973/74 to 1979/80 100 4-8. Export Incentives and Taxes, by Broad Export Categories, 1973/74 to 1979/80 102 4-9. Export Duty Rates in Detail, 1966/67 to 1978/79 106 4-10. Optimal and Actual Export Taxation for Selected Commodities, 1975/76 108 4-11. Profitability and Efficiency of Some Engineering Exports in the Early 1970s 122 SA- 1. Principal Exports, in Current Prices, 1950/51 to 1979/80 154 SA-2. Exports According to the Revised Indian Trade Classificaton, 1968/69 to 1978/79 158 SA-3. Quantity Indexes of Exports, 1960/61 to 1970/71 162 SA-4. Quantity Indexes of Exports, 1968/69 to 1978/79 164 SA-5. Unit Value Indexes of Exports, 1960/61 to 1970/71 166 SA-6. Unit Value Indexes of Exports, 1968/69 to 1978/79 168 SA-7. Official Indexes of Overall Export Volume, 1950/51 to 1978/79 170 SA-8. Export Value, Export and Import Unit Values, the Terms of Trade, the Purchasing Power of Exports. Export Volume, and International Prices, 1960/61 to 1978/79 171 SA-9. Export Volume, Purchasing Power of Exports, and the Terms of Trade for Various Groups of Market Economies, 1960 to 1979 172 SA- 10. Indexes of Sectoral Export Volume and Unit Value, 1960/61 to 1978/79 176 SA- 11. Indexes of Sectoral Export Volume for All Developing Economies, 1960 to 1978 180 SA- 12. Trend Growth Rates of Sectoral Export Volume for India and Developing Coun- tries, 1960 to 1978 182 SA-13. Growth Rates of Export Volume, by Commodity Category, 1968/69 to 1978/79 184 SA-14. Output, Absorption, and the Role of Trade for Some Exports, 1970, 1973, and 1976 186 FIGURES 2-1. Purchasing Power of Exports for India and Other Market Economies, 1960/61 to 1978/79 21 2-2. Export Volume, Purchasing Power, and Terms of Trade for India, 1960/61 to 1978/79 23 2-3. Export Volumefor India and Other Market Economies. 1960/61 to 1978/79 24  viii Contents 2-4. Export Volume Growth Rates for India and All Developing Countries (Excluding Petroleum), 1960 to 1978 28 2-5. Terms of Trade for India and Other Market Economies, 1960/61 to 1978179 29 2-6. Export Unit Values, Import Unit Values, and the Terms of Trade for India, 1960/61 to 1978/79 30  PREFACE THE WORLD BANK HAS ALWAYS MAINTAINED AN INTEREST in the export performance of its members and particularly that of India.' It is generally true that good export performance is an essential determinant of the ability to service debt and is, for that reason, an important consideration to the World Bank. In the Indian case, however, there is also the concem that because of the country's size, the flow of concessional capital can never be an adequate substitute for India's own ability to earn foreign exchange. Im- proved export performance will provide this needed foreign exchange directly and at the same time permit the country to borrow more commercial capital, should it become necessary. The concem about India's ability to obtain the foreign exchange required for development reflects the view that foreign exchange shortage has been a significant brake on the pace of Indian growth. The balance of payments crisis following 1973 and its implications for the export performance required thereafter caused the Indian authorities to take several steps to improve India's export prospects. Given the shared interest, the World Bank entered into a dialogue with the authorities on export policy, which started with the objective of increasing the volume of exports at about 8 to 10 percent a year. This was about twice the level achieved previously and soon became the stated target of the Indian govemment. Research on individual export categories and commodities assessed the plausibility of the targets for individual categories and commodities that had been prepared by the govemment. It was questioned, however, whether the problem facing India's policymakers was simply to identify and produce a range of specific exportable commodities. Thus, an overview of the total export situation, and in particular of export policy and its relation to performance, was prepared, and it is largely from the overview that this book developed. Exports as a Separate Area for Analysis The history of the World Bank's interest in the subject of India's exports and the view that exports are important in their own right both as a cause of, and solution to, other problems are two reasons for the focus of this book. It is also necessary, however, to believe that a discussion of exports can be separated from that of other problems. It might be argued that this is im- possible because what happens elsewhere determines the progress of exports. To some extent, the work done for this book accepts this proposition. Thus, ix  x Preface the effects of policies other than those directly related to exports, especially in the industrial sector, have been considered. Furthermore, the feedback from exports to the rest of the economy is also discussed. The links with the rest of the economy should not be exaggerated, however. India has a large economy, with some underutilized resources (especially labor) and a relatively small export sector. Policies to increase the relative profitability of exports should affect their supply without any major repercussions on the rest of the economy, provided only that import policy adapts and that there is positive feedback from export performance on the level of economic activity. Thus, as a matter of analytical procedure, there seems to be nothing unreasonable about focusing on exports, bearing in mind that links with the rest of the economy not only exist but indeed justify the interest in exports in the first place.2 Available Literature on Exports There is a substantial literature on India's export performance in particular and on trade policy in general. The books by Manmohan Singh and by Deepak Nayyar both provide full accounts of the evolution of India's exports, commodity by commodity, for the 1950s and the 1960s, respectively.3 In addition, Banerji's book provides a thorough discussion and analysis of man- ufactured exports.4 These books suffer, however, from being focused largely on India's own experience and consequently do not emphasize how India has failed to keep pace with other developing countries. Furthermore, even Nayyar's and Banerji's books are now out of date, the former having only scanty discussion of the early 1970s and the latter ending its analysis in 1970. Two significant books, both coauthored by Bhagwati, place India's export per- formance in the context of its wider policies for industrialization and of its attitudes toward trade.5 The first is the best book on India's industrialization and trade policies, even though it is also somewhat out of date by now. Another recently published book with a strongly analytical orientation is that of Panchamukhi, which examines India's overall trade and trade policies, focusing on the 1960s, from a rigorously theoretical point of view.6 Contributions of the Book This book serves several purposes, despite the defects that are inevitable in an occasional piece of this kind. First, it provides data on India's exports and export policies up to the end of the 1970s and is therefore a more up- to-date source of information than any readily available. Second, the report uses material from various unpublished, restricted World Bank reports. Of  Preface xi particular interest is a series of major reports on several key engineering industries, which are used to illustrate the problems facing industrial exports. Third, the book covers an important topic in an exceptionally important country and presents a relatively short account of the major issues and con- troversies, which may be particularly valuable for those interested in the subject, but who feel unable to tackle the great length of the other books on the topic. Shortcomings of the Book Although this book should prove useful to those interested in India's development, it does have serious and unfortunately ineradicable shortcom- ings. As with any Bank report that originated as a country study, it does not cover political and social issues, even when they are clearly important. Fur- thermore, the work was started in great haste and with an immediate insti- tutional purpose, namely, participation in a particular policy dialogue. The final form of the report evolved only in the course of the work. Because of the pressures, the existing literature could not be reviewed as thoroughly as would have been desirable; A comment should also be made on the timeliness of the information. The original work was done during missions in October/ November 1975 and January/February 1976. The report was written in the fall of 1976 and was finally completed in May 1977. In the process of revision, however, data on overall export performance are provided up to the end of 1979/80, and, more important perhaps, information is presented on the evolution of export policies up to the beginning of 1980/81. Nonetheless, although this effort at updating has been made, there has certainly not been uniformly adequate treatment of events since early 1976. Acknowledgments In the course of the preparation of this book assistance was received from the staffs of too many official and private bodies and too many individuals to enumerate. Particular mention should be made, however, of officials of the Department of Economic Affairs; Ministry of Commerce, Civil Supplies and Cooperation; and Ministry of Industry as well as the staff of the Industrial Credit and Investment Corporation of India. I would also like to thank certain individuals who provided particularly valuable information and comments, namely Dr. Bimal Jalan, then economic advisor to the Department of In- dustrial Development, Dr. Arjun Sengupta, then economic advisor to the Ministry of Commerce, Civil Supplies and Cooperation, and finally, Dr. Vijay Kelkar, Dr. Sengupta's successor.  xii Preface I would also like to thank all those who contributed to the report from which the book derived or to subsequent updating. The major contributor to both was Roger Grawe, without whose assistance this book would have been impossible; other important contributions were made by Mark Baird, William Dellalfar, Charles Taylor, and James Harrison, all of the World Bank staff. Angus Hone, a consultant to the Bank, provided valuable analysis and information on some of the main export categories. I am also grateful for the comments on earlier drafts of Donald Keesing and Bevan Waide, of the World Bank staff, and Bela Balassa and James Riedel, both consultants to the World Bank. In preparing the manuscript I benefited from help with the research by Joan Voigt, Aeran Lee, Christopher Hall, and William Shaw. I am also grateful for the secretarial assistance of Karen Adams, who was responsible for the arduous and thankless task of preparing the final manuscript. Finally, I would like to thank my wife for putting up with a book, whose major contribution to our lives was to plunge me periodically into deep depression. To them and to all the others who assisted me I am grateful. Needless to say, all responsibility for views expressed in the book as well as for errors of omission and commission rests with the author alone. In particular, the opinions expressed do not in any way represent those of the World Bank. Notes to the Preface 1. The World Bank's interest in the subject has led to the preparation of several restricted reports, the last ones in 1971 and 1977. 2. This argument seems to conflict directly with that of Deepak Nayyar who argues that economic growth determines export growth and that "this is hardly surprising in an economy where exports account for less than 5 percent of the national output." Leaving aside for the moment the question of feedback from exports to economic growth, it seems more plausible to argue that it is only when exports account for a very large part of economic activity that their growth must be closely related to that of GNP. See Deepak Nayyar, India's Exports and Export Policies in the 1960s (Cambridge: Cambridge University Press, 1976), p. 377. 3. Manmohan Singh, India's Export Trends and the Prospects for Self-Contained Growth (Oxford: Clarendon Press, 1964); and Deepak Nayyar, India's Exports and Export Policies in the 1960s (Cambridge: Cambridge University Press, 1976). 4. Ranadev Banerji, Exports of Manufactures from India: An Appraisal of the Emerging Pattern (Tubingen: J. C. B. Mohr (Paul Siebeck) for the Institut fitr Weltwirtschaft an der Universitat Kiel, 1975). 5. Jagdish N. Bhagwati and Padma Desai, India: Planningfor Industrialization (London: Oxford University Press for the Development Centre of the Organisation for Economic Cooperation and Development, 1970); and jagdish N. Bhagwati and T. N. Srinivasan, Foreign Trade Regimes and Economic Development: India (New York: Columbia University Press for the National Bureau of Economic Research, 1975). 6. V. R. Panchamukhi, Trade Policies of India: a Quantitative Analysis (Delhi: Concept Pub- lishing Company, 1978).  ABBREVIATIONS AND ACRONYMS CCIE Chief controller of imports and exports c. i. f. Cost, insurance, and freight DGTD Directorate General for Technical Development DRC Domestic resource cost EEC European Economic Community EFTA European Free Trade Area f.a.s. Free alongside ship FCV Flue-cured Virginia (tobacco) FERA Foreign Exchange Regulation Act f.o.b. Free on board GATT General Agreement on Tariffs and Trade GDP Gross domestic product GNP Gross national product HPS Hand picked selected (groundnuts) icici Industrial Credit and Investment Corporation of India IMF International Monetary Fund IsIC International Standard Industrial Classification MRTP Monopolies and Restrictive Trade Practices Act OECD Organisation for Economic Co-operation and Development OGL Open general license PPP-EER Purchasing power parity effective exchange rate PVC Polyvinyl chloride REP Import replenishment license SEEPZ Santa Cruz Electronics Export Processing Zone SITC Standard International Trade Classification STC State Trading Corporation UNCTAD United Nations Conference on Trade and Development xiii  CURRENCY EQUIVALENTS (AS OF 1979/80) US$ 1.00 = rupees (Rs) 8.1 Rsl = US$0.124 Rsl million = US$124,000 All years to 1965/66 US$ = 4.7619 rupees 1966/67 = 7.0 1967/68-1970/71 = 7.5 1971/72 = 7.444 1972/73 = 7.706 1973/74 = 7.791 1974/75 = 7.976 1975/76 = 8.653 1976/77 = 8.939 1977/78 = 8.563 1978/79 = 8.206 1979/80 = 8.076 Source: Intemational Monetary Fund, International Financial Statistics (Washington, D.C.: IMF, monthly). xiv  India's Exports   1 INTRODUCTION AND SUMMARY THE GROWTH OF EXPORTS from India had been at best modest over a long period. The events that occurred during 1973/74 underlined the resulting vulnerability of the Indian balance of payments. I To the rise in the price of oil were added the rising prices of fertilizer and wheat, in addition to the need to import larger quantities of food following a series of mediocre harvests. Between 1972/73 and 1974/75 the expenditure on food, fertilizer, and oil increased from US$551 million to US$3,139 million, and their combined share in the total import bill shot up from 23 to 55 percent, as shown in Table 1-1. The increased bill for these three categories of imports actually exceeded India's entire export earnings of US$2,558 million in 1972/73. Since the expected trade deficit increased by approximately US$1.5 billion and since net aid had been supplying little more than US$500 million in 1972/73, it was obvious that India faced a major balance of payments crisis. A substantial increase in the inflow of resources from abroad was required to weather the crisis, and this did occur. But, as is clear from Table 1-2, sharp cuts in the availability of all but the most essential imports (largely food) were also required, with presunrably serious consequences for future devel- opment. Between 1973/74 and 1975/76 imports in almost all major categories other than food fell in real terms, and the real level of overall imports fell by 13 percent. The lessons of experience seemed clear. India's long emphasis on import substitution had not reduced its vulnerability to adverse external circum- stances, but had perversely increased it. The level of imports was so low in relation to gross national product (GNP) (about 5 percent in 1973), and imports were reduced so completely to essentials, that any significant change in the terms of trade or in the relation between supply and demand in a sector as vital as cereal production led immediately to a severe balance of payments crisis. The constraints imposed by the low level of imports are also indicated by the fact that between 1960/61 and 1973/74 the volume of imports rose by only 34 percent, whereas gross domestic product (GDP) at factor cost (in 1970/71 prices) grew by 53 percent. It seemed clear that every available means of increasing the level and rate of growth of foreign exchange resources had to be explored, and the obvious starting point in an economy with a long history of import substitution was exports. 3  4 Introduction and Summary Table 1-1. Balance of Payments, 1972/73 to 1975/76 (millions of U.S. dollars in current prices) Item 1972/73 1973/74 1974/75 1975/76 Exports 2,558 3,239 4,174 4,672 Imports -2,423 -3,793 -5,665 -6,449 Petroleum -265 -719 -1,451 -1,417 Cereals -105 -597 -951 -1,537 Fertilizers' -181 - 291 - 737 -710 Trade balance 135 -554 -1,491 -1,777 Nonfactor services (net) 57 61 215 310 Resource balance 192 -493 -1,276 -1,467 Investment income (net) -284 -259 - 198 -216 Current transfers (net) 96 158 257 470 Current account balance 4 - 594 - 1,217 -1,213 Net aid disbursements 542 764 1,246 1,810 Use of IMF credit - 75 522 242 Errors and omissions - 512 - 140 - 589 - 45 Use of reserves (- = increase) -34 - 105 38 -794 Capital account balance -4 594 1,217 1,213 Reserve level (end of year) 1,311 1,416 1,378 2,172 a. Includes fertilizer raw materials. Source: World Bank data. The Role of Exports Since exports are just one aspect of the allocation of resources, it might be more appropriate to consider this issue as a whole, with export performance seen as one product of wider policy choices. There is some validity to this argument, but nonetheless the narrower approach is followed here. Long before the issue of the best policy for resource allocation arises, it becomes clear that a minimum of foreign exchange is necessary if a developing country is going to achieve any rapid growth. The problem of bottlenecks and short- ages that has beset India reflects, to a large extent, the scarcity of foreign exchange, since many of the required goods are tradable. Not only has this resulted in underutilization of capacity and lost opportunities, but, perhaps still worse, a whole apparatus of controls has been created to tackle the problem, with the most pervasive consequences for industrial development. Furthermore, these very policies have, in turn, tended to penalize exports further. In addition to the view that the lack of foreign exchange is a problem in its own right, the focus on exports is explained by the assessment of the benefits that might result from greater success in expanding them. A com-  Table 1-2. Quantum Indexes of Main Import Categories, Contrasted with GDP and Manufacturing Output (1968/69= 100) Growth (percent) Item 1960/61 1972/73 1973/74 1974/75 1975/76 1960/61-1973/74 1973174-1975176 Food 73 34 78 101 134 6.8 71.8 Crude materials 158 107 83 61 66 -47.5 -20.5 Mineral fuels 94 391 427 291 299 354.3 -30.0 Chemicals 27 90 91 93 79 237.0 -13.2 Manufactured goods- 165 164 156 155 120 -5.5 - 23.1 Machinery and transport equipment 120 91 106 82 90 - 11.7 -15.1 Miscellaneous manufactures 71 108 121 99 123 70.4 1.7 Total 85 99 114 100 99 34.1 -13.2 GDP at factor costb 78 113 119 119 130 52.6 9.2 Manufacturing output' 67 121 127 129 134 89.6 5.5 Note: Beverages, tobacco, and animal and vegetable oils and fats have been excluded; the index for 1960/61 is derived from that with 1958= 100 and is linked in 1968/69. a. Manufactured goods classified chiefly by material. b. From Government of India, Central Statistical Organisation, National Accounts Statistics (New Delhi), various issues. Data for 1960/61 and 1968/69 at 1960/61 prices have been converted into 1970/71 prices using the price deflators derived from 1970/71 data in cso, National Accounts Statistics, 1960/61- 1974/75, October 1976. Sources: Reserve Bank of India, Report on Currenc-y and Finance (Bombay: RBI, annual), various issues; and World Bank data.  6 Introduction and Summary prehensive review of all aspects of resource allocation policy was never seen as a useful avenue to policy reform. An improvement in export performance should of itself, however, put great pressure for change on the more unde- sirable features of the regime governing the allocation of resources in industry. Thus, greater exports should lead to liberalization of imports. This would not only produce greater competition for a highly protected domestic industry and give greater choice to those previously compelled to use domestically produced goods, but would also reduce the constraining effect of scarce inputs on the growth of the more efficient firms. In addition, there would be some direct effect on quality, as exporting firms leamed to cope with overseas competition. An exclusive focus on exports, leading perhaps to chaotic policies to promote them regardless of cost, could result in misallocations of resources as serious as any that already exist. There is already evidence of inefficient export activity and even of negative value-added exports. In general, how- ever, the danger is not overwhelming. Unlike import substitutes, which are largely subsidized by consumers, export incentives require visible budgetary expenditure. These costs are evident to the authorities, and there is constant pressure to minimize them by getting the most exports for the least expense. Although these pressures can certainly not prevent all inefficient export activities, they do reduce the possibility of excess as opposed to the alternative strategy oriented toward the home market.2 A Temporary Glut of Foreign Exchange There was a profound change in India's foreign exchange situation in the mid-1970s. From crisis, India moved into unprecedented glut. Examination of this remarkable transformation and the ultimate return of foreign exchange scarcity at the end of the decade, when oil prices soared again, reveals neither the success nor the failure of exports, but rather their continued modest contribution and the importance of improved performance. The improvement in India's foreign exchange position resulted from both improved receipts and reduced import requirements. The change in the sit- uation in current prices between 1973/74 and 1980/81 is shown in Table 1- 3 (which updates Table 1-1 and also changes the presentation to focus on import capacity). Attention needs to be paid to the period from 1973/74 to 1978/79, after which imports rose again rapidly. Exports and current transfers, the latter largely remittances from Indians working in the Persian Gulf, accounted for the bulk of the growth in receipts between 1973/74 and 1978/ 79, whereas the contribution of net aid and receipts from the Intemational Monetary Fund (IMF) rose sharply and then fell. The importance of mer- chandise exports as a source of foreign exchange declined, and a high pro-  Introduction and Summary 7 portion of foreign exchange went into reserves. Foreign exchange reserves rose to the equivalent of eight months of the succeeding year's imports by the end of 1977/78-a level unprecedented since the 1950s. The change in current prices overstates the true contribution of exports. Inflation guaranteed a rise in the value of existing exports and also sharply eroded their purchasing power. Table 1-4 gives a much more accurate picture of the situation, since it shows the contributions of different sources of foreign exchange receipts to their combined purchasing power. The total rise in the purchasing power of foreign exchange receipts between 1973/74 and 1978/ 79 was 44 percent; all of this growth occurred after 1975/76, since it took two years to recover from the effects of the loss of purchasing power caused by the shift in the terms of trade in 1973/74. Furthermore, exports contributed only 38 percent of the growth of the purchasing power of foreign exchange receipts between 1973/74 and 1978/79. Indeed, exports regained their 1973/ 74 purchasing power only in 1976/77 and grew by just 20 percent during the entire five-year period. Much of the increase in the purchasing power of overall foreign exchange receipts was brought about by increases in the real value of transfers and of nonfactor services as well as reductions in the net outflow of investment income. lndeed, 51.8 percent of the growth in the real value of foreign exchange receipts was produced by nonfactor services and current transfers. Meanwhile the real value of aid rose between 1973/74 and 1975/76 and then fell below the 1973/74 level. Table 1-4 shows not only the very modest contribution of exports to the total expansion of import capacity between 1973/74 and 1978/79, but also the reduction in real imports that played so important a role in the first three years of crisis management after 1973/74. The immediate reason for this reduction in real imports was the tight general control referred to above. Thereafter, however, improved harvests as well as greater production of goods such as fertilizers and iron and steel reduced the requirements for these key imports. Imports of oil were also tightly constrained. Cereal imports continued to decline after 1976/77, as Table 1-5 shows, reaching negligible levels, and the combined share in imports of the four categories of cereals, mineral fuels, manufactured fertilizers, and iron and steel accounted for only 36 percent of imports in 1977/78, down from 63 percent in 1975/76. Imports of these categories (other than cereals) started to rise after 1976/77, however, as did total imports, because of import liberalization and growing domestic demand. Tight limits on imports inevitably proved a temporary expedient. However important remittances from abroad, nonfactor services, and fur- ther import substitution were in dealing with the immediate crisis, the im- portance of exports far from disappeared. The fact that by 1976/77 India was able to recover the purchasing power of exports of 1973/74 was itself valuable. Furthermore, the balance of payments surplus of 1976 to 1979, which was equal to only 1 to 2 percent of GNP, could be absorbed easily by efficient  Table 1-3. Development of India's Import Capacity (millions of U.S. dollars in current prices) 1973/74 1974/75 1975/76 1976/77 1977/78 Item Value Percent Value Percent Value Percent Value Percent Value Percent Merchandise exports 3,239 83.1 4,174 74.2 4,672 64.5 5,753 76.7 6,315 68.2 Nonfactor services 61 1.6 215 3.8 311 4.3 366 4.9 691 7.5 Investment income (net) -259 -6.6 -198 -3.5 -216 -3.0 -162 -2.2 -89 -1.0 Current transfers 158 4.1 257 4.6 470 6.5 692 9.2 1,077 11.6 Net aid 764 19.6 1,246 22.1 1,792 24.7 1,395 18.6 983 10.6 Use of IMF credit 75 1.9 522 9.3 242 3.3 -337 -4.5 -330 -3.6 Errors and omissions -140 -3.6 -589 -10.5 -28 -0.4 -204 -2.7 617 6.7 Import capacity 3,898 100.0 5,627 100.0 7,243 100.0 7,502 100.0 9,264 100.0 Reserve accumulation -105 -2.7 38 0.7 -794 - 11.0 -1,574 -21.0 -2,076 -22.4 Imports -3,793 -97.3 -5,665 -100.7 -6,449 -89.0 -5,928 -79.0 -7,188 -77.6 (Table continues on the following page.)  Table 1-3 (continued) Increment 1978179, 1979/80b 1980/81h 1973/74-1978/79 1978/79-1980181 Item Value Percent Value Percent Value Percent Value Percent Value Percent Merchandise exports 6,978 69.4 7,958 69.4 8,998 59.7 3,739 60.7 2,020 40.2 Nonfactor services 773 7.7 633 5.5 463 3.1 712 11.6 -310 -6.2 Investment income (net) -35 -0.3 350 3.1 303 2.0 224 3.6 338 6.7 Current transfers 1,216 12.1 1,458 12.7 2,462 16.3 1,058 17.2 1,246 24.8 Net aid 993 9.9 1,215 10.6 1,682 11.2 229 3.7 689 13.7 Use of iMP credit -158 -1.6 n.a. n.a. 1,035 6.9 -233 -3.8 1,193 23.8 Errors and omissions 286 2.8 -143 -1.2 133 0.9 426 6.9 -153 -3.0 Import capacity 10,053 100.0 11,471 100.0 15,076 100.0 6,155 100.0 5,023 100.0 Reserve accumulation -1,534 -15.3 -222 - 1.9 548 3.6 -1,429 -23.2 2,082 41.4 Imports - 8,519 - 84.7 -11,249 - 98.1 -15,624 -103.6 - 4,726 - 76.8 -7,105 -141.4 Note: Errors are due to rounding, n.a. Not available. a. Estimated from data for first three quarters of the year. b. Preliminary estimates. Source: World Bank data.  Table 1-4. Development of the Purchasing Power of India's Foreign Exchange Receipts (millions of U.S. dollars in 1968/69 prices) Increment 1973174-1978/79 Item 1973/74 1974/75 1975/76 1976/77 1977/78 1978/79 Value Percent Merchandise exports 2,438 1,857 1,925 2,521 2,896 2,936 498 38.4 Nonfactor services 46 96 128 160 317 325 279 21.5 Investment income (net) -195 -88 -89 -71 -41 -15 180 13.9 Current transfers 119 114 194 303 494 512 393 30.3 Netaid 575 554 738 611 451 418 -157 -12.1 Use of IMF credit 56 232 100 -148 -151 -66 -122 -9.4 Errors and omissions -105 -262 -12 -89 283 120 225 17.3 Import capacity 2,934 2,504 2,984 3,287 4,248 4,231 1,297.0 100.0 Reserve accumulation - 79 17 - 327 - 690 - 952 - 646 - 567.0 -43.7 Imports -2,855 -2,521 -2,657 -2,598 -3,296 -3,585 -730.0 -56.3 Note: Errors are due to rounding. Values are deflated by the unit value index of imports in dollars. Sources: Tables 1-3 and SA-8.  Introduction and Summary 11 Table 1-5. Quantity Indexes of Key Imports (1973/74 = 100) 1973174 1974175 Share in imports Share in imports Item ilndex (percent) Index (percent) Cereal 100 16.0 130 16.9 Mineral fuels tOo 19.0 68 Z5.6 Manufactured fertilizers 100 5.5 128 9.6 Iron and steel 100 8.4 121 9.4 Combined share in total impoTts - 48.9 - 61.5 1975176 1976177 Share in imports Share n imports Item Index (percent) Index (percent) Cereal 188 25.4 127 16.9 Mineral fuels 70 23.3 73 27.9 Manufactured fertilizers 95 8.2 87 3.8 Iron and steel 66 5.8 54 4.3 Combined share in total imports - 62.7 - 52.9 1977/78 1978/79 Share in mports Share in imports Item Index (percent) Index (percent) Cereal 118 1.7 16 1.4 Mineral fuels 87 25.8 108 24.6 ManufactuTed feitilizers 112 4.3 159 5.4 Iron and steel 66 4.4 109 6.9 Combined share in total imports - 36.2 - 38.3 - Not applicable. Sources: Reserve Bank of India. Report on CurrencN and Finance (Bombay: RBI, annual), various issues; and World Bank data. import liberalization and high GNP growth. At the same time, in an economy with a long history of import substitution, prospects of steady further reduc- tions in import requirements were dim. Indeed, by 1977/78 imports of cereals were already negligible, and even those of finished fertilizers and iron and steel totaled little more than US$600 million between them. Thus, even their complete elimination could save little further foreign exchange. Import requirements for oil could also hardly be expected to fall, with domestic production no more than stabilizing the required quantity of imports. On the receipts' side, remittances seemed unlikely to continue their rapid growth, and no source of foreign exchange other than exports was likely to grow  12 Introduction and Summary rapidly and on a large scale. Thus, in the long term, exports, which still contributed about 70 percent of India's total foreign exchange receipts in 1978/79, had to grow steadily and rapidly if India was to be unconstrained by shortages of foreign exchange. The Renewed Foreign Exchange Crisis What might have been expected in 1978/79 to take as long as five years actually took only one, as the soaring price of oil at the end of the decade brought India to a condition similar to that of six years before. Imports soared in 1979/80 from US$8.5 billion in the previous year to US$11.2 billion and then rose further to US$15.6 billion in 1980/81 (Table 1-3). The main reason was increased expenditures on oil, which rose from US$2.0 billion in 1978/ 79 to US$4.0 billion in 1979/80, and to US$7.0 billion in 1980/81. Exports were left far behind, falling to only 60 percent of foreign exchange receipts and 58 percent of imports in 1980/81. Indeed in the latter year oil imports consumed 78 percent of the receipts from merchandise exports. The period of foreign exchange glut proved, therefore, to be temporary, and the far from dynamic performance of exports in that period to be a harbinger of problems for the future. Given the low base of exports in relation to imports in 1980/81 and the modest hopes for steady growth in other sources of foreign exchange, unprecedented and sustained export dynamism was needed if India's growth was not to be constrained by a scarcity of foreign exchange. Analysis begun at the time of one crisis was relevant to the problems of the second, therefore, despite the several years of unwonted and fortunate ease that came between. Conclusions The analysis below stresses that India's exports are constrained fundamen- tally by the inward-looking policy framework, in which exports are treated essentially as an afterthought. Given the unwillingness of policymakers to permit specialization in production and trade, export growth was constrained by the sluggish growth of output, as several analysts argued. This was not inevitable, however, but was the consequence of domestic policies that made efficient specialization impossible. The result was the loss of many oppor- tunities and a performance for a long time inferior to that of the average of developing countries. Particularly serious was the slow growth of manufac- tured exports-the most dynamic sector for developing countries and one in which India was well placed for success in the 1950s.  Introduction and Summary 13 In the 1970s India's performance improved relative both to its own past and to that of other developing countries. The reasons for this seem to have been improved incentives, including real depreciation of the exchange rate, slow domestic growth, and determined government efforts during the foreign exchange crisis of the middle of the decade. Although the improved growth occurred in most major export categories, the improvement was not sufficient to prevent India from falling still further behind its major competitors. Thus, in the 1950s India had been the foremost exporter of manufactures among the developing countries. By the middle of the 1960s it was second, by 1970 it was third, and by 1978 seventh. In 1978 the Republic of Korea's manu- factured exports exceeded India's by 200 percent. Furthermore, after excep- tional growth in 1976/77, performance tailed off in the rest of the decade as the domestic economy grew and a comfortable foreign exchange position emerged. Comparison of India's performance with that of other developing countries as well as direct analysis of affected products makes it clear that overseas market constraints have been a negligible factor in explaining India's export performance. Domestic policy is much more important. Although some im- provement in performance is possible within the basic policy framework, the resulting growth of exports is likely to be modest in relation to India's re- quirements and to be inefficient as well. More dramatic improvements in performance require an equally radical examination of policy, as has been proved in part by the unsatisfactory consequences of the cautious liberalization of imports and reform of incentive policy that occurred in the second half of the 1970s. Instead of being treated as an afterthought in a policy envi- ronment that inevitably penalizes them, export opportunities need to be integrated into policies for development and trade. It is necessary to take full advantage of India's comparative advantage and to allow specialization in production. At the least a free trade regime for exporters is required with liberal access to imported inputs. It is only in such an outward-looking framework that exports themselves will grow much more rapidly and their contribution to India's economic growth be as beneficial as possible. Outline of the Book The book starts with an analysis of India's export performance during the 1960s and 1970s compared with that of other developing countries. Particular attention is paid in Chapter 2 to the characteristics and pattem of export growth, developments in the period following 1973, and the role of exports in the output of particular sectors. The analysis proceeds in Chapter 3 to a discussion of the major constraints, both domestic and external, on exports. Industrial policy and industrial struc-  14 Introduction and Summary ture are stressed in particular. Chapter 4 then examines the specific incentive policies designed to offset the constraints imposed largely by the inward- looking orientation of trade and development policy. The characteristics and defects of export incentives are carefully evaluated. In the final chapter the options for policy reform are considered. The attempt is made to draw lessons from the temporary period of foreign exchange ease and liberalization of imports and reform of export incentives that oc- curred between 1975/76 and 1979/80. The arguments for and against more outward-looking policies are carefully evaluated, and the implications of alternative strategies are assessed. It is concluded that greater freedom for exporters, greater security of incentives, and higher levels of profitability are needed if exports are to grow more rapidly than hitherto. Notes to Chapter 1 1. The Indian fiscal year runs from April 1 through March 31. 2. Bhagwati stresses the budgetary constraints on subsidies as one reason for the apparently superior resource allocation under a policy that promotes exports. See Jagdish N. Bhagwati, Foreign Trade Regimes and Economic Development: Anatomy and Consequences of Exchange Control Regimnes (Cambridge, Massachusetts: Ballinger Publishing Company for the National Bureau for Economic Research, 1978), p. 211.  2 PAST PERFORMANCE OF EXPORTS How FAST HAVE EXPORTS GROWN, and has the growth rate been acceler- ating? Have changes in the terms of trade negated much of the benefit of the effort to expand the volume of exports? How has India's performance compared with that of other countries? Have India's exports been held back by the stagnation of major export categories, and, if so, was wortd demand the main reason? How well has India succeeded in expanding new exports? These questions are explored below in preparation for the analysis of key constraints and policies in Chapters 3 and 4, respectively. Overview of the Economy and the Industrial Sector India is the world's second most populous country. Using the standard exchange rate conversion, its GNP in 1978 ranked eleventh among market economies and fourteenth in the world.' It jumps to seventh place, however, when methods developed for a project on international comparisons of real product are applied.2 India's overall economic performance has been better since its independence in 1947 than before, but it has been somewhat worse than that of most other countries, especially in the 1960s. India's GNP per capita grew 1.4 percent a year between 1960 and 1978, putting it fifty-third out of the eighty-three developing countries with populations over 1 million, for which these data are available.3 Industrial performance and relative size India's industrial growth also lagged: Of forty-eight developing countries for which the data are available India's growth rate of manufacturing output in the 1960s put it in the forty-first rank; in the 1970/78 period it was forty- fifth out of seventy-one.4 In 1955 India's manufacturing sector was the eighth largest among market economy countries and by far the largest among de- veloping countries (except China); by 1976 India's rank had slipped to fif- teenth.5 The adjustment to common prices would not change the interna- tional ranking of the size of the manufacturing sector by much since the 15  16 Past Performance of Exports Table 2-1. Relative Size of Sectoral Expenditures for India and Major Developed Countries, 1973 (United States = 100) Federal Republic of United Expenditure France Germany Japan Kingdom India Consumption 16.8 18.8 24.4 16.5 17.7 Clothing and footwear 13.9 21.6 35.1 17.8 14.1 Fumiture and domestic appli- ances 14.8 26.1 26.8 12.2 1.7 Transport equipment 6.1 5.8 3.2 7.6 0.6 Capital formation 27.3 38.3 26.5 15.0 11.9 Producer durables 23.8 29.6 24.1 17.4 4.4 Government 14.5 16.2 18.2 15.7 28.5 Gross domestic product 18.9 22.8 24.2 16.1 17.7 Source: Irving B. Kravis, Alan Heston, and Robert Summers, International Comparisons of Real Product and Purchasing Power (Baltimore, Md.: Johns Hopkins University Press, 1978), table 4.9; and World Bank, World Bank Atlas (Washington, D.C.: World Bank, 1976), annex. intemational value of traded goods in general, and manufactured goods, in particular, are closer to those produced by exchange rate conversions than those for nontraded goods and services.6 As is shown in Table 2-1, the domestic market for most industrial products was small in relation to those of the major developed countries, whereas this was not true for GDP as a whole or for consumption (except compared with the United States). The only industrial sectors for which expenditure com- pared in size with that of major developed countries (other than the United States) were clothing and footwear. In the case of producer durables, even the United Kingdom's expenditure exceeded that of India by 300 percent. These figures indicate that, to the extent that economies of scale are a factor in industrial efficiency, India could have been expected to be more open to trade than the larger economies. Since it was not, potential economies were probably being foregone. Character and consequences of the economic strategy India's basic economic strategy and its consequences have been extensively analyzed. 7 The overriding aim has been across-the-board import substitution, with emphasis on developing (largely public sector) heavy industry.8 India has relied extensively on quantitative restrictions on trade and on detailed, industrial licensing. The government has also tended to be pessimistic about export possibilities, especially for traditional exports.9 As a result of the strong bias toward import substitution, India has a relatively closed economy and an increasingly unspecialized industrial sector.  Past Performance of Exports 17 The unspecialized character of industry is indicated by the marked shift in the composition of industrial production: consumer, intermediate, and capital goods contributed about one-third each of value added in the middle 1970s, compared with the overwhelming preponderance of consumer goods produc- tion twenty-five years before. The ratio of imports to GNP in 1973 (5.5 percent) was lower than that for any country in that year except the U.S.S.R. (whose ratio was only a little less, 4.6 percent).'