Export incentives : the impact of recent policy changes

LAWS 1355" POLICY RESEARCH WORKING PAPER- 1355 Despite improved export incentfies, India's export profitability dedined under The Impact of Recent Policy Changes the dual exchange rate regime (March 1992- Sanjay KatJ,urza Februaiy 1993). The situation reversed with the unification of the exchange rate in March 1993, and an export surge since then has been led by the sectors in which export profitability increased most. The World Bank South Asia, County Department II Resident Mision in idia. Sepember19.94  I POLICY RESEARCH WORICING PAPER 1355 Summary findings India's trade policy regimrre has changed dramatically * The gap between domestic and export profitability since July 1991. The objective of reform has been to increased in the period of the dual exchange rate regime, improve export performance by improving export meaning that domestic sales, already more attractive than incentives and eliminating discretionary controls. export sales, became even more so. Using a simple model, Kathuria sets out to examine * This adverse movement in export incentives was whether export incentives actually improved as a result revcrsed with unification of the exchange rate in March of policy changes. One part of the two-part modcl 1993. compares export profitability across regimes. The other Overall, the regime has moved closer to its eventual compares the gap between domestic and export goal of being neutral about import substitution and profitability across regimes. The export base is divided cxport promotion, which is reflected in a significant into eight subsectors, and several simulation exercises are ch,mge in the attitude of India's corporate sector toward applied to each of them. exports. The main results: It is more than a coincidence that the export surge in * For most export sectors, export profitability was fiscal 1993-94 was led mainly by the sectors that lower under the dual exchange rate regime (March 1992- witnessed the greatest increase in export profitability. February 1993) than in the period before July 1991. This paper -a product of South Asia, Country DepartnientIt, Resident Mission in India-is part of a larger effort in the department to monitor economic developments in India and to assess their significance. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Mona Haddad, room G3-113, extension 32160 (31 pages). September 1994. The Polkcy Research Working Paper Seies disseminates the findns of work in progress to etcoiwage tie exag of ides about developmenti sseAn objectiv of the seriesisg tar thc findings out quckly, een if thepresntasare lss han fllypoisbd The papers carry the names of d2e authors and shouldbe usedand cdedaccordingly. Thefindirgsr, ierpretations, and acodusios are the authors' owm ad should rot be attributed to the World Bank its Eecutiue Board of Directors, or any of its mmber cosauie& Produced by the Policy Research Dissemination Center  EXPORT INCENTIVES: THE IMPACT OF RECENT POLICY CHANGES SANJAY KATHURIA, SA2ND WORLD BANK RESIDENT MISSION NEW DELHI  Table of Contents I. INTRODUCTION .................................. 1 II. CHRONOLOGY OF EXPORT INCENTIVES ................ 4 Chart 1: Salient Features of the Trade Regimes .............. 6 In. THE MODEL ............. ....................... 7 Export Profitability ................................ 7 Domestic versus Export Profitability ..................... 10 IV. THE RESULTS ................................... 12 Simulation Assumptions ............................. 12 The Results .................................... 14 Table 1 ....................................... 17 V. CONCLUDING OBSERVATIONS ....................... 18 APPENDIX I: TlIE DATA ............................ 22 APPENDIX TABLES TABLE 1 ....................................... 24 TABLE 2 ...................................... 24 TABLE 3 ...... 25 TABLE 4 ...................................... 26 TABLE 5 ....................................... 27 APPENDIX II: INCLUSION OF IMPORT TARIFF-RELATED COSTS IN THE CEDP EXERCISE .28 BIBLIOGRAPHY ........................................... 30  EXPORT INCENTIVES IN INDIA: THE IMPACT OF RECENT POLICY CHANGES' I. INTRODUCTION One of the cornerstones of India's development policy has been an import - substituting industrialization strategy. It was accompanied by a heavy dose of export pessimism, which was reinforced by the poor export performance in the early years of planned development. Owing to shortage of foreign reserves, trade and industrial policies were dominated by an overwhelming concern for the likely impact of such policies on the balance of payments. Not surprisingly, effective protection rates for domestic production were much higher than for export production. This apart, domestic production was also protected by severe quantitative restrictions on imports. An improvement in the balance of payments in the latter half of the 1970s saw the beginnings of a gradual easing of the trade regime. Export promotion policies took on a new urgency, especially in the 1980s, and were rewarded by a significant increase in the export growth rate in the second half of the decade. Nevertheless, the totality of policies were unlikely to yield a sustained growth of exports, as we shall see below. It is well known that export profitability is a key determinant of export success.3 Inspite of the export promotion drive in the 1980s, profitability in the heavily protected domestic market ' Connmnts on an earlier draft were received from colleagues at a seminar organized at the World Bank in New Delhi in December 1992. These, alongwith very useful commenls and suggestions from Ponab Sen, Fahrettin Yagci. MVansoor Dailami and Helena Tang are gratefully acknowledged. I would also like to thank the participants at the Indian Econometric Society Annual Conference in May 1994 for their comments. I Apart from specifi export promotion resources, there has been. since the mid 19SOs, a steady decline in the REER of the mupee, from 98 in 1985 to 69 in 1990 (1980 = 100). according to one computation by H.K. Pradhan (1992). In another study, G. Pradhan (1991) finds that in a bLge number of products. such as refrigerators, sewing machines, ceiling fans, motor cars and buses, electric lamps, air conditioners, paints and varnishes, woollen yams and leather and coir products, the growth in fob price of exports (unit value of exports) over 1982487 and 1985-87 and 1987-89 exceeded the growth in the domestic price. Thus, we could associate a decline in the REER with increasing export profitability. ' An ICICI (1985) study found, in a survey of 79 Indian companies, that availability of export incentives, recession in the domestic market, and favorable f.o.b. realizations. in that order, were the three most important motivating factors for exports. I  remained significantly higher than profitability in the export market.4 Also, policies were such that export incentives relied primarily on product-specific rebates and import entitlement licenses which were marketable at a premium. Moreover, export promotion policies involved a significant drain on budgetary resources, and were unlikely to be sustainable in a post-reform regime that required severe fiscal tightening. The main objective of the trade and exchange rate policies introduced since July 1991 was to enhance export profitability and eventually eliminate the difference between domestic and export profitability.' Alongwith this, budgetary support to exports was drastically reduced. The emphasis also shifted from product-specific incentives to more generalized incentives based primarily on the exchange rate. The r