India escaped the direct adverse impact of the Great Recession of 2008-09, since its financial sector, particularly its banking, is very weakly integrated with global markets and practically unexposed to mortgage-backed securities.1 However, India’s “real economy” is increasingly integrated into global trade and capital flows. It thus did suffer “second round” effects when the financial meltdown morphed into a worldwide economic downturn.
As seen in Figure 1, Indian exports fell in line with global trade flows. This should firmly dismiss the decoupling myth for the Indian economy. Collapsing foreign trade, capital flows, and exchange rate movements all transmitted negative impacts to the Indian economy
Figure 1 Exports, India and the world
The synchronised trade collapse in the aftermath of the current recession has been steeper than overall economic activity and more severe than during the Great Depression. This is surely the result of a higher trade intensity of global GDP, which raised the rate of global growth during the past three to four decades.
In this respect, globalisation, of which the rising trade intensity is one of the features, has emerged as a double-edged sword and in the words of Paul Krugman “world trade acted as a transmission mechanism,” spreading economic distress “even to those countries that had relatively healthy financial systems” (WSJ 2009). The Frankel and Rose (1998) hypothesis – that tighter trade links leads to higher business cycle correlation – has been forcefully demonstrated. The contraction in world trade between July 2008 and February 2009 has been estimated around 42% in nominal terms.
What caused the trade collapse
A plausible explanation for the severe contraction in global trade during the Great Recession can be the increased income elasticity of world trade which has risen from around 2 in the 1960’s to around 4 in 2008 (Freund 2009).2 This increased elasticity of world trade is due to the emergence of cross-border production and supply networks. Economies are increasingly characterised by vertical specialisation and this has resulted in a major expansion of intra-industry trade, thereby amplifying contagion during the crisis.
Trade finance is the other major factor that has been proposed. Some estimates say that trade finance contributes to 80% of trade flows and hence it has contributed to around 10% to 15% fall in world trade (Auboin 2009).
Other factors through which exporters were hit hard were the sharp reduction in the prices of the major traded commodities. As Figure 2 shows, world commodity prices crashed between August 2008 to February by an average of 49%.3 Thus, the decline in world trade was a combined effect of both volume and price decline.
Figure 2 Commodity prices plummeted
Source: WEO, IMF (2009).
The Indian trade collapse
As Figure 3 demonstrates, Indian exports and imports fell in line with global trade flows. In terms of year on year growth rates, the export contraction started from October 2008; imports started contracting a little later, from December 2008. During the core period of the crisis, the average contraction in exports and imports has been around 20% in the first phase (October 2008-September 2009) and 28% in the second (December 2008-September 2009).
Figure 3 Indian trade, yearly growth rates, month-on-month
Source: Ministry of Commerce and Industry.
The trade collapse triggered by this global crisis is more severe than previous major episodes such as the ‘balance of payment’ crisis (1991), the Asian crisis (1997), and the ‘dot com’ bust (2000-01). This point is illustrated in Figure 4.
The 1991 Balance of Payment crisis, saw a sharp contraction in imports primarily due to the sudden spike in the value of petroleum imports with imports plummeting by 38% (November 1991). This was fortunately not accompanied by a decline in exports, which benefited from the marked rupee devaluation of July 1991.
Figure 4 Past crises and Indian trade trends (growth rates, %)
Note: Month on month growth rates.
Source: Reserve Bank of India.
Before the crisis, India’s exports and imports (from September 2003 to August 2008) had been growing robustly at 28% and 35% respectively. The slowdown in India’s trade flows, however, started even prior to the post-Lehman crisis as is reflected in the de-seasonalised month-on-month trade data. Exports had begun to decline from June 2008 when they went down by 13% and import contraction started in September 2008 when they contracted by 83% on a month-to-month basis.
This was surely the consequence of a policy-induced economic slowdown. Driven by inflationary concerns, the RBI pushed up interest rates until August 2008. On a year-on-year basis, exports started contracting from October 2008 (12%) whereas the import contraction started a little later from December 2008 (8%). These initial declines were pushed to the subsequent collapse by the global economic crisis.
India’s merchandise exports
The traditional export destinations for India have been Asia, EU and North America. Within Asia, ASEAN is the largest export destination (52%) followed by the EU27(21%), and the US (13%). The US’s share, however, has recently fallen to 11% (March 2009), even lower than that of the United Arab Emirates (13%). This sudden decrease can be considered an aftermath of the financial crisis.
Figure 5 Major export destinations of India (share of total exports, %)
Source: DGFT, Ministry of Commerce and Industry.
One of the core reasons for the sharp fall in India’s exports is the high income demand elasticity for exports which makes exports highly sensitive to GDP movements. India’s exports have been found to be more sensitive to income than to price changes.
The income elasticity of demand for India’s exports has been found to be highest for the US (2.5) while, for India’s global exports, it is estimated at about 1.9 (UNCTAD 2009). This is consistent with the fall in the US’ share in total Indian exports from 2008-09.
Figure 6 Major export commodities (growth rates, month-on-month)
Source: DGFT, Ministry of Commerce and Industry.
All of these products (except gems and jewellery) experienced a major contraction during the post-Lehman period. Petroleum and petroleum products saw the largest contraction (about 45%), but agriculture and allied products contracted by 28%, chemical and related products by 9%, textiles by only 2%, and engineering goods exports, which account for 22% of India’s exports, actually grew robustly at first, becoming negative only February 2009.
The export slowdown in India has been a demand-side phenomenon. Petroleum exports which registered the biggest decline have the highest income (5.4) and price elasticity (-1.3) in India’s export basket (UNCTAD 2009).4 Petroleum exports also have the highest price elasticity in the export basket.
Imports of goods and services
Crude oil, petroleum and petroleum products constitute the largest share (32%) of India’s imports. India is structurally deficit in terms of domestic availability of crude oil, having to import nearly half of its requirements. Over the years, however, Indian corporate giants like Reliance, Essar, and the Indian Oil Corporation have established globally competitive refining capacities. These are presently in excess of the country’s requirements so they import crude and export refined products. The expansion of this processing activity has contributed to the rather sharp increase in the share of crude oil and petroleum products in recent years.
India’s oil imports which had been growing robustly at around 40% (2007-08) saw a decline in growth of about 17% during 2008-09. India’s merchandise imports started contracting from November 2008 onwards on a year on year basis along with oil imports whereas the contraction in non-oil imports started from January 2009. During the period from October 2008–September 2009, imports have contracted more (22%) than exports (20%).
Figure 7 Oil and non-oil imports growth rates
Source: Reserve Bank of India.
Trade in services
India is a major services exporting country with about 3% of the world total service exports. India’s exports of services are mainly to the EU and the US. The latter alone accounting for around 11% of India’s total services exports.
Services exports have not been as affected as exports of merchandise. The sub-sectors within services exports that have registered some contraction are travel, insurance, business and communication services. Software services exports, which are for some reason classified under miscellaneous receipts for India have been a major contributor to the growth of services exports, accounting for as much as 45% of total exports, goods and services combined (2007-08). However the intensity of the adverse impact of the global economic downturn on India’s exports is perhaps best demonstrated by noting that even India’s software exports recorded a contraction in the fourth quarter of 2008-09 by more than 15%. While the actual decline was confined to only a single quarter, the growth of software exports in 2008-09 has been far from the levels achieved in the years preceding the global crisis.
During the crisis most businesses cut costs to cope with the declining revenues. This in turn meant a reduction in IT spending by advanced economies and a negative impact for the growth of Indian software exports. The financial crisis reflected in the slowdown of foreign business visitors and brought down foreign travel receipts by 4% (2008-09). As a related incidence, business and communication services also experienced contraction of 3% and 10% respectively.
Figure 8 Quarterly growth rates, total services, and software service exports
In terms of imports of services software, miscellaneous, business and financial services were adversely affected suffering a decline of 10% and 8% respectively in 2008-09.
While India’s services exports have not been as adversely impacted as merchandise trade, an increasing number of legislative measures and restrictive conditions included in the stimulus packages of the US, the UK, etc. may aggravate the negative impact in the coming period. In the context the agreement at the successive G20 summits to prevent any move towards competitive protectionism is of major importance.
The Indian policy response to the plummeting of its exports has been principally to provide fiscal incentives in the form of reduced import duties on imports needed for exports and raising the rates of duty drawback available to exporters. In addition, exporters have been givena 2% interest rate subsidy on the refinancing of trade finance as well as for their working capital requirements. This may have helped in the slight recovery that is now being seen in the month on month de-seasonalised data. However, the refinance facility has been recently withdrawn and could affect the export effort.
Conclusion: Strengthening the green shoot of recovery
Recent data points to an incipient recovery in India’s exports, perhaps in line with the fragile beginning of a recovery in global trade (Eichengreen and Rourke, 2009). The de-seasonalised month-on-month export data (Figure 9) shows that the recovery seems to have started in April 2009 with exports registering a month on month growth of around 59% from April to August 2009.
The import data is not less encouraging. Further evidence of a recovery in India comes from the growth in industrial sector output, which has seen a year-on-year growth of above 7% from June to September 2009. However, as the rather weak import data reveal, and given that exports in August 2009 were still lower than in the same month in 2008, it is clear that the recovery is still weak. Urgent and concerted policy attention is necessary to take exports back to their pre-crisis robust growth trajectory.
Figure 9 Trade since 2007, seasonally adjusted
Source: Ministry of Commerce and Industry.
These policy efforts would have to go significantly beyond the rather ad hoc and sporadic fiscal incentives that are regularly doled out to exporters in times of export downturn.
There is sufficient evidence that these fiscal incentives have high transactions costs and are often not availed of by the exporters. For example, a recent survey (Srinivasan and Archana 2009) showed that up to 30% of exporters do not avail of their duty drawback entitlements and nearly 70% reported the incidence of transactions costs in availing of these incentives. Moreover, the inherent uncertainty in the continuity of these fiscal measures does not provide the necessary basis for exporters to plan their production capacities and marketing expenditures on a sustained basis.
Given that the coming period is most likely to see a relatively weak recovery of global trade, India will have to try and achieve a robust growth in its exports by expanding its share in major markets rather than simply depend on the previous growth of global trade. This will require a major overhaul of the country’s export promotion mechanisms. The focus should shift to addressing the binding constraints currently imposed by physical infrastructure, skill shortages, procedural complexities and inadequate access to commercial bank credit especially for the small and medium exporters.
2 She also found comparing four earlier large recessions (1975, 1982, 1991 and 2001) that real trade growth had declined by five times as compared to the drop in real income growth.
3 Taking an average of energy, food and metal it was found that between August 2008 to February 2009 they fell by 64, 31 and 51%respectively.
4 In terms of volume, petroleum exports contracted by 10% as compared to the robust growth of 21% last year (2007-08) where in terms of prices it contracted by around 5%(2008-09) as compared to previous years huge growth of 54% (2007-08).
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