Foreign Trade Of India: Trade, Policies And Impact

This paper aims to evaluate foreign trade of India focusing only on the period after its independence. The focus is on the character and structure of the Indian economy and the policy decisions of the government that led to the remarkable change in foreign trade in India. The paper delves into the development and growth theories that influenced India’s policy decisions. It also looks into how India’s growth pattern confirms to a number of developmental theories and how it’s different from the others. The benefits and costs of India’s accelerated growth are discussed.

II. Introduction

When a population of over 1 billion people backs the 4th largest economy with the 2nd fastest growth rate in the world, you get a country that you just cannot ignore. India, now being touted as the new Asian tiger, can be said to be one of the most promising developing countries in the world. India’s economy has taken great strides since independence. However, India is still a low income country with a PC GDP of a mere $3700 (CIA Factbook). Its journey of experimenting with socialist policies to the recent opening up of the economy and its remarkable effects makes it an interesting case study. However, India has been particularly cautious of globalization. This has led to the befitting title “reluctant tiger [1] “.

In the 1990’s, India was forced by a BOP crisis to implement a slew of privatization, liberalization and globalization reforms. Thus, India deviated from its earlier socialist type mixed economy. As India employed the “pro-business” economic reforms, economic growth accelerated. The campaign of “India shining” epitomizes the convenience with which many brush aside the cost of this accelerated growth. In reality, India is not shining for all Indians. The distributional impacts of this uneven growth are widening the urban-rural divide. Despite the efforts of the government the inequality, especially regional inequality, is rising. Improving infrastructure can be one of the methods by which India makes its growth more inclusive of the poor.

III. Change in Foreign Trade

In 1947, after almost 200 years under the British rule, India was still reeling from the aftermath of the independence struggle and the partition. The government tried to protect India’s fledging economy by adopting a protectionist stand. It opted for a centrally planned economy with five year plans responsible for steering the economy. Though India has a mixed economy which involves both the private and the public sector, the public sector played an especially important role until before the 1990s.

Excluding 1963 [2] , export of goods and services as a percentage of GDP (see Table 6) was a constant 4% for more than a decade starting 1961 to 1973.This was because India’s exports comprised mainly of primary commodities like tea, cotton and jute, the demand for which is inelastic. Imports, however, consisted of machinery and raw materials required for industrialization. During the same period, import of goods and services (see Table 6) gradually decreased from 7% to 4% of the GDP. From 1973 to 1979, exports began to pick up and exports and imports formed roughly the same percentage of the GDP. In the 1980s, the exports again fell below the imports and this trend continued till 1990.

Though the current account balance (see Table 4) was always negative till 2000, it hit a low of -2.6 in 1989. The situation worsened to such an extent that the India had to borrow just to make its interest payments, thus entering into a vicious debt cycle. Moreover, the foreign exchange reserve (see Graph 1) during this period was very low, thus, creating problems for imports. India was forced to gradually open up its economy and lower the trade barriers.

Since 1991, the value of India’s international trade has become more broad-based and total external trade (see graph 3) has increased. Exports have increased from US $18 billion to US $ 125 billion. In the same period imports too have increased from US $ 24 billion to US $ 181 billion. Since liberalization, the value of India’s international trade has become more broad-based. These changes have been brought about by various factors.

IV. Factors that brought about a change in foreign trade

The growth in total external trade can be attributed to both internal growth and the opening up of the economy. From the time of independence to 1991, India aimed to achieve self reliance. “Average tariffs exceeded 200 percent, quantitative restrictions on imports were extensive, and there were stringent restrictions on foreign investment” (World Bank). Its policy included central planning, industrialization, creating a large public sector and regulation of businesses, financial markets and the labor market.

The government laid out the targets and goals in the five year plans and annual plans. The first five year plan was launched in 1951 and currently the 11th five year plan is underway. The plans helped in making India self-sufficient in food, facilitating industrialization etc. Since, the government did not consider the private sector to be ready to invest in certain businesses, it played the demiurge function. In addition to controlling sectors of strategic importance, the state invested heavily into industries that required huge amounts of initial investment and have a long gestation period. However, corruption and excessive red tape made these Public Sector Units inefficient.

Lewis’s surplus labor model is also applicable to India. At the time of independence, agriculture and allied sectors provided well over 70% of the total employment and contributed for more than 50% of the GDP. In reality, much of the labor force in the agricultural sector was underemployed. Moreover, India was dualistic. The economy and had a “traditional, low-productivity rural and predominantly agricultural sector, where the great bulk of the population worked and produced what it consumed”(Cypher and Dietz). Subsistence farming was very common in rural India. There also existed a “modern capitalist sector, where production was more technologically driven” (Cypher and Dietz). Then, a gradual process of labor transfer started. Labor moved from the agricultural sector of rural areas to the manufacturing sector in urban and industrial areas. As Lewis predicted, productivity in the agricultural sector increased. Simultaneously, employment in the industry rose along with total national output. Even in 2003, the agricultural sector employed about 60% of the labor force (CIA Factbook). However, as India undergoes this structural change from agricultural to manufacturing sector, the service industry is also growing rapidly. This is because of the Information Technology (IT) revolution.

The human capital theory emphasizes on building human capital by investing in health and education of the public. India set up 7 IITs (Indian Institutes of Technology) which are engineering and technology oriented institutes of higher education. In 2000, India also passed the Informational Technology Act. These measures spurred the IT boom. Ayres too advocated expanding educational opportunities for the society to promote economic and social progress.

Following the macroeconomic crisis in the late 1980s, India launched a series of policy measures as a part of the structural adjustment program. The Anderson Memorandum titled “Trade Reforms in India” (Nov. 30, 1990) was submitted to Government of India by the World Bank. The document included measures like opening up more areas for private, domestic and foreign investment, closing sick public sector units, reforming the financial sector by allowing in private banks, cutting social sector spending to reduce fiscal deficit, amending existing laws and regulations to support reforms, and liberalizing the banking system. It also recommended tax reforms leading to greater share of indirect taxes, a new Industrial Policy allowing more foreign investments, part disinvestment of government equity in profitable public sector enterprises, a market-friendly approach and less government intervention and most importantly a liberal import and export policy.

India’s industrial policy has undergone radical changes since 1991. Removal of entry barriers for private investment through de-reservation of industries meant for Public Sector, de-licensing of industries for private investments, repeal of Foreign Exchange Regulation Act (FERA) and allowing Foreign Direct Investment (FDI) into various sectors of Indian economy, removal of asset size restrictions by amendment of Monopolies and Restrictive Trade Practices (MRTP) Act, dilution of protection to Small Scale Industry (SSI) are the hall marks of India’s industrial policy liberalization since 1991.

“Although India has steadily opened up its economy, its tariffs continue to be high when compared with other countries, and its investment norms are still restrictive. This leads some to see India as a ‘rapid globalizer’ while others still see it as a ‘highly protectionist’ economy” (World Bank). However, according to World Development Indicators, India’s global integration is greater than that of USA and Japan (see table 8).

Foreign aid was another important factor affecting India’s growth. Aid and foreign assistance were instrumental in bringing about the very successful Green Revolution. “India began its own Green Revolution program of plant breeding, irrigation development, and financing of agrochemicals” (CGIAR). The productivity of agriculture improved drastically as farmers now had access to better seeds and advanced methods. The white revolution (milk) tried to replicate the success, but it was relatively less successful.

Lastly to boost exports, India has set up Special Economic Zones (SEZs).” With a view to overcome the shortcomings experienced on account of the multiplicity of controls and clearances; absence of world-class infrastructure, and an unstable fiscal regime and with a view to attract larger foreign investments in India, the Special Economic Zones (SEZs) Policy was announced in April 2000″ (Ministry of Commerce and Industry). A SEZ is deemed to be foreign territory for the purposes of trade operations, duties and tariffs.

Thus, the following were the factors which led to the changes in the Indian economy and consequently its foreign trade statistics. Firstly, the shift from the socialist inspired protectionist stand to open market type mixed economy. Secondly, India successfully invested into human capital. Thirdly, India removed many tariff and non-tariff barriers and lowered the import taxes. Fourthly, aid and foreign assistance have helped domestic sectors and industries capable of exporting goods. Lastly, SEZs have been established to help both domestic and foreign trade.

V. Benefits and Costs

The benefits of India’s growth are obvious. Consumers have a lot more choice, the standard of living has improved and India is enjoying a period of unprecedented growth. India’s growth rate has gone from being derisively called the “Hindu rate of growth [3] ” to the being wowed for being the “2nd fastest growth rate in the world”. For the past four fiscal years, real GDP has risen at over 8.5 percent per year, making India one of the world’s fastest growing economies. Yet, India still has the largest concentration of poor people in the world.

The disadvantages of Lewis’s surplus labor model played out in India too. A significant share of the rising income went to the capitalists, who reinvested it to make further profits. At first the government was unconcerned about the unequal distribution of income. It believed that the “trickle down” theory would help in gradually redistributing income. Year after year of unimproved poverty statistics finally convinced the government to abandon the wait for the “trickle down” to occur. The government started Poverty Alleviation Programs (PAPs) and also employment guarantee programs. Many of the employment programs focused on creating social infrastructure. “Decisive reforms are required to ensure continuing economic growth, yet the ability of the government to pass and sustain reform momentum depends on popular support. If large parts of the populations are left behind, even if only in relative terms, the viability of future reforms may be threatened”(Topalova). Thus, having an inclusive growth was of utmost importance. Thus the government aimed at “Achieving a growth process in which people in different walks in life….. feel that they too benefit significantly from the process” (Ahluwalia).

“All measures point to a significant increase in overall inequality in the 1990s, particularly in urban areas, and within all but one state (in Bihar inequality remained flat). While inequality was stable (in urban India) and declining (in rural India) in the 1980s, this trend was reversed sin the 1990s” (Topalova). The government has attempted to reduce this regional inequality by providing incentives to set up industries in the backward regions. However, even industrial townships like Bhilai, with industries with strong industrial linkages like steel, have failed to modernize neighboring areas.

One of the major causes behind this uneven distribution of income is infrastructure. India’s infrastructure is abysmally poor. Investing a greater part of the GDP on creating infrastructure would lessen the problem of regional inequality and also significantly increase the GDP.

India’s focus on higher education backfired when it caused a problem of brain drain. Individuals whose higher education was subsidized by the government were leaving India in droves in search of better job opportunities abroad. In such cases, the government needs to put in equal effort in creating jobs commensurate to the skills of the labor force.

VI. Conclusion

To bring it all together, the Indian has enormous potential. According to Goldman Sachs, “India is to become the world’s 2nd largest economy by 2050”. Though its potential for growth is unquestionable, the distribution of income depends on the future policies of the government. I look forward to the day when the Indian tiger roars with the strength of a billion people behind it.

IV. References

Ahluwalia, M., 2002. “State-Level Performance under Economic Reforms,” in Economic Policy Reforms and the Indian Economy, ed. Anne Krueger. New Delhi: Oxford University Press.

CIA Factbook

Consultative Group on International Agricultural research (CGIAR). January 23, 2007. “Rice research hub for Greater Mekong Sub-region opens in Laos: cooperation is key in Southeast Asia’s most important rice bowl”.

Cypher, James M. and James L. Dietz, 2006. “Developmentalist theories of economic development”, The Process of Economic Development (2nd Ed), New York: Routledge. Pg 142.

Directorate General of Commercial Intelligence and Statistics (DGCI&S), Ministry of Commerce, Government of India.

International Monetary Fund Database

Ministry of Commerce and Industry, Department of Commerce. Last updated: May 2008. “Special Economic Zones in India”. < http://go.worldbank.org/RJEB2JGTC0>

Planning Commission, Government of India

Reserve Bank of India, Handbook of Statistics on Indian Economy

The World Bank and India, Chapter 10 ” The Bank and Structural Adjustment” [www.ieo.org/world-c10-p1.html]

Topalova, Petia. March 2008 “India: Is the Rising Tide Lifting All Boats?”, IMF working paper.

World Bank Organization. “India: Foreign Trade Policy”.

World Development Online, The World Bank Group