**Why Indian Trade Underwhelms

NOVEMBER 22, 2016 

Exports of goods manufactured in India face several obstacles in reaching foreign markets that add to their price and limit their competitiveness. 

Forecast 

India's inadequate infrastructure and nonuniform state-based tax regime adds to the cost of exports, inhibiting their competitiveness. 

Lawmakers have created the Goods and Services Tax as a remedy, but a bold opposition will push against it, making it unlikely to be implemented by the April 1 deadline. 

India's trade negotiation gridlock and inverted tariff structure are additional hindrances to export growth. 

Analysis

The value of India's exports, including goods and services, grew by 9.5 percent in October compared with exports during the same month a year ago. The growth was driven by the increased pace of exports of gems and industrial goods, but the statistic does not capture the bigger picture. Excluding services, the export of goods, which constitutes 62 percent of overall exports, has actually fallen in 18 of the past 21 months. And that is a worrisome trend for India's economy, especially on top of the plummeting value of merchandise exports, which fell 6 percent to $318 billion in 2014 and another 17 percent to $264 billion last year. Reduced global demand for commodities explains part of the drop, but India cannot blame all of its troubles on outside factors. The rupee has strengthened over the past two years, partly because of the falling values of other currencies, which could have hurt exports. But more significantly, manufacturing problems and a complex and inefficient tariff structure have constrained the export market — and look likely to continue doing so well into the future.

Logistics

The first factor to consider when thinking about India's falling exports is the high cost of moving goods to market, which account for nearly 14 percent of gross domestic product. (A recent study concluded that India could save $50 billion annually by bringing its share of logistical costs down to 9 percent of GDP.) This cost adds to the price of Indian exports, undermining their competitiveness.

Contributing to high logistical costs is India's inefficient tax structure. Currently, each Indian state determines its own tax laws. The result is that trucks ferrying goods often spend up to 60 percent of their total travel time stopped at interstate borders to fill out tax compliance paperwork. To solve that problem, Indian lawmakers introduced the Goods and Services Tax (GST) to unify India's states into one national market. Prime Minister Narendra Modi's Bharatiya Janata Party, however, lacks the support needed to pass the bill alone. The party successfully built a coalition to pass a related constitutional amendment, but outrage over Modi's demonetization scheme will likely siphon off the support it needs to pass the remaining legislation required to implement the plan by the April 1, 2017, deadline.

Then there is the issue of India's underdeveloped and poorly maintained transportation infrastructure. Indian Finance Minister Arun Jaitley has estimated that improving the country's infrastructure would require $1.5 trillion over the next decade. This is a price tag impossible for the government to manage alone — the 2016 national budget was only $289 billion — so New Delhi will have to turn to private investment to promote infrastructure development. Attracting investors, however, will be difficult until the country passes reform measures needed to free up land for the projects. In fact, the country has about $120 billion of bad debt, much of it due to failed infrastructure projects. Moreover, India's vast and varied terrain make infrastructure projects a notoriously difficult challenge.

Another contributor to high logistical costs is the outdated technology used at India's ports. Only 126 of India's 344 ports and customs points use an Electronic Data Interchange mechanism to track imports and exports. The rest track them manually, creating up to a monthlong lag in data transmission. To bring India's ports up to speed would require a massive investment. Moreover, the country's infrastructure problems extend to its ports as well. For example, Mumbai's Jawaharlal Nehru Port, the country's largest container port, is in desperate need of a 15-meter (50-foot) dredging operation along its 34-kilometer (21-mile) fairway to accommodate bigger ships. Until that project is completed, ships will continue to offload their cargo onto smaller ships at other ports before it can reach Mumbai, a process that adds to delays and costs. Since the government lacks the funding necessary to upgrade the port, its operator — Jawaharlal Nehru Port Trust — has requested that the government allow it to raise tariffs to finance the expansion. It is unclear, however, when this clearance will be granted.

Tariffs and Free Trade

India's inverted tariff structure also hurts its export market. Typically, a manufacturing-based economy applies low tariffs on commodities it wants to import — for example, cotton. Then the country uses the commodity to manufacture a good — say, a T-shirt — for both domestic and export markets. To support that manufacturing and promote the sale of that manufactured good domestically, countries normally impose tariffs on imports of similar items. A country's tariff structure is said to be inverted when the duties it imposes on commodities imports are higher than those it puts on imports of finished goods. This can discourage consumers from buying domestically manufactured goods in favor of cheaper exported goods, thus limiting employment. This inversion has hurt India's manufacturing sector, but it, too, will be difficult to correct.

Free trade agreements are one cause of inverted tariff structures, and India must negotiate harder if it hopes to avoid adding to its tariff imbalance. That, of course, is easier said than done. India has been in negotiations with the European Union — its largest trading partner — since 2007, but despite holding 16 rounds of negotiations over nine years, an agreement remains elusive. India has chosen to focus on its services sector during negotiations, asking for the free movement of its information and technology professionals across Europe. But this clashes with rising nationalism in Europe, most definitively seen with the United Kingdom's decision to leave the European Union. In short, unless India can negotiate better free trade deals, the agreements may end up doing more harm than good. In the meantime, exports will continue to suffer because of the tariff imbalance, inadequate infrastructure and an uneven tax structure — all of which will be difficult to remedy amid a discordant parliament.