As the Narendra Modi-led government prepares to announce its last full budget on February 1, there has been speculation about its fiscal priorities.
A few pointers on public finance are significant. Disinvestment targets have not been met for successive years now while the Centre’s debt-to-gross domestic product levels have increased. The trade deficit – the difference between exports and imports – has been high and domestic private investment has remained low. State finances have also been in poor shape.
Alongside this, India is also facing one of its worst unemployment crises. Tension on the country’s eastern border with China may prompt the government to consider increased military expenditure when it announces the budget for the financial year 2023-’24.
Past budgets
In the past two budgets, there has been a fall in revenue-based expenditure on schemes like the rural employment guarantee programme. But the government’s pro-growth vision has meant a steep rise in capital expenditure-based funding to develop infrastructural capacity and increased logistical connectivity. Capital expenditure refers to expenses made for the purchase of long-term assets such as land and heavy equipment.
At the same time, the Centre has focused on improving private investment through the Production-Linked Incentive scheme, the National Infrastructure Pipeline and other initiatives, which have had mixed results.
In line with this, a Reuters poll of economists in December said that fiscal consolidation – policies to reduce government debt – may lead the Centre to avoid a spending spree, whether capital or revenue-based.
The government may also want to stabilise its own financial position for the electoral spending outlay it might present during the partial budget session in 2024 when general elections are due, which would require its fiscal deficit in the financial year 2023-’24 to be reduced.
The government must aim to prioritise its fiscal policy direction this year by driving better export-linked incentives to maximise India’s trade-to-GDP ratio (as seen in figure one below), which has grown significantly over several years.
The trade-to-GDP ratio, according to the World Bank, is the sum of exports and imports of goods and services measured as a share of gross domestic product. It measures the importance of international transactions relative to domestic transactions, according to the Organisation for Economic Cooperation and Development.
India’s overall trade-to-GDP ratio has steadily increased, particularly from the area of services over the past few years, which is promising. At the same time, a significant amount of the domestic production of goods and commodities has been increasingly linked to import dependence on goods and energy from other nations, including a high merchandise import dependence on China.
India’s trade basket
The InfoSphere research team at the Centre for New Economic Studies under the OP Jindal Global University studied India’s commodity services-based export-import levels.
The analysis was aimed at understanding how the potential for export-driven growth could be maximised, especially in the service sector where India’s current comparative advantage is clear, from the point of view of cost competitiveness and skill premium. The service sector, or the tertiary sector of the economy, produces services.
Exports
India’s major export revenue in commodities comes from a diverse range of petroleum, metals and engineering products. The countries that India exports the most to are the United States – in services – and China. In the service sector, India has done well over the past few decades, particularly in information communication technology, travel, financial, banking, insurance, tertiary health services and others.
Considering the economic position of India and other like-minded developing countries, as was done by the Economic Complexity Index, only China and Thailand fare better than India.
The Economic Complexity Index includes parameters such as income inequality and greenhouse emissions, along with observed economic growth, to provide a more rounded measure of a country’s economy. Like-minded developing countries is a phrase used to refer to negotiating blocs of countries.
Slowly but steadily, India’s overall economic performance may have improved, though growth has been low. But India’s export performance reflects an asymmetric outlook when merchandise goods’ exports are compared with service-based exports.
A slowdown in goods-based export growth witnessed in the September quarter of the 2022-’23 fiscal year is related to the country’s stagnating manufacturing growth. India’s manufacturing growth problem has long been a challenge.
Based on an analysis by the InfoSphere team, a 1% increase in metal exports alone would increase India’s gross domestic product by 0.43%. For paper-based goods exports, the increase in the GDP would be by 0.66%.
More trade in commodities is good for growth and worker-supported manufacturing activity for employment opportunities.
The service sector, however, is where India’s actual competitive advantage lies, as seen in Figure two. India’s overall share of service-based exports increased from 3.5% in 2019 to 4.1% in 2020, according to data gathered by the InfoSphere team. One of the major reasons has been the information communication technology revolution since the mid-1990s that enabled the rapid growth of technology and logistics for fast communication.
Though investments by multi-national companies allowed information communication technology to grow and export more from an urban-biased growth model, other services such as travel and macro-finance either decreased, or remained stagnant.
From a human capital perspective, an increase in service-based exports has played a pivotal role in creating better-paid employment contracts, meeting the job aspirations of an educated class (35% of organised employment is created by the services sector), and generating more foreign direct investments (see figure below for the spike seen in foreign direct investment levels in the services sector from 2003-’04).
The service sector is now a little over one-third of all exports while employment in the service sector has increased by 15 percentage points in the last three decades.
The Union Finance Ministry may do well to understand the impact of this trend better, looking at the effect of increased employment in services on the overall national income. Gross national income, according to Investopedia, refers to the total amount of money earned by a country’s people and businesses.
Figure five plots the relationship between the gross national income per capita of India and the employment rate in the service sector. The line reflects a positive relationship between the two variables, which means that as the employment rate increases, the gross national income per capita also increases alongside.
Results from the team’s analysis further suggest that a 1% increase in employment rate leads to an increase in gross national income per capita by approximately $195 – in purchasing power parity.
Imports
India’s dependence on the import of crude oil and precious stones has often led to a large current account deficit (and trade imbalance).
Imports were increasing steadily till 2012, after which they have seen a gradual decline. To understand this better, the imports of specific goods need to be considered.
What kind of a policy shift, backed by the fiscal priorities of the Union Finance Ministry, will aid a more dominant position for India’s export-linked trade policy?
Growth and export-performance growth depend on three factors. First, the nature and extent of diversification across destinations, products, technology, and services. Second, the composition of an export basket, measured by overall technological content, quality and sophistication. Third, the complexity of export baskets given the disintegrated nature of supply chains.
The economic complexity of exported goods has been stagnant for more than a few years now. To improve it, India needs to focus on further increasing its exporting capacity, like it did in the pharmaceutical sector with the export of generic medication, and in the case of automotive manufacturing parts.
India’s growth source has been anchored by the rise of its service sector – from exports or in terms of generating better employment. Greater emphasis on service-based exports is a good step towards aligning India’s competitive advantage to become a comparative advantage in trade as well.
To help realise this, the Union Budget, in its outlay for plans and schemes, could consider a positive step in this direction, not only for information communication technology but other key service-based areas such as education, healthcare, outsourcing-based service delivery products, travel, finance and more.
Deepanshu Mohan is associate professor of economics and director, Centre for New Economics Studies, Jindal School of Liberal Arts and Humanities, OP Jindal Global University. Aniruddh Bhaskaran, Hemang Sharma, Soumya Marri, Malhaar Kasodekar, Bilquis Calcuttawala, are members of the CNES InfoSphere team and work as research analysts at the Centre for New Economics Studies.
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