WITH the rapid thawing of India-Pakistan relations, it is possible that before too long India could become Pakistan’s largest trading partner.
As the gravity model of trade holds, distance and size of the trading partners should determine their share in total trade.
In Pakistan’s case, therefore, China and India should figure more prominently as trading partners rather than the United States and Europe. Once that occurs, this change will have profound consequences for the structure of Pakistan’s economy.
As Pakistan develops close trading relations with India, the country’s policymakers must keep a watch on what New Delhi is doing on the international trade arena. In this context some of the recent moves by the Indians will affect Pakistan.
The Indian economy is different from that of the other high-performing Asian economies. For China, as well as the smaller economies of South Korea, Taiwan and Singapore, huge foreign exchange reserves have been built up because of large trade surpluses.
While the Chinese current account surplus has begun to decline, slowing down the pace of building up of foreign exchange reserves, it is not a source of concern for its policymakers. In 2012, the current account surplus is expected to be three per cent of GDP. It was as high as 10 per cent in 2007. Beijing’s central bank has amassed $3.3 trillion in foreign exchange reserves over the past decade. But in the last one year its stock of reserves has increased by just seven per cent well below the annual 25 per cent in the preceding nine years.
However, the Indian situation is very different. It too has built a huge foreign exchange reserve estimated at $300 billion but that is the result not of trade surpluses as is the case with the East Asian economies. It is the consequence of large inflows of foreign capital. Foreign capital flowed in for investment and for the acquisition of stakes in the companies listed on the domestic stock exchanges.
The large Indian diasporas, impressed by the performance of their homeland’s economy, were an important source of foreign capital flows as were many big Western corporations. But some of the lustre that attracted foreign capital to India has worn off. The growth rate of the economy has declined by nearly three percentage points from those recorded in the late 2000s.
In the budget for the year 2010-11, a very confident Pranab Mukherjee, the finance minister, predicted that his country was on threshold of achieving double digit growth rates that would be sustained over many years. That dream was not realised partly because of the loss of confidence on the part of foreign investors in India’s immediate economic future.
The ruling coalition in New Delhi has not been able to introduce some of the reforms that were expected by the international markets. Two of these were of particular interest to them. One, the opening of India’s large retail sector to foreign investment.
In late 2011, New Delhi announced that foreign investment in retail trade would be allowed. This decision was received with great enthusiasm by large corporations such as Walmart and Carrefour who were keen to invest in India’s large retail market. However, the owners of small stores all over the country, fearing that the arrival of large retail firms would hurt their businesses, campaigned hard against the new policy. The government of Prime Minister Manmohan Singh was unable to resist this pressure and changed its position.
The second policy area that is hurting the country and also damaging its export prospects concerns the constraints imposed by the state governments on new investments. State capitals are resisting investments that eat up scarce agricultural land. The restive populations in the country’s forest belt led by Maoists are not prepared to allow mining companies that would have displaced them. This area is rich with mineral deposits and their exploitation would help the country’s foreign account. India, for example, is a major exporter of minerals to China.
Partly because of these developments, the country’s current account deficit increased to $13.4 billion in April as against $8.9 billion last year. Exports grew 3.2 per cent to $24.5 billion from a year ago while imports rose 3.8 per cent to $37.9 billion. Current account deficit is estimated to be $74 billion in the financial year starting April 1. This will be four per cent of gross domestic product. The government’s target for exports in 2012-13 is $300 billion.
The government is taking steps to narrow the trade deficit. It is bringing back some of the incentives that brought some positive results in 2011-12.
It plans to reintroduce and expand subsidies for textile and engineering goods exports, while the ban on the export of cotton and rice havebeen lifted. An effort will be made to divert textile exports from Europe to the Asian and other emerging markets, including, presumably, Pakistan.
At present 40 per cent of the country’s textile exports go to Europe. The government is working with the industry to reduce the share to 25 per cent.
The sharp weakening of the Indian rupee will also make its exports more competitive. The rupee has declined by almost 20 per cent in one year and touched its lowest point on May 9. This decline while welcomed by the traders is worrying the government because of its impact on inflation. To counter the declining trend, the Reserve Bank of India on May 10 ordered exporters to convert half of their income from foreign currencies to rupees. This will increase the demand for the domestic currency and increase its value.
These changes could subsidise exports to the tune of $372 million, similar to a package introduced last year but phased out at the end of March. According to a senior government official, “we have not finalised the exact measures that we are going to introduce but we will give subsidies to make exports a little more attractive abroad.”
The implication of these policy measures is clear for Pakistan as it prepares to open its economy to Indian imports. Even at this time of constrained imports, there is a large trade imbalance in favour of India.
This is likely to increase with the adoption by New Delhi of export promoting measures particularly in the sectors of interest to Pakistan.
Textiles is one of them. Therefore, in addition to worrying about India’s non-tariff barriers that will inhibit Pakistan’s exports to its neighbour, policymakers in Islamabad should be well-versed with India’s trade policy when taking part in the on-going dialogue.