The silver lining in India’s exports basket

The enduring silver lining in India’s exports picture, though, has really been on the services side. In August, services exports grew about 7% in year-on-year terms to $30.7 billion. For the first five months of this financial year, they grew around 11%. On current trends, it is possible that services exports will exceed goods exports (which were at $34.7 billion in August) at some point in monthly terms, at least temporarily.

If this happens, it will be the high point of a shift that’s been two decades in the making. Ten years ago, India’s services exports amounted to no more than a third of its total exports. This July, services exports were 47% of the total. According to a study by the central bank, since 1993, services exports have grown at an annual average rate of 14%, compared with around 10.7% for goods exports.

India is now the 7th largest services exporter in the world. In 2001, it was the 24th largest. In contrast, the country’s record in goods exports has been more mixed. In 2005, India accounted for around 1% of the world’s goods exports. In 2023, it had risen, but was still less than 2%. Over the same period, India’s share of world services exports rose from 1.9% to around 4.6%. Goldman Sachs expects India’s services exports to be around $800 billion by 2030, up from $337 billion in 2023, amounting to 11% of India’s GDP.

A joint World Bank-World Trade Organization report points out that the share of the service sector in global GDP rose from 53% in 1970 to 67% in 2021. If India missed the bus on the boom in global goods trade, it is lucky enough to have gotten a second chance with the boom in services trade, and has been able to profit off that to a much greater extent.

India is now the 7th largest services exporter in the world. In 2001, it was the 24th largest. In contrast, the country’s record in goods exports has been more mixed.

Given the optimism surrounding both current trends in services exports, and the likelihood that such trends will persist in the future, what effect will the transformation in India’s export basket have on the domestic economy?

Structural factors

Even beyond the numbers and the growth, services exports have advantages. India runs a surplus in services trade, of $13-14 billion a month. This helps reduce pressure on the current account deficit, which is created by virtue of India importing more goods than it exports.

This deficit has always existed. While it is often attributed to the need for India to import a large chunk of its petroleum requirements, it’s worth pointing out that even after excluding items like petroleum and gems and jewellery from the imports basket, imports still exceed exports by a substantial margin.

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India’s current account deficit is often attributed to the need for India to import a large chunk of its petroleum requirements. (AFP)

In the short term at least, this will likely continue because manufacturers operating under the production-linked incentive (PLI) scheme of the government, intended to promote domestic manufacturing, will still need to import input components from overseas. “Robust growth and stability in services exports have imparted strength to India’s balance of payments (BoP) by offsetting a significant part of the economy’s merchandise trade deficit,” points out a research paper by the Reserve Bank of India on services exports.

The other factor is how services exports respond to shifts in global demand. Exports in general are highly sensitive to the state of the global economy, especially demand conditions prevailing in richer economies.

Estimates last year by the chief economic advisor to the finance ministry found that a one percentage point increase in global GDP leads to a rise of 4.92 percentage points in the overall demand for India’s exports. This upside seems great, but also has a downside. A global economic crisis causing a fall in global GDP can lead to a disproportionately large drop in Indian exports.

Interestingly, as the RBI found in its study, this ‘income elasticity’ is much lower for services exports: around 2.5. In other words, a one percentage point rise or fall in global GDP leads to a 2.5 percentage point rise or fall in Indian services exports (after adjusting for price changes). In other words, services exports respond relatively weakly to increases in global GDP compared to goods exports, but also seem less vulnerable to sharp downturns in the global economy.

This was very much in evidence during the onset of the covid-19 crisis and global lockdowns in early-2020, which caused a collapse in goods exports. In contrast, the decline in services exports was nowhere near as much. Since a large proportion of services exports are delivered digitally, they are less liable to disruption than goods exports, which are more dependent on the vagaries of global logistics, especially at a time when geopolitical tensions can choke global commercial shipping.

Further, points out the RBI study: “Services, especially modern services, use fewer imported inputs, have lower fixed costs of entry and are in highly competitive sectors which allow for an elastic supply response [in response to a reduction in the price].” And the shift to remote work, as the RBI study points out, has been a boon for digitally-delivered services work, rising 37% between 2019 and 2022.

Beyond the back office

As the Goldman Sachs study points out, “When India’s services exports initially began to grow, it was on the back of ‘offshoring’: a cost-saving measure in which global companies outsourced their back-office operations to units in India.”

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India’s services exports initially grew on the back of offshoring. (Bloomberg)

They have evolved to something more. Now called global capability centres (GCCs), such back offices have become more specialized, says the study, and currently employ around 1.7 million employees. The number of such GCCs has risen from 700 to 1,580 over the last 13 years and accounted for $46 billion worth of revenue in 2023.

Both back office and IT services (and the overlap between them) then seem to encapsulate the India service export success. And, going by the numbers, this doesn’t seem to have changed much. As the chart, on the share of professional consulting in India’s services exports, shows, computer services were, and remain, the dominant software export, at around 47% of total service exports.

This, in fact, became a matter of concern to many analysts, who pointed out that such cost-saving services were highly price-sensitive. As the Indian workforce aged and salaries rose, they could easily be outbid by similar businesses in other countries, on cost terms alone, causing the back office to shift elsewhere.

And, as pointed out earlier, while services exports seem less vulnerable to economic downturns, they are far from immune. How price-sensitive, and how sensitive to the global economic context, the IT services market is has been laid bare over the last year. There have been significant layoffs across the IT sector. In 2023-24, according to a Mint report, the three big IT majors—TCS, Wipro and Infosys—together laid off about 64,000 employees.

But the background shift within services exports is a move up the value chain, which is arguably less sensitive to immediate price shifts. The share of professional consulting services in India’s service exports has increased from 7% in 2005 to 18.3% in 2023. As the report by the CEA points out: “While the early 2000s was a period of BPOs mushrooming to provide cost-cutting back-end IT services, India now looks beyond just cost-cutting … India has gone from providing back-end services in law, IT, and management in 2010 to providing upstream, high-value-added services in these areas by 2020.”

Domestic impact

For decades, the growth of services was regarded less than favourably by economists and policymakers. “Many services have long been portrayed as non-tradable activities characterized by low productivity and wages, responding primarily to domestic demand and offering less desirable growth and development paths relative to manufacturing,” pointed out the World Bank-WTO study. “The economic development gains associated with the export-oriented, manufacturing-led development in East Asia reinforced the belief that the pathway to sustained growth for lower-income economies necessarily lay with manufacturing.”

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For decades, export-oriented manufacturing was regarded favourably by economists and policymakers.

However, as the study pointed out, the services sector today generates more jobs (50% share of employment worldwide) and output (67% share of global GDP) than agriculture and industry combined.

But how will the growing importance of services trade shape the Indian economy? “We expect the growth in high-value services to domestically drive top-end discretionary consumption, and commercial and residential real estate demand,” says Santanu Sengupta in the Goldman Sachs research report.

One problem with the growing importance of services exports is how locationally concentrated they are. Large cities or urban centres such as Bengaluru, Hyderabad and Gurugram dominate employment in services exports, even though some of this is beginning to change, with companies more willing to employ workers in smaller cities and towns.

The other, bigger problem though is with how it could reinforce, rather than counter trends already visible in the broader economy.

The big challenge for the Indian economy since at least the 2008 global financial crisis has been jobs. Since 2011-12, GDP growth has simply not generated the same amount of jobs that it did earlier. According to World Bank data, direct and indirect employment created by exports fell to 13% of domestic employment in 2020, from 19% in 2012. “This is because India’s exports have increasingly consisted of skill-intensive manufacturing and services,” says the World Bank. “Because these sectors are highly capital-intensive, they are ill-suited to employ large shares of the Indian workforce.”

One problem with the growing importance of services exports is how locationally concentrated they are. Large cities or urban centres such as Bengaluru, Hyderabad and Gurugram dominate employment in services exports.

The services sectors in which India has had the most success in generating exports—IT services, business consulting etc—are also the same sectors that overwhelmingly employ a much more skilled workforce, which is concentrated in large urban areas. More importantly, this also applies to large organizations in the ‘formal’ sector, because this is where scale makes the supply of such services more efficient. So, in this respect at least, both services and manufacturing exports are similar.

On the one hand, this offers grounds for optimism. Assuming services exports grow at a fast enough pace in the future, we can hope that the demand for skilled employment will generate the supply needed. While the 14%-plus annual growth in services exports over the last few decades has certainly raised employment in the relevant sectors by hundreds of thousands of workers, it has not made a major dent on employment levels in the economy as a whole. The absolute size of services exports will have to be larger by many multiples to be able to do so.

Will services exports continue to grow at the same rate? As pointed out earlier, services now account for 67% of world GDP. While they could grow further, it is much more likely that the demand for cross-border services will track growth in global GDP in future years, rather than exceed it, as has been the case.

The substantial growth in services exports over the last few decades has been a net positive for the Indian economy. But will this growth do for the Indian economy what manufacturing exports have so far failed to do, and what such exports did for East Asia? That is unlikely.

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