Policy Memo: Unschackling India's External Sector

Part I: Introduction

India’s stellar economic growth has led to more than doubling of it’s GDP from $1.7 trillion in 2010 to $ 3.8 trillion in 2024¹. But growth has come without significant structural change as the services, manufacturing and agriculture sectors’ contribution to the economy has remained stagnant at around 55%, 14-15% and 17-18% respectively (Chart1). India’s transition from an agrarian economy remains incomplete with a comparatively dominant services sector and a sluggish industrial base².

Part II: Peer to Peer Comparison

Comparatively, India’s share of global manufacturing value added is less than 1/6th of China’s share and is less than 1/3rd of the US share (Chart 2). While India showed steady growth, increasing from 1.6% to 3.8% - for 138% growth in its share from 2004- 2023, Vietnam has seen more impressive growth despite its smaller size, increasing from 0.3% to 1.3% - which represents 333% growth. As part of ‘China Plus One’ strategy of reducing economic reliance on China, many global firms have diversified production and supply chains into other countries with Vietnam becoming a preferred choice over India³.

India's Export Basket: India’s external sector representing its international trade reflects the structure of its services led economy. It's share in global merchandise exports increased from 1.69% in 2014 to about 1.82% by 2022, but in contrast, India's share in global services exports is more than double, reaching around 4.4% in 2022⁴. This underscores the disparities in competitiveness between India's services and merchandise exports. While comparing India’s exports basket with its peers , share of services is the highest at 45.4% surpassing even the US (Chart 3). Vietnam and China have a more diversified exports basket with electronics, textiles, machinery and chemicals having significant shares. The substantial value addition in these sectors have driven sustained economic growth and structural transformation in both countries⁵.

PartIII: Economic Complexity & Comparative Advantage

While comparative advantage suggests specialization based on current relative productivity, economic complexity emphasizes upgrading and diversification toward more complex products to sustain long-term growth. The integration of these perspectives suggests that countries should not only leverage their current comparative advantages but also strategically invest in capabilities that allow them to move into more complex and competitive sectors. This dynamic approach aligns with Hausmann et al.’s findings that countries with higher economic complexity tend to experience more robust and sustained economic growth, highlighting the importance of embedding capability development into trade and industrial strategies⁶ . Chart 4 shows that complexity is correlated with income. This indicates that wealthier countries tend to have more complex economies, and vice versa.

Part IV: Binding Constraints

a. Managed Exchange Rate

The International Monetary Fund reclassified India's exchange rate regime from a "floating" to a "stabilized" arrangement, due to increased Reserve Bank of India’s interventions to manage the rupee's value⁷ . This has led to a stronger rupee compared to its peers, for example, Brazil’s Real depreciated in 2024 (Chart 5). Therefore, Indian goods are more expensive in international markets and exports less competitive.

b. Protectionism

Tariff and non-tariff barriers aim for protecting domestic producers from international competitors. One problem arises when the import duty levied on intermediate inputs and raw materials exceed the duty on the final product. This is called inverted duty structure and affects approximately 36% of products—spanning textiles, electrical and electronics, chemicals, and metals⁸. These distortions lead to higher input costs for domestic manufacturers, undercutting their competitiveness. Another problem is that import tariffs remain higher in India than its peers along with the lowest percentage of goods imported duty free (Chart 6).

Part V: Protectionism in Two Case Studies

a. Textile manufacturer

Viscose Staple Fiber is a critical input for the synthetic textile industry. While anti-dumping duties were removed in July 2021, followed by an import tariff reduction from 20% to 5%, the subsequent implementation of Quality Control Orders (QCO) caused a sharp decline in imports⁹ (Chart 6). Indian textile manufacturers have struggled to access imported inputs making them less competitive internationally while the apparel industry in Vietnam and Bangladesh have flourished because of its ability to source low-cost imported inputs.

b. Milled Rice Exporter

Despite having surplus rice stocks above buffer norms, to control inflation, India – the world’s largest rice exporter imposed 20% duty on export of milled rice in 2022¹⁰ . This allowed other top exporters like Pakistan and Thailand to increase their exports and corner market share in international rice markets (Chart 8). These export controls were lifted to increase agricultural exports and boost farmers’ income in 2024¹¹ .

Part VI: Recommendations

1. RBI should revert to a ‘floating’ exchange rate regime allowing for a more gradual depreciation of the rupee to enhance export competitiveness.
2. India’s economy transforms during crises. US ‘Liberation Day’ tariff imposed on India at 26% is lower than tariff on peers like China and Vietnam (Chart 9) . This crisis presents the perfect opportunity for executing ‘China Plus One’ strategy. India should dismantle its protectionist regime with reduction in tariffs and rationalization of inverted duty structures for enhancing competitiveness. It should join regional trade agreements like RCEP and CPTPP and finalize Free Trade Agreements with the UK and the EU integrating it with global value chains.

Bibliography

1. IMF. (October 10, 2024). India: Gross domestic product (GDP) in current prices from 1987 to 2029 (in billion U.S. dollars) [Graph]. In Statista. Retrieved April 09, 2025, from https://www-statista-com.lse.idm.oclc.org/statistics/263771/gross-domestic-product-gdp-in-india/
2. Adhikari, Santosh. (2019). Structural Transformation of India: A Quantitative Analysis. The Indian Economic Journal. Indian Economic Association. 66. 50-61.
3. Reuters. "India Should Join China-Backed Asian Trade Bloc, Government Think Tank CEO Says." Reuters, November 7, 2024. https://www.reuters.com/world/india/india-should-join-china-backed-asian-trade-bloc-government-think-tank-ceo-says-2024-11-07/
4. MOSPI. "Share of India's exports in global exports from 2015 to 2022." Chart. June 25, 2024. Statista. Accessed April 10, 2025. https://www-statista-com.lse.idm.oclc.org/statistics/1133079/india-share-in-global-exports/
5.World Bank. Vietnam: Vibrant Growth and Economic Transformation. Washington, DC: World Bank, 2020. https://www.worldbank.org/en/country/vietnam/overview.
6. Hausmann, Ricardo, César A. Hidalgo, Sebastián Bustos, Michele Coscia, Sarah Chung, Juan Jimenez, Alexander Simoes, and Muhammed A. Yildirim (2011). The Atlas of Economic Complexity: Mapping Paths to Prosperity. Cambridge, MA: Harvard University Center for International Development. https://growthlab.hks.harvard.edu/files/growthlab/files/atlas_2013_part1.pdf.
7. IMF. India: 2023 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for India. IMF Country Report No. 2023/426. Washington, D.C.: International Monetary Fund, December 2023. https://www.elibrary.imf.org/view/journals/002/2023/426/article-A002-en.xml.
8. K. Pathania (2021), Empirical Estimates of Inverted Duty Structure and Effective Rate of Protection — The Case of India, in Global Value Chains and the Missing Links, ed. [Editor if available] (Singapore: Springer)
9. Anand, Abhishek (2025). Breaking the Cycle: Reviving Growth amid Structural and Cyclical Challenges. State of the Economy. Madras Institute of Development Studies.
10. Reed, John, and Jyotsna Singh (September 9, 2022) . “India Restricts Rice Exports as Commodity Prices Surge.” Financial Times. https://www.ft.com/content/dcfb0818-b895-4c3e-abdc-6e9f4d90f1fb
11.Schipani, Andres, Susannah Savage, and Humza Jilani. (March 24, 2025 ). “Prices Slide as India Unwinds Ban on Rice Exports.” Financial Times. https://www.ft.com/content/c696580f-26e5-4360-937e-4b8375dc9ad6
12. Hausmann, Ricardo, César A. Hidalgo, Sebastián Bustos, Michele Coscia, Sarah Chung, Juan Jimenez, Alexander Simoes, and Muhammed A. Yildirim (2011) . Economic Complexity Briefing. Cambridge, MA: Harvard University Center for International Development. https://growthlab.hks.harvard.edu/files/growthlab/files/economic_complexity_briefing.pdf.