By Neelkanth Mishra, Last Updated: Sep 06, 2023, 05:39 AM IST
This was published in the Economic Times on September 6, 2023 (link)
India’s business services exports have grown so rapidly of late that their incremental impact is now nearly as large as that of IT Services exports. While their base is smaller, they grew by US$21 billion last year, not far from the growth in exports of IT services of US$27 billion. Can this surge be sustained?
Axis Capital’s research shows a global tide in services trade, and India is gaining market share. There are both structural and cyclical reasons behind these trends.
The most important structural reason is disaggregation in services value-chains. Put simply, the same service is now being broken up into multiple parts, which different individuals or firms can deliver from different locations. This is like what we have seen in goods value-chains over the past few decades – the display glass of your smartphone for example likely has glass from a US firm, liquid crystals from a German firm, display drivers from a Taiwanese firm and the backlight from China. This fosters specialisation, and thence faster innovation, and boosts trade.
Similarly, today, other than client-facing parts, many services, including high-end strategy consulting, can be delivered remotely. More than 40% of employees in some global consulting firms are now based in India. We have case studies from global procurement by US retailing giants to the rapid development of operating systems for cars being done in India. In oil services firms, which analyse reams of data gathered from drilling rigs, the analysis now occurs in India. International banks have been expanding rapidly in India for more than a decade.
In several cases the shift in jobs is no longer just about India’s lower costs, but increasingly about skill-arbitrage. For example, if an auto company wants to increase the number of electric vehicles it launches three to five years from now, it needs more designers and engineers. They can only be found in India.
This is being supported by a rapid increase in cross-country internet connectivity, with capacity growing at a compounded annual rate of 35%. This enables faster transfer of data, which is necessary for seamless cross-country collaboration. Demography-driven shortage of workers in the developed world is also helping, as does improving education in India. While immigration may be a solution, intensifying anti-immigrant sentiments over the past few years shows this has limits. The persistence of working from home (in the top ten US cities the return-to-office is still just half of pre-Covid levels) has also helped – WFH effectively means work-from-anywhere and is the first step towards offshoring.
These factors have meant that global trade in ‘modern services’ (financial, communication, computer, technical, legal, advertising and business services) is growing faster, and now accounts for 40% of global services trade. Given that these dominate India’s services export mix (75% of total), its services trade is growing faster than the world. To add to this, India’s share of global modern services trade has also picked up from 6% in 2018 to 8% last year, nearly 2.5 times its share of global GDP.
The growth acceleration seen in the years after Covid had some cyclical drivers too. But they are now fading. Excessive fiscal stimulus in the US had meant unfilled job openings rose sharply, accentuating the move to India to find people with skills. The pickup in wage growth exacerbated the cost arbitrage, allowing for more work to be shipped offshore. A significant part of global services trade is also linked to goods trade, like freight, logistics, and insurance. As global goods trade falls back to pre-Covid levels, these services are slowing too. Therefore, year-on-year growth in India’s services exports has slowed in recent months, but we see this as a temporary correction, as the structural drivers remain intact.
In India, growth for both imports and exports started rising 2017 onwards and accelerated further after Covid. Exports have done better, driving a doubling of net invisibles (this includes remittances too, which are also an export of services) between 2018 and 2023. Even if the pace of growth going forward slows to that seen between March 2017 and March 2020, net invisibles would grow to USD265bn in three years, higher than the largest annual goods trade deficit India has ever seen.
This transition to a current account surplus is a manifestation of what demographics predict (falling fertility increases savings for a few decades), and if achieved, would improve India’s macroeconomic stability (low dependence on foreign capital), and make India a supplier of savings to the world.
Services exports can create around 3 million direct new jobs over the next three years, 2 million of them high-paying. If this continues, it could be as transformative for India’s aspirations as well as its middle-class and its cities as the IT Services sector has been over the past three decades.
For this momentum to persist, if not accelerate, active policymaking must address important hurdles. A major challenge is creating new urban hubs to house these workers, as the current centres may not be able to expand rapidly enough. Global firms may be wary of shifting work till they are clear on how much tax they need to pay – India must improve the pace of signing advance pricing agreements.