Financial Services In India- An Introduction

An Assessment of Trade in Services: A Case Study for India

Dr. Arvind Virmani* Dr. Tarun Das**

___________________________________________ Indian Council for Research For International Economic Relations India Habitat Centre Lodhi Road, New Delhi-110003.

* Director, ICRIER, India Habitat Centre, New Delhi-11003. ** Economic Adviser, Ministry of Finance, Government of India. Note: The paper expresses personal views of the authours, which may not necessarily reflect the views of the organisations they are associated with.

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An Assessment of Trade in Services: A Case Study for India Contents Contents

Pages

1 Introduction 1.1 1.2 1.3 1.4 1.5 1.6 1.7

Issues for developing countries Objectives of the Marrakesh agreement and GATS Assessment made by the developing countries Assessment made by the WTO Secretariat State of play of the services negotiations Principles of the Services negotiations An examination of the views by the developing and developed countries

2 Services Production and Services Trade in Asia 3.11 3.12 3.13 3.14 3.15

Services production Globalisation and its impact on internal trade Services exports Impact of services trade on the economy ICT revolution and new economy

3 Service Sector Reforms in India 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8

Agreement under GATS India’s commitment under GATs India’s negotiations for financial services Reforms and liberalisation in banking and insurance Reforms in industry and infrastructure Telecommunications Electricity Transportation

4 Impact of Liberalisation and Reforms in Services on the Indian Economy 4.1 4.2 4.3 4.4

Production in services sectors Employment in services sectors Growth in telecom services Impact of financial sector reforms

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4.5 4.6 4.7 4.8

India’s software exports Information technology in India Services trade of India Services and Economic Growth

5 Concluding observations Benefits of Liberalisation of Services 5.1 Statistics on trade in Services 5.2 General Recommendation Selected References

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Chapter-1 An Assessment of Trade in Services: A Case Study for India

1.1 Issues for Developing Countries Developing countries have made substantial commitments under GATS with respect to many services sectors, without having much experience in their implementation. These countries have undertaken a higher share of full bindings in market access under the cross border and commercial-presence modes of supply. In contrast they have not received concessions of meaningful economic value under labour intensive services and the movement-of-natural persons mode of supply. Except in the areas of travel and worker remittances most developing countries have deficit in trade in services. Essentially developing countries have major supply constraints and do not satisfy the preconditions for building a competitive service sector. In the case of India, software exports, with an average growth rate of 50 per cent since 1995-96, have emerged as an important source of India's foreign exchange earnings, contributing substantially to invisible receipts. Other business services such as accounting, legal, health services could emerge as significant source foreign exchange receipts since India has a comparative advantage in these specialised human resource intensive services. The availability of permission to Indian nationals to undertake such services abroad would not be fruitful if the qualifications to provide these services from Indian Institutions are not recognised abroad. At the time of negotiations, it needs to be ensured that standardisation of these qualifications are sorted out to protect our interest. Moreover, social obligations in the case of services such as telecommunications (telephony to rural areas) and air transport (linking the north-east states, and other farflung areas) have to be carefully nurtured. The purpose of this report is to examine critically whether India has any significant benefits under the WTO commitments for liberalisation of trade in services. We would like address a number of questions, particularly the following: • • • • •

What is our commitment under the WTO agreement on trade in services? How far we have progressed as regards to liberalisation of trade in services? What has been their impact on production and trade of services and the overall economic growth in general? What should be the appropriate methodology to examine these? What lessons can we learn from the past experience?

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1.2 Objectives of the Marrakesh Agreement and GATS Objectives of the Marrakesh Agreement include the following: (a)

The Marrakesh Agreement establishing the WTO recognised in its preamble that “trade and economic endeavour should be conducted with a view to raising standards of living, ensuring full employment and a large and steadily growing volume of real income and effective demand”.

(b)

Secondly, it also says that there is a need “for positive efforts designed to ensure that developing countries, and especially the least developed among them, secure a share in the growth in international trade commensurate with the needs of their economic development”.

The preamble of the GATS agreement also states the following: (a)

That multilateral rules in services should take place under conditions of “progressive liberalisation and as a means of promoting the economic growth of all trading partners and the development of developing countries”;

(b)

Negotiations should be “aimed at promoting the interests of all participants on a mutually advantageous basis and at securing an overall balance of rights and obligations, while giving due respect to national policy objectives”;

(c)

That the GATS should “facilitate the increasing participation of developing countries in trade in services and the expansion of their service exports' 'through the strengthening of their domestic services capacity and its efficiency and competitiveness”'.

GATS Article IV on Increasing Participation of Developing Countries also sets out clearly the criteria of how participation should take place: (a)

Article IV: 1(a) states that developing countries' increasing participation in word trade should be facilitated by “strengthening of their domestic services capacity and its efficiency and competitiveness, inter alia through access to technology on a commercial basis”;

(b)

ArtilceIV: 1(b) talks about increasing developing countries' participation through “improvement of their access to distribution channels and information networks”;

(c)

And IV: 1(c) refers to increasing developing countries' participation through “the liberalisation of market access in sectors and modes of supply of export interest to them”.

Furthermore, Article: 2 also states that the “process of liberalisation shall take place with due respect for national policy objectives and the level of development of individual

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Members… There shall be appropriate flexibility for individual developing country Members for opening few sectors, liberalising fewer types of transactions, progressively extending market access in line with their development and when making access to their markets available to foreign service suppliers, attaching to such access conditions aimed at achieving the objectives referred to in Article I”'. The Preamble of the GATS agreement also underlines the issue that members have a right to 'regulate'… 'in order to meet national policy objectives'. It acknowledges 'the particular need of developing countries to exercise this right'. All the above objectives and principles should therefore be guiding principles for the assessment of the GATS. 1.3 Assessment made by the Developing Countries An assessment of trade in services made jointly by some developing countries viz. Cuba, Dominican Republic, Haiti, India, Kenya, Pakistan, Peru, Uganda, Venezuela and Zimbabwe (WTO 2001b) made the following observations: (a) Developing Countries Have Not Received Benefits From Their Commitments According to UNCTAD's 1999 Assessment, developing countries have made substantial commitments under GATS with respect to many service industries, often binding recently adopted legislation or pre-committing future policies without having had much experience in their implementation, and have undertaken a higher share of full bindings under the cross-border and commercial presence modes of supply. In contrast, they have not received concessions of any meaningful economic value under the movement of natural persons mode of supply. As a result, most developing countries have a deficit in trade in services except in the areas of tourism and travel and worker remittances. Hoekman has also pointed out that 'market access commitments by high-income countries tend to be restrictive with respect to activities where developing countries have a comparative advantage-both low and high skill labour intensive activities that require either temporary entry or establishment or work permits. (b) Market Power of Services Corporations Dwarf, Even Wipe-out Developing Countries Small Suppliers Many services markets are dominated by only a few large firms from developed countries and a number of small players. The top 20 service exporters are mainly from developed countries. In spite of GATS, developed countries account for 80% of world exports of services, and developing countries share of services export is about 20%, even though they make up 90% of WTO membership. It is therefore difficult, if not impossible for developing countries, without the advantage of an early start, to catch up with the large

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firms. Developing country providers (mostly SMEs) face competition from large service multinationals with massive financial strength, access to the latest technology, worldwide networks and sophisticated IT infrastructure. Liberalisation under these circumstances of unequal competition has aggravated the alarming divide in supply capacity between developed and developing countries. Since GATS, developing countries share in exports have increased only by 6% a large part of this is associated with the Asian countries' export of goods. However, during the same time, developing countries' services imports have increased by 15%. Assessments conducted at the national level have therefore no shown positive results. Developing countries small suppliers are also disadvantaged in other ways, such as through discriminatory access to information channels and distribution networks - e.g. suppliers of telecommunications network may discriminate by excluding certain users, charging higher fees or imposing restrictions on attaching equipment. An example is the display bias on CRS and GDS screens, which has restricted competition in the air transport sector. (c) Suggested methodology by developing countries for assessment of GATS In accordance with the objectives outlined above, the developing countries identified the following list of issues for which evidence can be gathered to assess the GATS. This is by no means exhaustive, and work can continue to further define and refine this list. (i) General Economy: • • • • • •

What has been the evolution of trade in services vis-à-vis the general economy since 1995? This assessment could be done with the help of economic trends and other national indicators. Has GATS played any part in contributing to economic growth? Has GATS brought about more employment? Has GATS been instrumental in creating the promised synergies between trade in services and trade in agricultural and industrial sectors? Has there been growth in these sectors due to GATS? Have developing economies become more diversified as a result of GATS?

(ii) Trade in Services • • •

Have developing countries, particularly the LDCs, secured a larger share in the growth in international services trade? Has trade in services or services exports increased horizontally and vertically? Has GATS led to an increased market access for developing countries’ suppliers in sectors and modes of supply of export interest to them? What has been the actual inroad and progress in terms of market share and market access for developed countries into the developing countries’ markets?

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• • • • •

Has GATS led to the strengthening of developing countries domestic services capacity, efficiency and competitiveness? Has GATS strengthened developing countries’ technology development in services production and supply? Have developing countries suppliers had more access to distribution channels and information networks? Have the economic benefits of GATS been mutually advantageous for both developed and developing countries? Have there been investments in new sectors in developing countries or are investments in services flowing only to sectors, which have already been developed?

(iii) GATS Commitments Rules • To what extent have nationality; visa and residency requirements prohibited the movement of natural persons from developing countries since 1995? • Has the same been true for the movement of natural persons from the developed countries into developing countries? • What is the extent of subsidies provided by developed countries to their services suppliers? In what sectors have these subsidies been granted, and how? • To what extent are investment incentives available to developed countries' suppliers, and what is the trade distortive impact of this? • What has been the effect of MFN exemptions? • Has GATs brought about greater access to basic infrastructure such as water, energy, health care, transport etc. to common people especially the poor? • Has there been an increase or decrease in the standards of services provided especially to populations that are poor, vulnerable or socially disadvantaged? • Has GATS contributed to greater access to telecommunications and Internet services by people in developing countries? • Has GATS led to an increase in privatisation of services? What has the impact been for the development of developing countries? The developing countries recommended that: (i) (ii) (iii)

First, such an assessment be carried out on the basis of the comprehensive studies made by the member states and international organisations, including the WTO. Second, given the expertise and work of UNCTAD on issues pertaining to developing countries, these assessments should be carried out with the assistance of UNCTAD, and if necessary, other relevant UN agencies. Third, studies on national experiences can also be fed into this assessment process. Demand driven technical and financial assistance should be provided for this purpose to developing countries, especially to the LDCs.

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1.4 Assessment made by the WTO Secretariat A note from the WTO Secretariat (WTO 2001b) appears to argue that the developing countries have benefited significantly from liberation of trade in services. The note points out that while a partial approach with a strong focus on sectors may appear to be attractive, from an analytical angle the sector-specific reforms may imply awkward tradeoffs. Since the services universe is very diverse- structurally, economically and politically- it would be naïve to assume that one single, detailed blueprint could be applied for assessment purposes across all sectors. The secretariat emphasized that the underlying question is: What are the economic effects in a country that liberalizes its own services regime in a stable external environment (no liberalization abroad)? The secretariat suggested that the factors listed in Tables 1 and 2 may be considered as a rough approximation and significant adjustments may be needed to accommodate specific conditions and policy environment in different sectors. 1.5 State-of-play of the services negotiations •

55 WTO Member Governments have tabled written proposals, either individually or jointly (European Communities, Andean Community, Mercosur, and others).

•

Of the 55 governments who have submitted proposals, a majority (32) are governments representing developing countries.

•

Among the sectors covered are: professional services (18 proposals representing 20 Members), tourism (14 proposals), telecommunications and transport services (12 proposals each), financial services (11 proposals) and distribution (10 proposals).

•

Three of the proposals deal with the education sector.

•

Medical and health services have not yet been mentioned at all.

Developing countries’ genuine interest in these interests is reflected not only in the large number of proposals for negotiations but also by strong demand for technical assistance from WTO Secretariat. In 2002 the WTO’s Trade in Services Division has received more than 60 invitations from developing and least developed countries to conduct services seminars and workshops.

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Table-1: Assessment of GATS A. Direct Economic Impact (a)

•

Price effects • Benefits for mobile users ("consumption abroad") • Domestic price reductions (b) Supply effects (i) Increased quantities (domestic market) (ii) Improved quality and choices  Benefits for mobile users ("consumption abroad")  Domestic effects (iii) Stability/reliability of supplies on the domestic market Status-quo regulations With regulatory adjustments (prudential rules, competition law) (c) Adjustment cost (associated with idle capacity/temporary unemployment) • Under status-quo conditions • With flexibility-enhancing policies and pro-competitive regulation (mobility, investment grants, retraining initiatives, etc.) B. Indirect Economic Impact (a) (b) (c) (d)

Performance of user industries (profitability, production, employment, trade, etc.) Industrial diversification Impacts on domestic factor endowment (skills, technology, etc.) Other macroeconomic effects (cyclical resilience, etc.) C. Non-Economic Considerations

(a)

(b)

(c)

Distributional objectives ("equity") (i) Impact on low-income consumers/consumer groups • Under status-quo conditions • With policy adjustments (universal service obligations, taxes/subsidies, etc.) (ii) Impact on disadvantaged regions • Under status-quo conditions • With policy adjustments General environmental/health implications • Under status-quo conditions • With regulatory adjustments (standards, certification requirements, etc.) Safety, security and other public-policy concerns • Under status-quo conditions • With regulatory adjustments (measures against money laundering, corruption, fraud, etc.)

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Table-2: Assessment Criteria - Liberalization by Trading Partners Potential effects on the WTO Members(s) concerned Direct Economic Impact on Related Sectors/Markets A. Supply-side effects: (i) (ii)

Expansion of trade/production/employment Temporary (?) shortage of domestically available supplies • Under status-quo regulation • With policy adjustments (mobility, investment grants, retraining initiatives, price deregulation etc.) B. Indirect Economic Impact

(a) (b)

(c) (d) (e)

Increased demand for related producer services (-profitability, production, employment, etc.) and, possibly, complementary manufactures Impacts on domestic factor endowment ("brain drain") (?), etc.) • Under status-quo conditions • With policy adjustments (public service obligations, taxes, subsidies, etc.) Foreign exchange earnings, positive exchange-rate effects (- welfare gains) Broader developmental implications (-increasing private savings/investments, taxes/government spending) Gradual loss of competitiveness in economically related markets s competing foreign suppliers gain access to cheaper and/or higher quality inputs (?) Non-Economic Considerations

(a)

(b)

Distributional objectives ("equity") Quality and availability of supplies for disadvantaged groups • Under status-quo conditions • With policy adjustments (public service obligations, taxes and subsidies, etc.) General environmental/health implications • Under status-quo conditions • With regulatory adjustments (stringent standards, certification requirements, etc.)

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1.6 Principles of the services negotiations The WTO negotiations on liberalisations of services trade have been inaccurately portrayed in certain quarters as facilitating the liberalisation or privatisation of government services including health, water distribution and education. In a Press Release (Press/300) dated the 28th June 2002 the World Trade Organisation (WTO) has made the following clarifications: •

Public services. Governmental services- i.e. services provided by governments on a non-competitive and non-commercial basis - are beyond the scope of GATS and not subject to negotiation.

•

Liberalization does not mean privatization. The GATS, and the ongoing negotiations, do not require the privatization, commercialization or deregulation of any service.

•

A voluntary process. No country is compelled to make any changes to its services regime, in whatever sector, which it is not prepared to concede voluntarily.

•

The right to regulate: a fundamental premise of the GATS. The objective of the GATS is to liberalize services trade, not to deregulate services, many of which are closely regulated for very good reasons. The Negotiating Guidelines adopted by the Council for Trade in Services in March 2001, clearly recognize "the right of Members to regulate, and to introduce new regulations, on the supply of services". The further state, unequivocally, that "the process of (services) liberalization shall take place with due respect for national policy objectives, the level of development and the size of economies of individual Members"

•

A democratic process. Most WTO Members are constitutionally required to submit the results of the negotiations for ratification to their Parliaments. In addition, the Swiss Constitution provides for the possibility of popular referendum.

•

Universal services. If countries decide to open a service sector to competition under the Agreement, they retain the right to operate whatever universal service obligation they deem necessary on social, regional and other policy grounds. For example, a government can request a private telecommunications company to offer its services to all inhabitants of the country and not just in the capital and big cities.

•

Transparency. All negotiating proposals tabled by WTO Members to date have immediately been put on the WTO Website. They are publicly available at lwww.wto.org.

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1.7 An examination of views by the developing and developed countries An examination of both the views indicates that the truth lies somewhere in between the views held by the groups of developing and developed countries. It is true that many developing countries have not been able to reap the benefits of liberalisation of trade in services due to some inherent structural problems. But it is also equally true that the developing countries as a group and some developing countries have gained significantly in production and trade in services. The impact of liberalisation of trade in services cannot be examined simply by sectoral developments in services trade or production. Since services provide basic infrastructure for industrial production and trade and also for other services, we have to examine the development and growth of the overall economy. In the following sections we examine the progress and developments of liberalisation of trade in services in India and their impact on the overall economy.

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