8. Additional Evidence

(a) The use of trade restrictions under flexible exchange rates

244. In response to a question from the Panel regarding the appropriateness of trade restrictions in the context of flexible exchange rates, India referred to the "1979 Declaration on Measures Taken for Balance-of-Payments Purposes" in which the CONTRACTING PARTIES decided that "restrictive trade measures are in general an inefficient means to maintain or restore balance-of-payments equilibrium". However, the preamble also recognized that the less-developed countries:

"must take into account their individual development, financial and trade situation when implementing restrictive trade measures taken for balance-of-payments purposes�.".

245. For India, the 1979 Declaration was premised on the belief that the special and differential treatment of the less-developed countries incorporated in Article XVIII:B continued to be important despite the introduction of flexible exchange rates. Even during the Uruguay Round, the fact that CONTRACTING PARTIES decided not to tamper with this special status of the less-developed countries demonstrated convincingly that import restrictions for balance-of-payments reasons could not be judged against considerations of economic efficiency alone. The balance-of-payments exception in the GATT 1994 reflected the fact that governments faced economic, institutional, structural and political constraints that did not always allow them to opt for the most efficient policy instrument. For example, exchange rate adjustment was subject to political constraints in less-developed countries because while the benefits of exports did not cover the entire Indian economy, the rise in domestic prices of essential imports such as petroleum products could result in increases in inflation that hit the poor the hardest. The recent economic crisis in at least one South-East Asian country was a good example of this and the logic and lesson provided were also relevant to India. Particularly in the context of India's attempt to liberalize its economy simultaneously across a number of economic sectors, the increased flexibility on the balance-of-payments front made possible by import restrictions was necessary to gain increased public and political support for economic liberalization. Accordingly, if Article XVIII:B did not exist, or if its use were subjected to rigid, legalistic procedures, the constraints on exchange-rate adjustments that were applicable to the less-developed countries could not be appropriately taken into account in WTO law, and the effectiveness of that law would be jeopardized. Departures from economic efficiency, of course, were not limited only to balance-of-payments policies. Most economists were of the view that anti-dumping measures were an inefficient instrument of competition policy and that safeguard measures, including those incorporated into the Agreement on Textiles and Clothing, were an inefficient means to promote adjustment. Nevertheless, such measures might be imposed under the WTO agreements. Each of the WTO agreements constituted a compromise between high aspirations and political realities. The finely-drawn balance of rights and obligations that the negotiators of these agreements arrived at when reaching these compromises must be respected by panels, whose function was � as the Appellate Body has repeatedly found � to help enforce the results of past negotiations reflected in agreed texts.
246. The United States responded to the same Panel question by arguing that under conditions of volatile capital flows and flexible exchange rates, trade restrictions could have perverse effects on external accounts by undermining market confidence and, at best, could provide only short-term relief from balance-of-payments pressures. ¹⁸⁶ Since it took time for the markets to react and contract prices to adjust to exchange rate changes, trade restrictions attempted to adjust the prices of imported goods or limit their availability more directly. This increase in imported goods price, or the prohibition on their importation, would decrease their consumption, and at a given exchange rate, reduce a current account deficit, stabilizing a balance-of-payments imbalance.
247. However, with a flexible exchange rate, imported goods prices could adjust, leading to a resumption of pressures on the current account. Further, when kept in place for extended periods, restrictions diverted resources from potential export sectors to import-competing lines of production and retarded development via the lost benefits from trade. In this case, such restrictions served as a palliative and did not remedy fundamental imbalances. ¹⁸⁷ Instead, they could actually prolong the adjustment process.
248. In addition, the United States wished to point out that in paragraph 44, the 1955 Report of the Review Working Party mentioned that developing nations may need to impose controls on "the general level of their imports." However, India did not maintain restrictions on the general level of imports. Instead, India targeted 2,700 line items, most of which were consumer goods.
249. In the 1955 Report, the authors were writing in a world of fixed exchange rates, global capital controls, low levels of international trade resulting from generally high trade barriers, and capital markets disrupted by two World Wars and a worldwide depression. These conditions no longer prevailed, and experience with macroeconomic management and economic development strategies in the intervening years had shown trade barriers, especially quantitative restrictions, to be inadvisable. Some developing countries might still face current account difficulties, but they had policy tools other than trade restrictions by which to expand economic growth. In most cases, a developing country could ameliorate current account crises with the appropriate mix of fiscal, structural, and monetary policies. While these direct remedies might not move a country to a current account surplus, they permitted the country to remain open to the well-developed international capital markets, thereby increasing growth rates above levels sustainable with domestic savings.

(b) The effect of trade liberalization on the balance of payments

250. In response to questions from the Panel regarding the pressure exerted on the balance-of-payments or international reserves by trade liberalization, the United States considered that even though import growth had been outpacing export growth in India, it was not fair to say that India�s balance of payments had been under pressure. Due to higher net transfers from abroad, and rapid growth in the export of nonfactor services, India�s current account deficit had not expanded markedly, staying below 1.5% of GDP since 1993/94 (except for 1995/96 when the deficit reached 1.7% of GDP). India�s foreign exchange reserves increased steadily from US$9.8 billion at the end of 1993 to US$26.6 billion in October 1997 (a 30% annual increase). The Indian authorities sold 8.4% of their reserves in intervening to support the rupee between the end of October 1997 and the end of February 1998. However, this intervention was necessitated primarily by concerns about the Asia crisis, not trade liberalization.
251. Some part of import growth was undoubtedly due to the reduction of import restrictions. However, there were several other factors which deserved the bulk of the responsibility for rapid increase in the value of imports: rapid economic growth (real GDP growth has been accelerating since 1991, reaching 7.5% in FY 1996/97): a depreciating rupee (the rupee fell 25% against the dollar between the end of 1993 and the end of 1997); and climbing oil prices (in local currency).
252. In fact, trade liberalization tended to promote increased efficiency. The recent effort by the Indian Government to open the Indian economy had led to improved economic growth. The IMF, in its report to the WTO Balance-of-Payments Committee identified the quantitative restrictions in India as a significant impediment to efficiency. ¹⁸⁸ The IMF staff had conveyed the view that eliminating the quantitative restrictions and establishing appropriate tariff levels would simultaneously open India�s economy, raise additional tariff revenue, reduce the government dissavings, and increase India�s already sizable foreign exchange reserve. From this assessment, the United States concurred with the IMF that India could liberalize its quantitative restriction regime in a timely fashion.
253. As a general point, trade liberalization and greater integration benefited developing countries. For example, after experimenting with trade restrictive import substitution policies, many Latin American countries began to open their economies up after the 1980s, leading to higher growth rates. Nevertheless, trade and capital liberalization also carries greater exposure to exchange rate and capital market volatility, so balance-of-payments pressures might arise at the same time. Their correlation, however, did not imply causation. Instead, such balance-of-payments crises might arise when a country had misaligned macroeconomic fundamentals. The appropriate response, though, to these imbalances was to address them directly instead of relying on trade restrictions. Further, there was no guarantee that maintaining trade restrictions would prevent a country from experiencing a balance-of-payments crisis. As private capital flows were orders of magnitude larger than any one country�s foreign exchange reserves, it was much more important for a country to have a credible and sound macroeconomic regime. Trade restrictions could signal a country�s attempt to skirt market forces. To the extent that a country was already in poor macroeconomic health, the restrictions might actually increase the likelihood of a balance-of-payments crisis, not decrease it.
254. India considered that although the statistical link between trade liberalization and the trade deficit could not be proved, available trade data, contained in the Economic Survey of India, 1996-97 indicated the need for caution in assessing the impact of removal of import restrictions on India's balance of payments. India considered, therefore, that the central economic issue in this dispute was whether India was entitled to a time-schedule for the progressive relaxation and elimination of its restrictions as required by Article XVIII:11.
255. India was particularly concerned about the potential adverse effects of immediate elimination of its remaining import restrictions on a significant number of tariff-lines in the context of its overall programme of macro-economic stabilization measures and structural reforms. Thus, in the context of the linkages between trade policy reforms and other reforms, an influential World Bank study of economic liberalization in about 40 less-developed countries entitled Best Practices in Trade Policy Reform, noted that:

Tariff reform may cause revenue losses, devaluation may increase inflation and liberalization may aggravate balance of payments problems. Does this mean that trade liberalization is inconsistent with stabilization efforts? Indeed, there is little doubt that macro-economic stability makes trade policy (and some other) reforms more difficult to implement successfully. For this reason, some analysts have argued that the fiscal deficit and inflation should be reduced before trade policy reforms are introduced. ¹⁸⁹

On the experience of developing countries with the sequencing of reforms, the study noted that:

In general, the benefits of trade policy reforms are greater when accompanied by domestic economic reforms. Hence, trade policy and domestic reforms are best carried out simultaneously. But in practice not all actions can be taken at the same time and so the issue of sequencing becomes relevant. Initiating trade policy reforms often exposes the need for domestic reforms and investments . . . . It also exposes unforeseen infrastructural needs of industries that are based almost entirely on foreign demand . . . . And sometimes domestic reforms should be deferred until the business and financial communities clearly understand that the protection against imports will be reduced. Otherwise, when investment or price controls are removed in highly protected sectors, increased investment and production might be encouraged in the wrong sectors. At other times, trade policy reforms may need to wait until a domestic control is relaxed. For example, a processed product (such as textiles) may see its effective protection vanish or become negative if its tariffs are reduced while the price of its basic input (cotton) which is set by a monopolistic parastatal, remains high. ¹⁹⁰

�

Experience suggests that substantial and comprehensive liberalization can be completed in less than five to seven years from the start of the adjustment program, although the decision on the pace of reform ultimately depends on the specific circumstances of the country involved. This should allow time for quantitative restrictions to be phased out and for tariffs to be reduced to, say, 15 to 25 percent. ¹⁹¹

In India's view, the conclusions of this study were particularly noteworthy:

If all reforms cannot be carried out simultaneously, careful sequencing of the reforms can usually avoid conflicts among them. With respect to macroeconomic stability, it is necessary to consider the likely consequences of trade liberalization for the fiscal deficit and ways to offset adverse effects, if they are judged likely to be serious. When the inflation rate is very high and variable, stabilization efforts can precede other reforms.

Greater emphasis on complementary policies, investments, and institutional reform will improve the payoff to trade policy reform. Where domestic market problems are severe, deregulation, infrastructural improvements, and institutional reforms are essential for the success of trade policy reforms. ¹⁹²

256. India assured the Panel that India supported trade liberalization and believed that it brought benefits in terms of economic growth. The issue in this area, was not so much whether trade liberalization improved the balance of payments in the long run, but the manner in which trade reforms should be carried out. In accordance with Article XVIII:11, India considered that it should progressively relax and eliminate its import restrictions in a manner that did not result in producing conditions that would compel it to reinstitute import restrictions to manage its balance of payments.
257. In response to a request from the Panel that India identify the concrete reasons why the immediate removal of its remaining import restrictions would thereupon lead to a balance-of-payments problem, India pointed to the behaviour of India's trade account since India began its programme of economic liberalization in 1991. The following table from the Economic Survey of India, 1997-98 (published by India's Ministry of Finance prior to the presentation of the annual budget in Parliament) contained data on India's trade deficit between 1991 and 1997.

Table 1

Years	1990-91	1991-92	1992-93	1993-94	1994-95	1995-96 -	1996-97
Trade Balance (US$ million)	-9,348	-2,798	-5,448	-4,056	-9,049	11,359	-1,429
Trade Balance (% of GDP)	-3.2	-1.1	-2.4	-1.6	-2.9	-3.4	-4.0

258. The table showed that the trade deficit had deteriorated continuously since 1992-93, increasing to nearly US$14.3 billion in 1996-97 or to 4.0% of GDP. Significant deterioration on the trade account began in 1994-95 after a three-year phase between 1991-92 and 1993-94 when the trade deficit was relatively low. By 1996-97, however, the trade deficit had already reached an alarming 4% of GDP and was provisionally assessed to have worsened further in fiscal 1997-98. India noted also that by 1995-96 itself, the deficit on the trade account had increased to above that recorded in 1990-91 when India was forced to turn to the IMF for emergency loans. Projections by the Planning Commission for the medium term indicated that imports were likely to increase further if the import restrictions that were currently in place were eliminated immediately. ¹⁹³
259. The dramatic change in the behaviour of imports in the reform period came out far more clearly if import volumes were considered. In the period 1992-93 to 1995-96, import volume grew, on the average, at 22.1%. ¹⁹⁴ Import volume growth during this period stood in sharp contrast to its behaviour during the decade of the eighties. During the periods 1980-81 to 1985-86 and 1985-86 to 1990-91, import volume grew at the more sedate pace of 6.6% and 5.7% respectively.
260. India's Planning Commission had also carried out an analysis to estimate the likely impact of immediate elimination of India's import restrictions on its balance of payments. It noted, however, that the standard econometric techniques for predicting the impact on India's balance of payments of the immediate removal of India's residual import restrictions could not be readily used in the case of commodities subject to import restrictions because continuity assumptions are isolated. Therefore, its analysis was based on inferences from the behaviour of commodities which were not under import restrictions. The basic analysis was presented in the following table. ¹⁹⁵

Table 2

Domestic production and imports of tradable commodities in India

(Rs million)

		1989-90	1996-97
I	Gross value of domestic output
	(a) Total	4,713,609	13,428,860
	(b) Under import restrictions	2,799,826 (59.4%)	7,340,765 (54.7%)
	(c) Not under import restrictions	1,913,783 (40.6%)	6,088,095 (45.3%)
II.	Value of Imports
	(a) Total	367,266	1,639,530
	(b) Under import restrictions	65,801 (17.9%)	260,222 (15.9%)
	(c) Not under import restrictions	301,465 (82.1%)	1,379,308 (84.1%)
III.	Total value of consumption (I+II)
	(a) Total	5,080,875	15,068,390
	(b) Under import restrictions	2,865,627 (56.4%)	7,600,987 (50.4%)
	(c) Not under import restrictions	2,215,248 (43.6%)	7,467,403 (49.6%)
IV	Share of imports in total value of consumption (II / III)
	(a) Total	7.23%	10.88%
	(b) Under import restrictions	2.30%	3.42%
	(c) Not under import restrictions	13.61%	18.47%

Note: Figures in brackets are percentages to total.

Source: The Government of India.

261. As was evident, the share of imports in the "total value of consumption" differed substantially between products subject to import restrictions and those which were not. In 1996-97, these figures were 3.42% and 18.47% respectively. Thus, the removal of import restrictions would certainly lead to an increase in the share of imports of such products, although the magnitude of the increase would depend on a number of factors such as the level of tariff protection, the relative international competitiveness of products subject to import restrictions relative to those that were not subject to import restrictions, the relative domestic supply possibilities, etc. Therefore, it was not possible to pinpoint exactly the likely magnitude of increases in imports.

To continue with The effect of trade liberalization

¹⁸⁶ Precisely, the question was: "To what extent are trade restrictions an appropriate response to balance-of-payments difficulties in a context of flexible exchange rates and volatility of capital flows? Is the reasoning advanced in the 1955 Report of the Review Working Party on "Quantitative Restrictions" relevant in the context of more flexible exchange-rate arrangements that have been adopted in more recent years?"

¹⁸⁷ The United States pointed out that in India�s case, the quantitative restrictions fall on consumer goods. Hence, resources are being diverted to develop domestic, consumer goods industries at the expense of exports that could generate foreign exchange.

¹⁸⁸ WT/BOP/R/22, Op. Cit., para. 8, sub-paras. iv - v.

¹⁸⁹ Vinod Thomas, John Nash, et al, Best Practices in Trade Policy Reform, (World Bank, 1991), pp. 204-205.

¹⁹⁰ Ibid., p. 206.

¹⁹¹ Ibid., p. 207.

¹⁹² Ibid., p. 215.

¹⁹³ The Planning Commission has estimated that import elasticity in the Ninth-Plan period is expected to be 1.75 without the removal of the existing import restrictions.

¹⁹⁴ To put this in the proper context, it is perhaps useful to mention that export volume over the same period grew at the significantly slower pace of 16.8%.

¹⁹⁵ The assumptions on which the analysis was based are as follows:

1. Since imports are measured in terms of the value of the product, it is not proper to relate them to the value added in different sectors. Rather, they should be related to the gross value of output. The latter data are not generally available in the National Accounts. Therefore, they have been collated separately.
2. The analysis is limited to tradable commodities, which include products originating in agriculture, mining and quarrying and manufacturing. All non-traded goods and services have been excluded. The tradable commodities have been classified on the basis of whether their imports are subjected to import restrictions or not. Although such categorization cannot be entirely water-tight, the broad orders of magnitude indicated are relatively accurate. As is evident from the table above, the gross value of output of commodities subject to import restrictions has declined from almost 60% in 1989-90 to below 55% in 1996-97.
3. Imports have also been categorized on the same basis as domestic production. Thus, imports subject to import restrictions are estimated to be 18% of total imports in 1989-90 and 16% in 1996-97.
4. The total value of consumption has been defined as the gross value of domestic output plus the value of imports on a commodity basis. No correction has been made either for exports or for changes in stocks because this is unlikely to make any substantive difference.