The 'missing middle' in India's exports

Rupee depreciation finds a new ally

India has traditionally grown faster than its export markets, buying more than it is able to sell, resulting in a persistent trade deficit. Every few years, this weakness comes up as a source of vulnerability, especially if foreign inflows are not enough to fund it. And in 2026, it’s back in focus.

 

Policymakers are taking many steps to bolster external finances. They responded to rupee depreciation amid the West Asia crisis with an “all-in” foreign exchange (FX) package. Banks raised a whopping $127 billion from a foreign-currency fixed deposit scheme for non-resident Indians, raising the Reserve Bank of India’s spot FX reserves. But the window is now shut. And these deposits need to be eventually repaid. There will be a need to ramp up sustainable inflows from other sources over time.

 

If India wants to address this deficit sustainably, it needs to raise the competitiveness of its exports. “True competitiveness” may take time though, as reforms progress gradually. In the meantime, “price competitiveness” can help. Rupee depreciation can perhaps be a driver here. And what better time to test it than now, when the rupee has weakened 11 per cent against the US dollar, 20 per cent against the British pound, 20 per cent against the Chinese yuan, and 24 per cent against the euro — all within 18 months.

 

In classic trade theory, rupee depreciation should eventually improve India’s trade balance —a phenomenon known as the “J-curve” effect. The intuition is simple: When the currency depreciates, in the early phase (the downward part of the “J”), the trade balance typically worsens as the import bill remains sticky, while exports take time to respond. Over time (the upward part of the “J”), imports become costlier, shifting demand towards domestic alternatives, and exports become more competitive, thereby improving the trade balance.

 

What’s puzzling in India this time around and historically too, is that the textbook J-curve pattern has been hard to spot despite periods of sizeable depreciation. True, exports rise (as they have this time, too). But not enough. The trade balance doesn’t really narrow. The J-curve remains elusive.

 

What’s keeping goods exports from reacting more to FX depreciation? We split exports by technology intensity into high-tech (mobile phones, machinery, pharma), mid-tech (apparel, furniture, footwear) and low-tech (foodgrains, ores). Both high-tech and low-tech exports do react well to rupee depreciation. It is mid-tech exports that have shown a negligible response, remained stubbornly weak over the last decade, and kept the J-curve elusive.

 

This result can seem counterintuitive. One might expect labour-intensive low-ticket goods to be more price-sensitive, and therefore the first to respond when the currency weakens. Unfortunately, it is not.

 

And this is not the only place where we see a “missing middle” in India’s exports.

 

We split exports by stage of production — primary, intermediate, and final goods. A strikingly similar pattern emerges as intermediate goods are gradually being sandwiched out of India’s exports.

 

We think this sits at the heart of India’s structural gap in manufacturing. A rising share of final goods exports often goes hand-in-hand with a heavier reliance on imported intermediates — machinery parts, components, and other industrial inputs.

 

The success of mobile phone exports captures this well. Boosted by the production-linked incentive (PLI) scheme, India has emerged as a major assembly hub. But imports of the intermediate inputs that go into phone production have also surged.

 

What explains the “missing middle”? Several factors may be at play, but one stands out in our analysis — a tariff disadvantage. We compare tariffs faced by Indian exports and those faced by East Asia and Pacific peers in key destination markets, and find that India has a particularly large tariff disadvantage for mid-tech exports. This disadvantage is large enough to offset the opportunities that rupee weakness brings.

 

And it’s not just export tariffs. India’s own import tariff structure may be blunting intermediate manufacturing competitiveness. Higher duties on the inputs needed for goods manufacturing tend to raise production costs and can create an inverted duty structure where input tariffs exceed those on final goods, discouraging manufacturing. We see this particularly for intermediate goods.

 

But this is also where opportunities lie.

 

After a sluggish past, India has recently stepped up its pace of signing trade deals with various countries/regions, such as the European Union, the UK, Oman, and New Zealand. India is also discussing a trade deal with the US, though that has many complexities to address. If executed well, these agreements can narrow India’s tariff disadvantage versus its peers and address parts of the inverted duty structure, opening up markets that have, in effect, remained closed for years.

 

But signing is only the start — implementation, rules of origin, compliance, lowering quality control orders, and firms’ ability to use preferences will determine the realised gains.

 

Furthermore, looking west may not be enough. India needs to accelerate and modernise trade agreements with East Asia as well. This region is not only a supplier of important inputs but also the driver of valuable regional supply chains critical for more global value chain integration.

 

All said, in the coming months, rupee depreciation may find an ally, namely tariff normalisation. The two, together, may give India an opportunity to bring back the “missing middle” of its exports, whose benefits can range from more growth to jobs and better external finances.

The writer is managing director, chief India economist and macro strategist, HSBC