The Woes of Indian Manufacturing

Amid deteriorating macroeconomic fundamentals and stalled reforms, with GDP growth at a decade low and a rupee falling precipitously against the dollar, Prime Minister Manmohan Singh is seeking to revitalize attempts to ramp up the country's laggard manufacturing sector.

It is going to be a long campaign. The prime minister chaired a high-level meeting on July 9 to deal with a list of projects prepared by the Commerce and Industry Ministry that are designed to drive up exports, galvanize indigenous manufacturing and hike steel production three-fold to 300 million tonnes annually by 2025. Textile exports are forecast to surge by 30 percent this year. The plan also studies the feasibility of manufacturing civilian aircraft in India and initiating a project for an alternative public transportation.

The core of the new strategy, says an industry ministry source, "is to facilitate the rapid scaling up of the country's manufacturing capabilities which can significantly drive growth."

Yesterday, the government also moved to open its economy further to foreign direct investment, scrapping the limit on foreign holdings in mobile telephone operations, currently 74 percent. Restrictions on other sectors from insurance to tea plantations will be eased or abolished as well.

The ambition is to leverage the growing challenges to China's manufacturing as China's work force starts to age and shrink, its labor costs rise and China evolves into a high-cost economy. But there are fundamental reasons why India has also not been able to capitalize on its inherent advantages like cheap and plentiful labor and land, trade analysts say. The vestiges of the License Raj, the stultifying regulations and accompanying red tape required to set up and run businesses between 1947 and 1990, still hamper investment.

Two years ago, the government sought through its National Manufacturing Policy to enhance manufacturing's share of GDP to 25 percent within a decade, augmenting global competitiveness, focusing on domestic value addition, technological depth and environmental sustainability of growth. It also sought to roll out mega industrial zones, create 100 million jobs by 2022 and put India on a par with manufacturing powers like China and Japan.

However, the trend is moving in quite the reverse direction. Instead of increasing, manufacturing as a share of India's gross domestic product declined to 15.2 percent in fiscal year 2012-13 and is expected to plummet further as the sector is roiled by slowdowns and excess capacity, the Associated Chambers of Commerce of India cautioned in a recent study.

"Often, our production is at the lower end of the value chain," Singh said recently. "Our exports consist of raw materials and primary goods and our imports consist overwhelmingly of manufacturing." The remarks came in the wake of a May trade deficit of more than US$20 billion. "If we have to grow at 8-9 percent, this has to come through sustained growth in manufacturing," the prime minister added.

For instance, although demand is huge for consumer electronics, India has no manufacturing capabilities in the sector. As a result, electronic requirements comprising finished goods as well as components are largely imported from China, South Korea, Taiwan, Southeast Asia and western countries like the US, Israel and Europe.

"The serious consequence of this stagnation has been a big setback for exports which find markets for industrial products in the overseas markets,' said Veer Jerath, an economist who is on the panel of several industry policy bodies. Infrastructure bottlenecks and regulatory hurdles for mega projects are cited out by entrepreneurs as "major hindrances" in taking the big leap forward in industrial activity, Jerath added.

According to the Governor of the Reserve Bank of India D Subbarao, "there is over-capacity in the industry and no fresh investment can take place unless full capacity is utilized, which is again a function of consumer confidence, demand and employment."

These are fundamental reasons why India has also not been able to leverage China's latest challenges in manufacturing despite its inherent advantages, trade analysts say.

Japanese companies that invested heavily in China during the last three decades are now keen to move out due to overexposure in China. But India has failed to ensure that it emerges as an alternative destination for these companies.

China has also increased minimum wages by about 30 percent in the last year to enhance consumer incomes and purchasing power. Furthermore, Western companies are increasingly resisting the requirement that they transfer technical expertise to Chinese partners as the price of setting up production facilities in China. In addition, China's one-child policy has led to a population decline, especially among new labor-force entrants while its labor force between the ages of 15 and 65 is expected to peak in 2014.

Yet higher pay, notably for factory workers producing goods for foreign companies, is driving low-skilled manufacturing jobs to cheaper venues such as Vietnam, Bangladesh and Pakistan, bypassing India.

"Most US companies simply love China because it provides stability. Regulatory bottlenecks are few and far between, processes are streamlined and there's relative ease of doing business as compared to India," said Rajat Shahi, a Gujarat-based textile exporter who has been doing business with Chinese companies for 15 years.

Trade analysts say that for large-scale manufacturing to take off, India must be transformed into an attractive investment destination, defined by easy availability of land, labor and capital. Starting and closing businesses and getting clearances must become less time-consuming, expensive and cumbersome.

Enforcing contracts in India takes twice the time it takes in OECD countries and costs almost 40 percent of the contract signed. India's archaic labor laws are also the most rigid in the world. No wonder, in the World Bank's Doing Business rankings, India was 164th out of 183 in starting a business and 134th in case of doing business.

In addition, most Indian states suffer from deficient grid power as well as acute water shortages. The time taken for clearances in ports is anywhere between three days and one month. These inefficiencies hardly enthuse new entrants to the sector.

"Unless a major paradigm shift takes place to create a manufacturing-friendly ecosystem through policy changes, significant improvements in power, ports and issues related to people coupled with a tariff structure that promotes and incentivizes manufacturing, India can forget about furthering its ambition to become a manufacturing hub," concludes Shahi.