India @75: Addressing manufacturing growth challenge

By Sunitha Raju

What are the challenges the manufacturing sector in India faces? What is the remedy to that?

With the nominal GDP at US$ 3.5 trillion in 2022, India recently became the fifth largest economy in the world by overtaking the UK. Over the last decade, India’s position in the global GDP ranking improved from 10 to 5. Reports also forecast that by 2029, India can replace Japan as the third-largest economy in the world, given the annual GDP growth of over 7-8%. While this overall GDP growth has been impressive, the question that arises is whether this growth is sustainable and indicates a higher living standard for the people of India. According to recent IMF estimates, India’s per capita GDP will be at US$ 2191 in 2021, ranking 142 global positions by GDP (nominal) and 125 by GDP (PPP).

India’s per capita income, which was US$ 1,605 in 2015, will increase to US$ 1,900 by 2020. However, even in per capita income terms, India’s global standing is low when compared to other developing countries. For example, in 2020, China’s per capita income is US$ 10,500, Malayasia is US$ 10,400, Thailand’s is US$ 7,189, Indonesia’s is US$ 3,869, Philippines’s is US$ 3,298, Vietnam’s is US$ 2,785, and Bangladesh’s is US$ 1,968. Even smaller countries like Vietnam and Bangladesh have per capita income higher than India. One reason India lags behind these countries is the low share of manufacturing in the GDP. Although there have been structural changes in India’s GDP over the last 50 years, where the share of Agriculture has decreased from over 50% to 15%, the share of manufacturing, which currently is at 16%, has not seen a significant increase.

The economic development paradigm emphasizes the production shift to manufacturing as the “engine of growth” for maximizing welfare in the long run. Higher manufacturing production is driven by rising manufacturing productivity, which also has positive spillover effects on non-manufacturing sectors, as brought out by Kaldor’s Growth Laws. With the income elasticity of manufactured goods being greater than one, it implies that as income rises, there is a more than proportionate increase in demand for these goods. Manufacturing also has dynamic benefits like a trained labour force, higher innovations, higher and stable prices for exports and, thereby, higher income for people.

Facing the reality

Niti Ayog’s ‘Strategy For New India @75’ (2018) has envisaged increasing the share of manufacturing to 25% of GDP and exports to increase from US$478 billion in 2017-18 to US$800 billion by 2022-23. These targets were a follow-up of the National Manufacturing Policy of 2011, which visualized pushing manufacturing share in GDP to 25% by introducing policies for creating National Investment and Manufacturing Zones (NIMZs), development of SMEs, Skill Upgradation, Promotion of Green Manufacturing and Rationalizing and Simplifying business regulations. The policy also emphasized the development of core infrastructure creation of financial & institutional mechanisms for technology development. However, the implementation issues of these policies did not lead to the desired outcomes. Subsequent policies of ‘Make in India’ and ‘Skill India’ with the broader objective of attracting FDI into manufacturing also did not achieve the targets.

The major factors constraining the growth of Indian manufacturing have been extensively documented, of which the most important are: poor core infrastructure, high cost of capital, labour and logistics issues. All these constraints have resulted in Indian manufacturing losing global competitiveness. As per UNIDO’s data, India’s per capita MVA (Manufacturing Value added) is US$ 302 as against US$ 1,660 for Thailand, US$ 857 for Indonesia, US$ 620 for the Philippines and US$ 2,520 for Malaysia. This data indicates that India’s manufacturing value added is less than 25% of Thailand, Indonesia and Malaysia, with the difference much higher for China and other developed countries. Another important fallout of low MVA is low manufacturing exports. India’s share in world manufacturing exports is less than 2%, while China emerged as the major global exporter overshadowing USA and EU.

The recent trend in India’s manufacturing exports, reaching US$ 418 billion in FY2021-22 compared to US$ 290 billion in FY 2020-21 and registering an annual growth of 40%, is not a trendsetter because India’s share in world manufacturing exports continues to be less than 2%. As per UNIDO data, India’s share in global manufacturing exports in 2020 was 1.57%.

UNIDO’s Competitiveness of Industrial Production (CIP) index assesses and benchmarks industrial production across countries by taking various dimensions like the capacity to produce and export, technological upgrading and deepening and world impact. India’s overall global rank in CIP was 39 in 2018, while for China, it is 3. Between 2010 and 2016, India’s position decreased by 2 points. With low relative competitiveness, it is not surprising that India’s manufacturing imports increased while exports remained subdued, thereby resulting in a trade deficit. Further, even as the share of manufacturing exports in India’s export basket has increased over time, these exports were mainly in low technology-oriented intermediate products.

The Way Forward

The above trends clearly indicate that there is an urgent need to develop a conducive manufacturing ecosystem for sustainable growth. This is particularly important as the manufacturing sector’s potential for productive employment is high. Building manufacturing competitiveness is a priority for India to enhance growth and exports. In this regard, necessary initiatives are briefly discussed below.

• Developing India As A Manufacturing Hub: Post-Covid and the supply chain disruptions that followed emphasized the need for ‘resilience in global supply chain networks’, especially in the context of the over-reliance on China’s manufacturing industry. With the focus on “on-shoring” or shifting production facilities from China, the arguments for India filling this space and emerging as an important manufacturing hub gained momentum. A recent World Economic Forum (WEF) white paper on “Shifting Global Value Chains: An India Opportunity” underlined India’s role in reshaping GVCs and the potential to contribute over US$ 500 billion annually. This is contingent on creating globally competitive manufacturing companies, building capabilities through workforce skilling, innovation, quality and sustainability; reducing trade barriers and enabling competitive global market access for Indian companies; and focusing on infrastructure development for speed and flexibility.

To seize this opportunity and catapult India as a manufacturing hub, an important policy initiative has been the PLI (Production Linked Incentive) scheme which aims to incentivize domestic production by large foreign companies. Currently, the scheme is extended to 13 sectors/industries, mainly focusing on high-value and technology-intensive manufacturing like Electronics (Semiconductors), Automobiles, and Pharmaceuticals. These initiatives aim at public-private investments in R&D, innovation and strengthening of the supply chain in high-value manufacturing sectors. The government is also supporting the development of industrial clusters. For example, under EMC(2.0), electronics clusters are developed for electronic component manufacturing.

In all this, India’s challenge is integrating the MSME sector into this development path, especially as they account for over 90% of the manufacturing enterprises and 33% of manufacturing GVO. Scaling up, internationalization and access to technology and finance have been important deterrents. Therefore, contract manufacturing is necessary to develop linkages between MSMEs and large domestic firms and MNCs. The effort should be to make MSMEs integral parts of the upstream and downstream parts of the supply chain. In this regard, the challenge of high-value addition brings into focus issues like Cluster development, Innovation hubs, testing, and standards, which can develop the capacity to absorb foreign technologies and strengthen firm linkages.

• Attracting FDI Inflows: Recent reports indicate that manufacturing attracted FDI inflows of US$ 21 billion in FY 2021-22, an increase of 76% year-on-year. Country experiences, particularly ASEAN, show that supplying, sourcing and partnering with MNCs have high technology spillovers and productivity gains. Viewed thus, the liberalization of the FDI regime in India is a welcome move. However, the exit of five international automakers between 2017 and 2022 underlines the risks and uncertainties in the Indian manufacturing ecosystem. Some of the factors that brought in this trend are archaic labour laws, uncertainty in policy and regulatory framework and unfavourable growth conditions. Further, lack of technological compatibility, variance in regulatory specifications and high level of import duties are shifting the trend towards ‘on-shoring’, i.e., reallocating investments towards advanced and profitable countries. Therefore, developing a conducive manufacturing ecosystem is the immediate challenge to shift the FDI inflows focus from equity to long-term production engagement.
• Boosting Manufacture Exports: The recent Baines & Company report has argued that India’s manufacturing sector has the potential to reach US$ 1 trillion by 2028 from the current US$ 418 billion in FY 2022. Scaling up Indian manufacturing exports is being driven by supply chain diversification, government initiatives, sectoral advantages, Capex-led growth, Mergers & Acquisitions and VC-led investments. The sectors identified for pushing up exports are chemicals, pharma, electronics, automotive, industrial machinery and textiles. While these projections are important, decentralizing and strengthening local production and value chain is necessary for sustaining export growth. The recent proposals for developing District Export Hubs aim at decentralizing export promotion activity to boost local production and make districts active stakeholders. By doing so, the objective is to benefit MSMEs and small industries with export opportunities.

Similarly, the DESH (Development of Enterprise and Service Hubs) bill 2022, which is an effort to reorient SEZs for making WTO complaints, also aims at boosting exports and attracting investments. The proposals aim at providing WTO complaint incentives for making our firms globally competitive and integrate into global value chains. This provides an opportunity for MSMEs to engage as ancillaries to lead firms and thereby effectively participate in the value chain production activities and integrate MSMEs into India’s export trajectory.

From the above, it is evident that India’s manufacturing practices need a complete re-orientation to attain global competitiveness. The large domestic market must be leveraged to develop and reap scale economies and product and process innovations. The current focus on labour cost arbitrage needs to shift towards technology-induced cost efficiencies and effectively integrate the MSMEs into the value chain. Through these measures, the untapped potential can be realized and effectively capitalized.

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(Sunitha Raju is a professor at the Indian Institute of Foreign Trade.)