How to boost India’s manufacturing sector

India needs to have a big-picture longer-term orientation in policy making. It’s sensible to make Indian manufacturing competitive in both domestic and export markets simultaneously. (Image: Shutterstock/Representative)

The Indian government has rolled out a slew of supply-side measures over the last few years to boost domestic manufacturing. Income tax on the profits of corporations was slashed - it’s now as low as 17 percent for new manufacturing units, tariff walls were erected to protect from cheap imports, and production-linked incentive (PLI) schemes were announced to encourage investments. The Reserve Bank of India (RBI) did its bit to lower the cost of capital by keeping interest rates ultra-low, almost negative for a long time when adjusted for inflation, though it hurt savers.

Yet, the pace of fresh investment remained sluggish, leading finance minister Nirmala Sitharaman to almost admonish the top guns of India Inc at the Mindmine Summit for not investing enough.

Despite the policy interventions by the government, the share of manufacturing in India’s GDP hasn’t increased much. The gross value added (GVA) in the sector contracted 4.3 percent year-on-year in the April-September quarter at a time the country’s GDP grew a comfortable 6.3 percent. In fact, it has been hovering around 15-18 percent since the 1960s. (Yes, you heard it right, it’s actually the 1960s.) Obviously, something is seriously lacking.

It can be argued that neglect of demand, both internal as well as external, is a significant factor pulling down the country’s manufacturing sector. Thus, jobless growth (and of late, high inflation) cap disposable income and, in turn, demand. To make matters worse, cheaper imports from countries such as China further cut into the market share of Indian manufacturers. Therefore, the government must take measures to create and safeguard domestic demand for Indian manufacturers when external demand is likely to remain weak.

However, what we don’t discuss though we should, is the role of well-intentioned but contradictory policies and regulations in shackling the country’s manufacturing sector. Thus, import duties are raised to support Indian manufacturers by creating a nearly captive market. Similarly, export incentives are given to Indian manufacturers/exporters (in an environment dominated by a largely undifferentiated commodity-heavy export basket with no real pricing power) to enable them to lower prices and attract buyers in an intensely competitive global marketplace.

The problem is that measures taken to support indigenous manufacturers, i.e., attempts to create a captive market through increased import barriers, often run counter to the objective of promoting exports. Thus, high import duties on steel to help their indigenous manufacturers impose cost inefficiencies on downstream industries such as manufacturers of all kinds of steel-intensive merchandise and, in turn, dampen their sales prospects including export prospects. Obviously, some user industries such as car makers would protest. To placate them, import tariffs on cars were raised, and local car manufacturers were given a nominal export incentive of 2-5 percent of exports' free on board (fob) value. In the process, more market distortions are created.

Moreover, the increase in import barriers increases the relative attractiveness of the domestic market vis-a-vis the export market, which is at least 10 times bigger opportunity, notwithstanding the rhetoric of a US$3.5 trillion market of 1.4 billion people. India is not as big a market as we tend to believe. For perspective, China’s per capita income is five and a half times of India’s. It’s no wonder, China sells 4 million luxury cars per annum against 25,000 or so in India. Other than lower purchasing power, exorbitantly higher taxes on discretionary consumption affect demand and hurt manufacturing growth.

That is not all. There is a conflict between the supply side and the demand side. On the one hand, the government has been incentivising auto manufacturers through lower corporation taxes, high tariff walls and PLI subsidies and on the other, imposed exorbitantly high taxes on bikes and cars, on fuels and everything from motor insurance to repair and maintenance, all of which jacks up the cost of ownership and depresses automotive demand. Increased transportation cost has a cascading effect on multiple manufacturing sub-sectors leading to a lower overall demand for manufactured goods. That affects the growth of manufacturing GDP.

Things get complicated when geopolitics is added to the equation. Direct and indirect restrictions on sourcing inputs from the cheapest suppliers adversely affect the cost competitiveness of Indian manufacturers and make them vulnerable to competition, both in domestic and export markets. Similarly, price caps and export curbs disincentivise investments (by increasing regulatory uncertainties) and hurt manufacturing growth. Moreover, India has failed to exploit FTAs because of excessive focus on defensive trade interests rather than export push.

India needs to have a big-picture longer-term orientation in policy making. It’s sensible to make Indian manufacturing competitive in both domestic and export markets simultaneously. This can be achieved by progressively increasing import duties with the extent and level of processing to avoid inverted duties. As a general rule, raw materials should attract lower duties than intermediates, and intermediates should attract lower import duties than finished goods to promote value-added manufacturing. Excessive raw material protectionism must end.

The exchange rate should be made an effective tool of policy making to enable external demand to play a bigger role in boosting Indian manufacturing. A weaker rupee scores over opaque import barriers and could support both internal and external demand simultaneously. It will encourage Indian manufacturers to integrate with more dynamic and larger global markets rather than excessively relying on smaller domestic markets to scale up and achieve cost competitiveness. It can be argued that a weak rupee will increase the government’s subsidy bill on fuel and fertilisers. However, that’s a small cost we should be willing to pay for strengthening Indian manufacturing and supporting exports, including those of manufactured goods. That’s the way to go forward.

Ritesh Kumar Singh is a business economist and CEO, Indonomics Consulting Private Limited. He tweets @RiteshEconomist. Views are personal, and do not represent the stand of this publication.