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The rise of Indian manufacturing?
Shankar Acharya
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December 27, 2007

Over the past year or two there has been mounting confidence about the new found strength of India's manufacturing sector and its long-term potential. The recently approved 11th Five Year Plan expects manufacturing to grow at 10-11 per cent a year during the period 2007-12.

Last week a business television channel posed the upbeat question "Does the next decade belong to Manufacturing?" Earlier this month, Rakesh Mohan of the Reserve Bank of India [Get Quote], in an otherwise very friendly review of my latest book, wrote (Economic and Political Weekly, December 8, 2007): "The resurgence of the manufacturing sector seems to have escaped Acharya's attention." Cut to the quick (though I am never sure which part of the anatomy is referred by this phrase), I decided to revisit the basic data on the sector. Here's what I found.

First, it's quite clear that from a global perspective India's manufacturing sector is quite modest in size. Thus in 2005, value added (or net output) of India's manufacturing amounted to only $115 billion as compared to $750 billion in China and over $1,500 billion in the US.

These comparisons are at official exchange rates (not at purchasing power parity rates) but that's entirely appropriate for a sector where the output is internationally tradable. As regards India-China comparisons, it's not just value added; manufactured exports are also seven times greater from China than India.

More interesting is the trajectory of India's manufacturing output over the last fifteen years, covering three plan periods since the early 1990s reforms. The chart illustrates some salient points.

First, the growth of manufacturing since 1991 has followed quite a roller-coaster profile. There was an initial post-reforms upswing in the mid-1990s, followed by a steep tumble in 1997-08, stagnation for the next four years and then a steady recovery and acceleration since 2002-03. In 5-year averages, manufacturing grew by a robust 9.5 per cent in the Eighth Plan (1992-97), a lacklustre 3.3 per cent during the Ninth Plan (1997-2002) and a resurgent 8.7 per cent in the recently completed Tenth Plan (2002-07).

Second, the share of manufacturing in GDP has remained disappointingly flat, attaining a local peak of nearly 18 per cent in 1995-96 and a low of 15 per cent in 2001-02. At 16.3 per cent of GDP the share of manufacturing in 2006-07 was still below the 16.7 per cent level of 1990-01.

In contrast, the share of services (even excluding construction) in GDP has risen steadily during this period from 44 per cent to 55 per cent. This stagnation in the share of manufacturing is very different from the experience of successful East Asian economies. A comparison with China is very unfavourable to India: in 2005, China's manufacturing share in GDP of 34 per cent was more than double India's.

What about future prospects? Optimists believe that while the mid-1990s industrial boom was a temporary spurt propelled by the early 1990s freeing of industrial and trade controls, the more recent, post-2002 resurgence is much more firmly grounded in an internationally competitive and confident manufacturing sector, which has internalised capabilities for sustained, strong corporate performance and buoyant investment.

They point out that in the past three years manufacturing averaged growth of just over 10 per cent a year. Against that background the Eleventh Plan's expectation of 10-11 per cent growth for the next five years should be an easy target. Indeed, they expect faster growth and a steadily rising share of manufacturing in GDP.

Well, maybe. But let me raise a few doubts for the optimists. First, the period 2001-07 witnessed an unexpectedly strong performance of the global economy, led by a powerful, import-intensive boom in the US. With each passing month there is a growing consensus that the "sub-prime"-triggered credit crunch in industrial economies will slow US and global growth significantly in the next couple of years. If that were to happen, Indian industry is unlikely to remain unscathed, notwithstanding the popular, but untested, theories of "decoupling".

Second, an important stimulus to the recent, strong manufacturing growth has come from a surge in corporate investment activity. Can this be sustained for long? Has India outgrown the vagaries of business cycles? The graph is none too reassuring.

Third, the momentum of manufacturing growth could be significantly dented by our exchange rate policy, which has been mismanaged since March this year. Labour-intensive exports and import-substitutes are already hurting. More pain may well be in store if the appreciation of the rupee is not curbed.

Fourth, we have been enjoying a benign period of declining fiscal deficits in the last five years. That particular joyride is threatened by a number of factors, including: the mounting off-budget subsidies for oil, food and fertilisers, the ticking time-bomb of the Sixth Pay Commission, rising expenditure on various populist programmes and a possible slowdown in the rapid growth of corporate income taxes.

If fiscal deficits widen again, upward pressure on interest rates and (downward on) investment is inevitable.

Finally, progress in releasing our infrastructure constraints remains painfully slow, especially in power, water, roads and urban services. How long before this takes its toll of manufacturing sector dynamism?

What can government policy do to improve the medium and long-term prospects for the manufacturing sector? Quite a lot, though none of it is particularly novel. First, in the short run, macroeconomic policy should be calibrated to curb the appreciation of the rupee. Second, every effort should be made to hang on to the hard won gains of fiscal consolidation, including through necessary hikes in domestic prices of petroleum products.

Third, the usual agenda of infrastructure reforms would pay high dividends for manufacturing productivity and competitiveness. Fourth, reform of our labour laws would encourage scaling up production levels in manufacturing units in labour-intensive industries such as textiles, garments and leather products, thereby increasing output, exports and employment in these sectors.

Finally, for the longer run, there is a whole raft of measures that need to be adopted in education, training and health to enhance the productivity of our labour force and generate the kind of skill mixes sought by an expanding industrial sector. It's all been said before, with dubious impact on actual policy!

The author is Honorary Professor, ICRIER and former Chief Economic Adviser to the Government of India. The views expressed are personal.

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