India, a Manufacturing Hub?

Bo Bennett, an American businessman, once said: “As sure as the spring will follow the winter, prosperity and economic growth will follow recession.” For India, this is an interesting point to consider. To sustain high growth in future, it must pay close attention to a complex web of interconnected factors such as appreciating U.S. dollar, falling crude oil prices, a slowing China, a restless exchange rate, and exports. The growth of the manufacturing sector is a case in point.

During the last 19 months, Narendra Modi’s government has worked towards improving ease of doing business in India, while pushing for aggressive resource expansion within the manufacturing sector. This is best evidenced by the Make in India program. Being part of this fourth Industrial Revolution seems right for India as it increases its share in the global manufacturing production pie. However, for this policy vision to be a success, it is critical that policymakers are aware of the potential opportunities and challenges brought about by some external and internal economic factors.

External factors: Trade, Currency games, and more

Figure 1: India’s Bilateral Trade with the United States

Figure 1

Source: Author’s calculations from Export-Import database (Ministry of Commerce, India)

The increasing trend of trade balance between India and the United States has been a positive sign for India’s export market over the last three to four years (see figure 1).

Figure 2: Currency Trends (U.S. Dollar vs. Indian Rupee)

Figure 2

Source: Author’s calculations from Trading Economics

The Indian rupee (since 2014) has been weakening against an appreciating U.S. dollar (see figure 2), which has allowed the Indian export basket to become cheaper and rise in the American market. A weakened rupee (if it does not depreciate or fall in value further) will make India a cheaper destination for investment, thereby potentially attracting more money from American and other investors from the West. However, a gradual increase in short-term real interest rates from the Federal Reserve is also likely to make the United States a more profitable investment destination. This will negatively impact FDI in India, adversely affecting the Make in India plan in particular.

Provided the Reserve Bank of India (RBI) can successfully maintain the rupee’s current value, India will seek more foreign investment from developed economies. However, such calculated impact analysis of macro-investment decisions assumes ceteris paribus (i.e., all other things being equal). This may not be prudent in understanding the subtleties of a real economy. Factors such as domestic political stability, currency valuations, real interest rates, global commodity prices (especially the role of falling oil prices), aggregate export demand, and level of inflation play an equally critical role in regulating financial flows from one country to another.

Figure 3: India-China Balance of Trade (in U.S. $)

Figure 3

Source: Author’s calculations from Export-Import database (Ministry of Commerce, India)

Figure 4: Currency Trends (Chinese Yuan vs. Indian Rupee)

Figure 4

Source: Trading Economics

India’s widening trade deficit with China also remains a cause of worry for its big manufacturing plans. This deficit (see figure 3) has been exacerbated by a slowing Chinese economy. Reducing dependence on cheaper Chinese imports remains key. With a depreciating Yuan (see figure 4), China’s exports will become even more competitive, and Beijing is likely to dump a lot of domestic exportable goods on foreign markets, including India.

Table 1: Major Imports from China (2014-15)

Commodity Wise Imports Quantity (in thousands) Cost ( in US$ Million)
ORGANIC CHEMICALS 1,389,642.64 6,327.50
FERTILISERS 9,060,935.12 3,154.68
IRON OR STEEL 3,756,649.40 2,713.34

Source: Export-Import Data, Ministry of Commerce

China’s top five exports to India (see table 1) have all been in the manufacturing industrial sector, which drive productivity in the Indian heavy industry segment. To truly follow the spirit of Make in India, the government must consider a higher import duty on these with a focus on producing import substitutes.

Internal Factors

Figure 5: India’s Industrial Production Level (in %) & GDP from Manufacturing (IND Billion)

Figure 5

Source: Calculations from Trading Economics

Domestic growth trends for India’s manufacturing sector (see figure 5) look worrying. In fact, the manufacturing sector’s GDP and industrial production levels have come down sharply from November 2015. This is following an initial uptick due to positive business sentiment following Modi’s electoral victory. This is also supported by the Business Confidence Index, calculated by surveying 300 companies of all sizes, from different regions in India.

In addition to this, 17 percent of Indian bank loans are stressed, which highlights India’s financial problems at a domestic level. A smooth passage for bankruptcy reform (still pending approval in the Parliament), remains key in putting corporate and financial sectors on sound footing. Indian policymakers would do well to take lessons from the history of stagnated investment witnessed across Europe (2009 onwards) and in Japan (1980s), which demonstrated the folly of allowing corporate debt overhangs and Non-Performing Loans (NPLs) to go unresolved. Establishing financial safety nets against external and internal economic shocks accompanied with the functioning of adequate regulatory frameworks will remain vital for the health of the Indian economy.

Overdependence on foreign investment to drive infrastructure, manufacturing, and production will need some rethinking. Instead of focusing solely on FDI, the government, in partnership with the RBI, should look at incentivizing national savings (at a household or firm level). The upcoming budget presents an opportunity to increase the disinvestment limit, as well as recommend more investment incentives via conditional tax breaks for domestic investors.

The Indian government may be right in its vision for the growth of the Indian economy. But as a developing country, policymakers would do well to keep an eye on these internal and external factors while designing and implementing policies. It is not enough to just conceive policies—pragmatically seeing them through to fruition in the long run is what drives prosperity.


Image: Raveendran-AFP, Getty

Posted in , Economics, Economy, India, Policy

Deepanshu Mohan

Deepanshu Mohan is Associate Professor of Economics and Director, Centre for New Economics Studies at the O.P. Jindal Global University in Haryana, India. He is also a Visiting Professor at the Department of Economics, Carleton University in Ottawa, Canada. He holds a BA in Economics from Fergusson College, Pune, and a Masters in Economic History from London School of Economics and Political Science. His main research interests lie in international economics, history of financial crises, and Indian economic & social history.

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One thought on “India, a Manufacturing Hub?

  1. Lovely theoretical piece, but one which skirts the main issues. Never been a Professor but have experience of setting up manufacturing, retail as well as export businesses with my own funds. For a small Entrepreneur with limited funds, it was a nightmare.
    India simply does not have the enabling environment for any such manufacturing projects. The legal system has so many laws that it can cripple you — labour laws, Tax Laws, Industrial Disputes Act, Companies Act and so many no one would have heard of. People have forgotten that from the 1960’s and 70’s government encouraged many to set up small scale Industries. These poor guys who fell for the bait, almost all have been wiped out, due to lack of finance, militant labour, poor bargaining power between suppliers and customers and harassment from government agencies. Dealing with Customs, Excise, Sales Tax, Factory Inspectors, labour Inspectors etc, can be harrowing.

    In a country with the highest human density in the world, shortage of land has driven prices to levels where no viable economic activity is possible. Unless we have a project that entails heavy capital investment with negligible requirement of land, prospects are dismal. Projects that require hundreds of acres of land do not deserve even a feasibility study — utter waste of time, energy and resources. Having covered the issue of land, let us now come to labour. Ideally with a huge population we should have focused on labour intensive industries. Sadly due to our socialist background we have the most restrictive labour laws in the world, ostensibly to protect labour. You can hire as many as you want but can fire no one. Most labour intensive industries like Garments, Leather Goods etc are seasonal with orders available for at best 6 to 9 months, with wafer thin margins. In sectors like this a factory set up with a $ 10 million investment may need 1000 workers. Who in their right mind will venture into this quagmire of quicksand ?

    Author is talking about trade balances and currency fluctuations and like Keynesian economists believes that a cheaper currency will drive up exports. Since I came into the work force the Indian rupee has gone from Rs 8 / $ to Rs 68/$ but not in a single year has the trade surplus been positive. What it did produce was rampant inflation. If we devalue the Rupee by even 50% overnight, the dream of exports surpassing imports will still remain a dream. Building physical infrastructure will take decades and huge sums of money, however to falsely believe it can make India a major export power, will be to live a delusion.

    India’s most precious resource is its high quality human resources which helped it dominate the global Economy for almost two thousand years. With the developed world having an ageing population the demand for quality skilled labour more so in STEM fields, will remain buoyant. Investment in educational and research infrastructure will pay better dividends, at least till reforms bring the transformation needed.

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