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Industry: Waiting to happen - Views on News from Equitymaster
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  • Feb 22, 2003

    Industry: Waiting to happen

    After years of pursuing a protectionist policy, India opened its doors to global competition in 1991. Like glasnost and perestroika in Russia, the magic words in India were globalisation and liberalisation. Since then it’s been a bumpy ride. This is evident from the fact that overall industrial growth showed a much higher variation in the nineties, as compared to the swing seen in the eighties. The general index of industrial production (IIP) ranged from 0.6% to 12.7% as compared to a range of 3.2% to 9.3% in the eighties.

    Economic reforms: No impact?
    Year Mining and
    Manufacturing Electricity General
    Average (1980-1992) 8.4 7.6 9.0 7.8
    Average (1993-2002) 3.4 6.5 6.1 6.2
    Average annual growth rate (%)

    The performance of the industry between 1991 to 2001 can be divided roughly into two phases. A growth phase between 1991-96 and post 1996 sober phase till date.

    Between 1994-1996 the Indian industry posted strong growth figures. This was surprising considering the shape of the economy at the time. For one, there was not much improvement on the infrastructure front and interest rates were quite high. Added to that, duty barriers were being increasingly reduced, making it easier for foreign companies to enter the Indian markets. This should have ideally put the domestic production under pressure, but instead the inverse happened.

    Economists explained this surge in IIP during 1994-96 as a result of the Indian consumers finally being able to buy quality goods that they had often desired in the past. The policy at the time was also a reason for the surge in IIP during this period. At the time, import for intermediate goods was allowed but not the end product. Hence, producers’ imported intermediate goods and assembled them in Indian production facilities. Thus, the consumer aspiration of quality foreign goods was met through these assembly facilities.

    However, once this pent up demand was met, the industrial growth slowed down. Also, with trade barriers being increasingly lowered, the competition for Indian industry became fiercer day by day. Due to the slow pace of improvement in reforms on various fronts the Indian industry has been finding it increasingly difficult to compete.

    Another explanation for the graph is that post liberalization (between 1994-1996), a significant amount of capacity came online in various industries like steel, cement and textiles. This was reflected in the steep growth of the IIP. However, the supply far exceeded demand. Consequently, industrial growth post this period has been sluggish. While a weak industrial climate is one of the factors hurting industrial growth, lack of infrastructure has been equally detrimental.

    We, therefore, look at the recent structural changes that have taken place on the infrastructure front and the areas in which reforms are yet to take place.

    To aid the industry the government will have to work on two fronts. Firstly improve the demand scenario for the industry and secondly, improve the operating environment.

    Improving demand
    The subject ‘Economics’ tries to answer 3 basic questions: what is to be produced, how will it be produced and for whom it will be produced. ‘For whom’ here is the Indian population, 70% of which is derives its income from agriculture and animal husbandry. The Indian economy too, like the US economy, derives a significant part of the growth in output from the growth in private consumption. As long as the consumption remains depressed the industrial growth will likely be subdued.

    Private consumption fueling demand...
      Growth in
    Growth in
    Investment Overall Growth
    1970-71 to 1979-80 2.3% 0.5% 0.9% 2.9%
    1980-81 to 1989-90 3.9% 0.9% 1.6% 5.8%
    1990-91 to 1990-00 3.3% 0.8% 1.9% 5.8%

    Thus, the imperative is to reduce the dependence on rain gods by strengthening the infrastructure for irrigation. Bad monsoons in FY99 and FY00 have caused agricultural production to decline by 2% and 6% in FY00 and FY01 respectively. This impacted the agricultural output and consequently for FY01 the agricultural output was lower by 0.2%. In a step to boost the irrigation infrastructure rapidly the Government has set up a special taskforce to implement a project that will link thirty-one major rivers. The objective is to channelise surplus water to those areas, which face a shortage.

    However, there is more. With increase in population, per capita land holding of the farmer has become increasingly fragmented. According to 1991 census, 78% of the farmers in India had land holdings below 2 hectares. Therefore, their ability to earn has been impaired, which has reduced disposable income, which in turn is reflected in lower consumption. Thus, consolidation of land holdings also needs to be addressed. This could improve productivity and yields, as mechanization is feasible only in the case of larger farms.

    Often, stress has been laid on lower taxes to improve level of disposable income and hence, consumption. However, lowering taxes can only aid consumption marginally, since only 2% of the population pays taxes. Therefore, what needs to be addressed immediately is consolidation of land holdings and improved irrigation facilities.

    Another area that needs immediate attention is the distribution of micro-credit. Though steps have been taken to lower the cost of capital and create more liquidity in the systems, the distribution of credit to the farm sector, especially to the smaller farmer, continues to be inefficient.

    Improving infrastructure
    The transition to a free market economy is not going to be an easy one. Only agile, alert and resilient organisations are going to survive. Thus, the onus is on the government to set the stage for the entry of foreign competition. Consider this: contribution of the small-scale industry (SSI) to the GDP is almost 30% and it provides employment to 61% of the non-agricultural workforce. If the Indian industry, especially the SSI, is going to take on foreign competition, the least the government can do is create a level playing field. If this segment cannot compete because of structural inefficiencies, the whole reform process may fail to reach the desired growth objective.

    Many but too small...
    Rs bn FY99 FY00 (Projected)
    No of units (m) 3.1 3.2
    Total production 5,275.0 5,784.7
    Average Turnover (Rs m) 1.7 1.8
    GDP 17,626.0 19,446.0
    % of GDP 29.9% 29.7%
    Exports 489.8 539.7
    % of total production 9.3% 9.3%
    Employment (m) 17.1 17.8

    Cost of capital
    According to the 56th National Sample Survey Organisation, the biggest problem faced by unorganised manufacturing sector is capital shortage. This is despite the banks complaining of a lack of credit off-take from the industrial sector. Obviously there is no co-ordination between demand and supply. Or to put it more pointedly, the banking system is reluctant to back small entrepreneurs.

    Undoubtedly bold steps have been taken in the past to address the shortage of capital and high cost of capital hurting the industry. In budget 2001-02, the FM announced an interest rate cut on small saving deposits by 100 to 150 basis points. Interest rates in the economy are now market determined. Consequently, the lending rates have fallen significantly over the period of two years. In the recent past, corporates like Reliance and Hindalco have placed papers at sub 7% rates. However, the impact is just trickling down to smaller industries. Significant efforts have to be made so that the SSIs can access capital at much lower costs.

    Another bottleneck for the growth of the industry is the power shortage staring the country. The generating capacity in India is currently about 103,000 MW. Out of this, India utilised a poor 57% in FY02 due to inefficient transmission and distribution. India's T&D to generation ratio stands at a dismal 0.3:1, as compared to an international benchmark of 1:1. Average transmission and distribution losses (T&D) are nearly 20% of total power generation compared to 10% for developed economies. This has lead to a huge-demand supply gap. As a result, it has become necessary to resort to power cuts and other regulatory measures to ration power supply. Such rationing has resulted in forced outages and large fluctuations in the supply of power. India has to generate an incremental 10,000 MW of electricity every year for the next 10 years to plug the demand-supply gap and more importantly it has to bring transmission and distribution (T&D) at par with power generation. The T&D losses are due to a variety of reasons, viz., substantial energy sold at low voltage, sparsely distributed loads over large rural areas, inadequate investment in distribution system, improper billing, and high pilferage.

    Perhaps the most notable feature of the 2002-03 budget was the change in Government’s power focus from generation to transmission & distribution. Also, the central Government signed agreement with states for corporatising SEBs and a time bound rehabilitation of the SEBs to improve the distribution network. Privatisation of state distribution companies has been gradually taking place with Delhi Vidyut Board being the latest to join this fast growing list.

    While significant positive steps have been taken, an area that needs to be addressed is the recovery of revenues from the farm sector. The ‘hidden’ gross subsidy for agriculture and domestic sectors has been growing swiftly. The figure has increased from Rs 75 bn in FY92 to Rs 344 bn in FY01 and is projected to go up further to Rs 388 bn in FY03. While a few states like Punjab have taken initial steps on this front, lack of political will is hindering a nationwide reform process.

    Construction of roads is one area where the incumbent government has focused and delivered significantly. In budget 2002-03 the government announced that The Golden Quadrilateral, linking the four metros, is likely to be completed by 2003 end, which is 12 months ahead of schedule. Work on the North-South and East-West corridors has also commenced and is expected to be completed by 2007. This move will significantly help the industry by cutting down transportation costs and also encourage more business.

    Labour laws
    Another notable feature of the 2002-03 budget was the announcement that companies employing less than 1,000 people would not need permission for closure. This is likely to give a fillip to entrepreneurial spirit and the much-needed flexibility in operations to the SSIs, helping them become globally competitive.

    Private players like Tisco have significantly shown improvement in productivity by re-aligning human resource requirement to state of the art technology deployed by the company. The company started trimming its workforce from 78,688 employees in 1993. By FY02, the workforce was down by 41% to 44,235 employees. However, the drive towards more efficient operations has not been limited to the private sector. PSU Banks have implemented VRS Schemes that have trimmed 11% of the total PSU banking workforce by end of FY02. Further, through divestment, the Government has been reducing the number of employees in its ranks.

    Land reforms
    According to a McKinsey report, doing away with the distortions in the real estate market would add another 1.3% growth to the country’s output. High cost of land hurts industrial growth as it raises the hurdle rate for investments. According to the consulting firm, when seen in relation to GDP, the cost of land per square meter in Indian metros is about 11 times more than that in Tokyo and 8 times higher than in Singapore. This is due to the fact that real estate markets have not developed in India and the demand for land far exceeds supply. The factors responsible for a lack of an organised real estate market include lack of land records and delays in legal processes that have tied up large tracts of land, high registration charges and poor tenancy laws. While some steps like reforms in Rent Control Act, repealing of the Urban Land Ceiling Act, rationalisation of stamp duties, streamlining of approval process for construction and simplification in legal and procedural framework for use of agricultural land for non-agricultural purposes have been initiated, ironing out the distortions of real estate is still far from over.

    To sum up, significant progress has been made to lower all factors that act as barriers to industrial growth. While the first decade post liberalization does not paint a very rosy picture, the next decade holds promise of the Indian industry announcing its arrival on the global scene much like the domestic IT services industry. One of the pressing concerns has been lack of investments in the industry. However, as the regulatory environment becomes more and more favourable, investments will naturally follow.



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