India’s gross domestic product (GDP) shrank by a whopping 23.9% year-on-year in the second quarter of 2020, marking the first GDP contraction in over four decades. A contraction isn’t a surprise given the pandemic-induced lockdown has brought the Indian economy to a virtual standstill for a few months. But its extent is.
Even prior to the COVID-19 outbreak, India’s economy was floundering, and GDP growth had been on a downward trend. Despite improvements in transport and logistics infrastructure, manufacturing growth has been stop-start, at best. In this interview, we speak with Ritesh Kumar Singh, chief economist of Indonomics Consulting and former assistant director of the Finance Commission of India, about India’s manufacturing sector, why companies want to move production from China to Vietnam and not India, and what India can learn from some other economies.
Unravel: Are we seeing new manufacturing in India?
Ritesh Kumar Singh: Undoubtedly, there have been big positive developments. Samsung has set up the world’s largest mobile phone factory in Noida. Apple’s major vendor Foxconn is manufacturing the iPhone11 in its Chennai plant, while Winstron is planning to produce the premium iPhone SE 2020 at its plant in Bengaluru. Another vendor Pegatron has recently registered its Indian subsidiary as Apple looks to diversify its supply chain.
However, except perhaps Samsung’s factory in Noida, most of the electronics manufacturing in the country is actually assembly work. India’s plan to replace China as the world’s factory or a preferred investment destination is far from realised. Of the 56 firms that left China between April 2018 and August 2019, only three shifted to India while 26 went to Vietnam, according to Nomura. This shows India is not benefitting from the manufacturing shift away from China.
It is no wonder then, that the share of manufacturing in India’s GDP still remains at 17.5% in fiscal year 2019-20, about the same as the 17.2% it was in fiscal year 2013-14. Obviously, India needs to do more if it wants a bigger share of the global manufacturing pie.
Unravel: When top global manufacturers look for alternative production destinations, why does Vietnam trump India?
Mr Singh: Vietnam has a clear edge because of the kind of FTAs it is party to. For example, if you have a factory in Vietnam, you can supply at low or zero duties to the whole of ASEAN, China, India, the EU and Japan, and possibly to all RCEP member countries when RCEP is concluded this year as is planned.
On the other hand, India, a far more complex economy which is dominated by rent-seeking cronies, has not been able to tap the FTA route to expand market access and push its manufacturing exports. I also think the bureaucracy and the government machinery in Vietnam is more approachable and business friendly compared to that in India. Besides, India also seems to be turning its back on free trade with its clarion call for self-reliance and its withdrawal from the RCEP; although it must be added that the RCEP withdrawal was as much about protecting its farmers and indigenous manufacturers as it was about retreating from free trade.
Vietnam has a clear edge because of the kind of FTAs it is party to. For example, if you have a factory in Vietnam, you can supply at low or zero duties to the whole of ASEAN, China, India, the EU and Japan, and possibly to all RCEP member countries when RCEP is concluded this year as is planned.
There are other challenges too. Growing regulatory uncertainties in India deter all kinds of investments, especially from overseas. This is even more the case after India didn’t renew its bilateral investment pacts with over 50 countries. That leaves foreign investors facing adverse policy changes at the mercy of a snail-paced Indian judiciary.
Unravel: Which are some other countries India can learn from?
Mr Singh: India can certainly learn from Ethiopia. Its administrative machinery, including government officials and ministers, go out of their way to help investors. The results are there for all to see. It’s attracting lots of FDI interest, especially in labour-intensive sectors such as textile and clothing. Even Indian companies such as Arvind Mills and Raymond have set up manufacturing plants to tap on Ethiopia’s cheap labour, cleaner hydropower and duty-free market access to all major consumer markets including the EU, India and the US.
In contrast, India’s administrative machinery is Kafkaesque. This must change if India really wants to push its manufacturing share of GDP to 25% by 2025.
Unravel: What is your assessment of the Make in India programme?
Mr Singh: I think it’s a modest success at best as can be seen from the near stagnant share of manufacturing in India’s GDP – from 17.2% in fiscal year 2013-14 to 18.2% in fiscal year 2018-19, which is again expected to fall to 17.5% in fiscal year 2019-20. This is about quantity.
There are also issues related to the quality of manufacturing performance. The share of high-tech exports in total manufacturing goods export is extremely low in India at 9%, compared with 31.5% in China or 40% in Vietnam. It is clear that India is not moving up the manufacturing value chain and at the same time, it is fast losing to countries like Bangladesh and Ethiopia in the labour-intensive manufacturing segment as well.
Unravel: India’s quest for self-reliance is resulting in a protectionist stance on trade. Is this sustainable?
Mr Singh: While I’m all for supporting indigenous manufacturers, protectionism is the least desirable answer as it comes with several side effects. It may be the most popular policy flavour globally, but that doesn’t make it a smart choice. Protection from imports encourages complacency and rent-seeking behaviour, and discourages innovation. It is well-known that investment in R&D by Indian companies is low even by developing countries’ standards. Besides, protection from imports creates an inefficient industrial infrastructure, and that in turn discourages exports.
That is a key lesson India had learnt the hard way during four decades of the licence and quota raj that capped India’s GDP growth rate at sub-4%. Moreover, protectionism will short-change Indian consumers.
Unravel: What, in your opinion, needs to be done to give Indian manufacturing a push?
Mr Singh: Almost everyone will agree that India needs to fix its basic infrastructure, especially that related to logistics and transport, including roads, railways and ports. Luckily, the Modi government is doing a good job on this front. Besides, India’s corporate tax rates are now comparable to those in countries like Vietnam.
However, in my view the most important action needed is to effectively deal with the country’s bad regulation pile up. For example, India must junk its raw material protectionism that’s hurting the country’s much more dynamic downstream industries, from capital goods to home appliances. Similarly, ensuring a fibre-neutral policy regime (something like Vietnam) will align India’s textile value chains to global demand and boost exports. Populist measures such as hiking minimum wages often delinked with labour productivity discourages labour intensive manufacturing and job creation, and hence India needs to dump such ideas.
India also seems to be turning its back on free trade with its clarion call for self-reliance and its withdrawal from the RCEP; although it must be added that the RCEP withdrawal was as much about protecting its farmers and indigenous manufacturers as it was about retreating from free trade.
Moreover, it’s time India got serious about ensuring a predictable regulatory environment with respect to investment, trade and taxes and made it easier to enforce contracts. Similarly, an impartial regulatory regime that doesn’t discriminate between indigenous and foreign companies will be helpful at a time India is trying to lure away top global manufacturers from China.
Further, in my view, New Delhi should identify 10 manufacturing industries with strong forward and backward linkages such as automobile, textiles or electronics and concentrate its regulatory and financial energy in supporting them. It should also remove all kinds of entry barriers to infuse competition and innovation.
India’s domestic market is large and growing but it’s still not big enough to help businesses reap the benefits of economies of scale, and therefore, India can’t ignore exports. One of the ways to address the limitations of the smaller domestic market is through inking FTAs with the largely untapped EU, Latin America and Eurasian Economic Union. That will boost exports and help increase manufacturing’s share in GDP.
Unravel: And how can India address the more immediate demand-related challenge?
Mr Singh: Indian manufacturing is also troubled by a serious demand slump at present. Thus, in the short run, the Modi government must do something to revive consumer demand. Reducing personal income tax will certainly help in this respect. Improvement in the purchasing power of the poor is no doubt helpful, but it will mostly support demand for essentials such as food and clothing. And while that is required, it is not enough. It’s the relatively affluent households who drive consumer demand for high value discretionary items such as cars and white goods. Unless they get relief on direct and indirect taxes they have to pay on their consumption, the problem of weak demand will persist.