Economics Essay – Indian Growth Industry

Indian Growth Industry

Chapter 9

Industry Dynamics

Since F04, the Indian economy has been moving on to a high growth path. The notable aspect of this high growth is that it is driven primarily by industry and services sector. India’s industrial sector, which witnessed an average growth of around 5.5% upto 1990s, peaked in FY07. The industrial sector grew by an impressive 11% in FY07. The high growth in industrial sector has enabled the country to achieve sustainable economy growth.

This Chapter seeks to provide an insight into the dynamics of the Indian industrial sector. In this endeavour we begin by providing an analysis of the trends in Index of Industrial Production (IIP), going further to provide brief insights into the state-wise distribution of the industrial sector and Small Scale Industrial sector in India. The chapter also intends to analyse trends in investment (both domestic and foreign direct investment). A brief insight into the Public Sector Units (PSUs) and disinvestment is provided towards the end.

9.1 Trends in Index of Industrial Production

In India, the first official attempt to compute the growth in the general level of industrial activity was made way back in 1937 through compilation of Index of Industrial Production that covered 15 industries. After 1937, base year was changed at various intervals in order to capture the changing composition of industrial production and emergence of new products and services as well as to measure the real growth of industrial sector. The latest series with 1993-94 as the base year containing 543 items came into existence on 27-May-1998.

A detail analysis of industrial production as measured by Index of Industrial Production (IIP) reveals that the industrial production grew at an average rate of 5.4% during the first three decades after the independence. The low level of growth, particularly since mid-60s upto 1980, can be largely attributed to the lack of investment demand due to the industrial licensing regime. Further, the controls on production and capacity expansion of private sector and widespread of public sector had adverse impact on efficient utilisation of resources, which was reflected in the high incremental capital output ratio (almost 6.6%) during the 1970s. Besides, a number of exogenous shocks like the devastating three-year drought of 1965-68, the downturn in the availability of foreign resources and the oil price shocks of 1973 and 1979 had adverse impact on growth of industrial production. For instance, the sharp rise in international oil prices by OPEC in response to the Yom Kippur war of October 1973 led to high inflationary pressures in the domestic economy. The inflation in fuel group rose substantially to 18.6% during FY74 as compared with 3.97% during the previous fiscal, pushing the headline inflation to 20.2% (from 10% during FY73). High raw material costs due to rising prices of fuel and several other commodities weighed down the growth in industrial production during 1973-75.

With the gradual liberalisation of industrial and foreign trade policy during 1980s, growth in industrial production witnessed substantial increase and registered an average growth of 7.8%. The substantial growth in infrastructure industries (growth in the composite index of six infrastructure industries averaged at 7.46% during FY83-FY90) also played a critical role in the growth of industrial production. Moreover, in the 1980s, sectors, such as automotive industry, cement, cotton spinning, food processing and polyester filament yarn industries experienced modernisation and expansion of production of scale. This had a positive impact on the overall manufacturing sector. Growth in manufacturing sector averaged at 7.41% during 1980s driven by food products, textile products, rubber, plastic, petroleum & coal products and basic metal & alloy industries.

In addition, there was a rise in public sector investment in infrastructure sector which gave a boost to capital goods sector. Growth in capital goods sector averaged at around 11.50% during FY82-FY90. Further, consumer durables sector witnessed a strong growth (averaged at 14.64% during FY82-FY90) thus revealing the impact of industrial and trade reforms initiated by the Government on consumption demand.

IIP continued to grow above the 8% mark in FY91, driven primarily by food products, cotton textiles, basic metal & alloy industries and machinery & equipment other than transport equipment industries which together contributed almost 61.5% of growth in IIP. High growth experienced in these sectors was further manifested in the performance of capital goods and consumer durables sector which registered an impressive growth of respectively 16.02% and 10.46% during the same period. However, high growth in industrial production witnessed during 1980s and FY91 could not be sustained during the subsequent year due to the Balance of Payments crisis (1991). This led to severe imports compression, which resulted in a decline in imports (in dollar terms) by almost 20%. The decline in imports that affected production of import-intensive industries coupled with the tightening of credit availability and subdued demand conditions owing to a decline in agriculture output (particularly food grains) and slowing down of overall economic growth had dampening impact on the industrial activity. In FY92, growth in IIP slumped to mere 0.61%, with as many as ten out of seventeen major manufacturing categories within manufacturing sector registering negative growth. This pulled down growth in manufacturing sector to -0.77%. The decline in production of various industrial sectors was further reflected in the performance of capital goods (-8.57%), intermediate goods (-2.20%) and consumer durables (-10.72%).

Post liberalisation, the manufacture of commodities that required imported inputs/components and/or commodities which could be supplied through domestic assembly (like computer hardware) witnessed substantial increase. As a result, growth in IIP picked up during FY93-FY97 and registered an average growth of 7.38%. During the same period, IIP posted its highest ever growth of 13.02% (FY96). Within manufacturing sector, food products, beverages, tobacco & related products, cotton textiles, basic chemicals & chemical products, basic metal & alloy and transport equipment & part industries witnessed substantial growth, together contributing 60% to growth in IIP. With the overall recovery in industrial activity, investment demand displayed a significant rise and had positive impact on growth in capital goods sector. At the same time, consumer durables sector grew by 13.43%.

Source: CSO and D&B Research

In spite of a recovery in the manufacturing activity, growth in the mining & quarrying industry declined during FY93-FY97. The sector registered a negative growth of 1.91% in FY97 (the lowest growth since 1982), pulling down growth in IIP by 3.33%. Mining & quarrying sector had witnessed a considerable slowdown since mid-1980s due to a decline in capital expansion in this sector amidst fiscal constraints. Besides, the poor quality of available deposits of certain minerals such as gold, copper and metallurgical coking coal adversely impacted the growth of the industry post liberalisation. Prior to trade reforms when India had high tariff rates and severe import constraints, extracting very lean ore at a high cost was viable. However, after liberalisation and trade reforms, metal companies were allowed to import good quality ores at low tariffs. This coupled with low capacity utilisation had adversely impacted the domestic mining & quarrying industry.

During FY98-FY02, growth in mining & quarrying sector slowed down further and averaged at 2.25%. Further, the capacity expansion by domestic companies which peaked during mid-1990s led to an over-capacity situation to a certain extent during FY98-FY02. This coupled with a huge inventory build-up resulted in lower demand for new investment. A decline in domestic demand for intermediate goods, low inventory demand for capital goods and infrastructure constraints (particularly in power and transportation sector) and high interest rate regime together led to a considerable moderation in production growth across the sectors. Growth in manufacturing sector declined to 5.28% during FY98-FY02 as compared with 8.05% during FY93-FY97. Within manufacturing industries, cotton textiles, basic metal & alloy industries and transport equipment & parts industries significantly slowed down.

During FY03-FY07, industrial production begun to march on to a high growth path (shown in Fig 9.1), posting an average growth of 8.17%. An upsurge in industrial output was mainly attributed to increase in exports, relatively lower interest rates & availability of retail finance that stimulated demand for consumer goods and liberalisation in foreign direct investment (FDI) policy. On a sectoral basis, growth in manufacturing sector increased considerably driven primarily by Basic chemicals and chemical products (except products of petroleum & coal), Basic metal & alloy industries, Machinery & equipment other than transport equipment and Transport equipment & parts. These sectors together contributed more than 50% of the growth in manufacturing output.

Further, high growth in Basic metal and alloy industries as well as Machinery & equipment other than transport equipment sectors benefited capital goods sector. In recent years, the country has witnessed IT boom which has led to rising income levels. This coupled with improved availability of credit led to boom in real estate sector and automobile industry, which in turn helped to accelerate growth in consumer durables sector.

9.1.1 Major Contributors to Growth in Industrial Production

While detailed insights on various industrial sectors are provided separately in Chapter Sectoral Overview, in this chapter we seek to provide a brief insight into industries which have witnessed strong growth in last few years. A detail analysis of industrial production data reveals that some of the sectors like food & beverages, basic chemicals & chemical products, basic metal & alloy, machinery & equipments and transport equipments & parts have grown significantly in last few years and have emerged as major contributors to IIP growth.

For example, the Indian chemical industry has grown significantly since independence. During the pre-liberalisation period, protectionist measures like import substitution policy and high tariff walls played a key role in the development of the industry. In addition, between the period late 1960s to 1980s, the domestic fertiliser and pharmaceuticals industries witnessed strong growth, which in turn accelerated growth in the chemical industry in India. However, after liberalisation and trade reforms, the reduction in tariff rates exposed domestic chemical companies to competition from their international counterparts. This indeed had a positive impact on the Indian chemical industry (as Indian companies were required to undertake various initiatives like research & development, development of technological capabilities in order to increase competitiveness). During the same period, major investment plans by both Indian companies and MNCs were initiated. Besides, the shift in demand towards low cost products in the global chemical industry in last few years helped the chemical industry in India to grow further. The Indian chemical companies have benefited the most from this trend as they have developed capability to produce several basic chemicals in a cost effective manner over the years. Further, the ability to produce bulk generic chemicals at low cost has encouraged several Multi National Companies (MNCs) to invest in India. The basic chemicals & chemical products industry grew at an average rate of 8.96% during FY03-FY07 backed by domestic demand as well as rising exports of drugs & pharmaceuticals and fine chemicals.

Besides chemicals industry, basic metal & alloy and machinery & equipments (other than transport equipments) have evolved as one of the key contributors to the IIP growth. The establishment of public sector companies in basic metal & alloys sector laid foundation of this industry. However, the sharp rise in the growth of basic metal & alloys industry was witnessed mainly after liberalisation which introduced various policy reforms (such as delicensing of industries, declining role of public sector companies, etc). Moreover, the rise in investment expenditure for capacity building by private sector companies as well as overall economic growth that raised demand for steel, non-ferrous metals & alloys provided an impetus to the industry. At the same time, strong growth in manufacturing activity spurred demand for machinery & equipments. For instance, the boost in automobile & auto ancillary industries led to sharp rise in demand for die-moulds and cutting tools. Besides automobile industry, robust growth in electronics, consumer durables, IT products, telecom and packaging industries has spurred demand for machinery & equipments.

The automobile industry is yet another sector which has grown at rapid pace after 1990s. This mainly came on the back of various tax reliefs provided by the Government in order to promote the sector, liberalised imports and rise in FDI. In addition, relatively lower interest rates since FY02 and increased availability of credit have stimulated demand for auto industry in India. The high growth in auto sector has further been manifested in rising industrial production of transport equipments.

Further, rising household incomes, increasing urbanization, changing lifestyles and evolution of big retail stores (supermarkets, malls, etc) has led to the sharp rise in demand for food products, especially milk-based products like processed cheese, butter and ice cream. Besides, certain Government initiatives like development of food parks, warehousing and cold chain facilities also helped to accelerate growth in the food & beverages industry.

While the above mentioned sectors witnessed high growth in recent years, sectors like Leather and leather & fur products and rubber, plastic, petroleum and coal products industries that were on high growth path upto FY02, experienced a decline in growth during FY03-07.

Box 9.1: Indian – An Emerging Global Manufacturing Hub

While the advent of the information technology revolution and business process outsourcing led to rapid growth of the services industry in India, poor infrastructure, bureaucracy and restrictive labour laws had restrained growth of the manufacturing sector for quite a long period. However, things are changing rapidly with an increasing number of Multinational Companies (MNCs) (like Huyndai, Ford Motor Co, Matsushita, Toyota, GE, Siemens, LG, Motorola and Nokia, etc) establishing their manufacturing operations in India. The advantages the country offers in terms of availability of skilled manpower at relatively low costs, the huge domestic market and significant cost reductions in logistics and inputs are expected to enable India emerge as one of the world’s most attractive manufacturing destination.

Besides, Government has taken various initiatives in order to remove the infrastructure bottlenecks. These initiatives include:

1. The introduction of several projects to improve road and port transportation; which includes the largest road networking project, The National Highway Development Programme

2. The introduction of New Telecom Policy in 1999 which significantly reduced telecom costs

3. The introduction of Electricity Bill which allowed the increased participation of the private sector companies in the power sector

4. The rationalisation of corporate tax and indirect tax structure

Meanwhile, with the changing trends in the manufacturing activity, certain functions which were earlier linked to the manufacturing chain like Research & Development, marketing, customer support are being largely outsourced in order to make the operations economical. The emerging trend has benefited many companies in India.

9.2 Trends in Index of Six Infrastructure Industries

While we analyse growth trends in India’s industrial production, it is essential to look into the performance of six core infrastructure industries as it has played a crucial role in the IIP growth. An analysis of data on infrastructure industries reveals that growth in the composite index of six infrastructure industries averaged at 7.84% during FY83-FY87 driven primarily by electricity, cement, crude petroleum and petroleum refinery products. The crude petroleum sector registered an average growth of 14.03%, contributing almost % to the growth in six infrastructure industries. The robust growth displayed by crude and petroleum sector was mainly due to the rapid growth of crude oil production following the discovery of Bombay High – an offshore field.

Growth in the six infrastructure industries, however, witnessed a witnessed a generally decelerating trend between the period FY88 to FY94 on account of reduction in public sector investment in infrastructure sector due to fiscal constraints. On an average, growth in the composite index of six infrastructure industries declined to 6.43% during FY88-FY92 and further to 4.26% during FY93-FY94. The impact of a decline in growth six infrastructure industries was further manifested in slowing down of industrial activities.

Growth in the infrastructure sector, however, picked up during FY96-FY97 and registered an average growth of 7.15%. An upsurge in growth of six infrastructure industries was backed by a substantial increase in production of finished steel and cement which contributed almost 48% to the growth in composite index of six infrastructure industries.

This high growth in six-infrastructure industries was, however, short lived. The composite index for six infrastructure industries posted an average growth of 5.18% during FY98-FY02. Barring petroleum refinery products, growth in all major categories in six infrastructure industries displayed moderation. The substantial decline was witnessed in crude petroleum sector due to declining production following the closure of wells in offshore fields and low reserve accretion. The sector registered an average growth of -0.5%, thus pulling down growth in the composite index of six infrastructure industries by 3.31%. Further, the Table 9.3 indicates that a decline in growth of crude petroleum sector had adverse impact on industrial production as well. It weighed down the IIP growth by 0.75%.

Growth in six infrastructure industries recovered once again during FY03-FY07 and posted an averaged growth of 6.37%. Electricity and finished steel industries together contributed as much as 65% to the growth in six infrastructure industries. Although electricity sector accounts for one of the key contributor to the growth in infrastructure industries, growth in the electricity sector has shown some moderation, manifesting the decline in public investment.

In recent years, finished steel sector has emerged as one of the major contributor to the growth in infrastructure industries. Finished steel sector witnessed a significant rise in production after liberalisation. An upsurge in growth of finished goods sector is mainly due to various reform measures like abolition of licensing requirements for reform measures, removal of steel industry from list of industries reserved for public sector, removal of price and distribution controls, etc.

Further, the huge investments planned in the infrastructure sector both by the Government and private sector and booming construction sector have led to rise in cement output in recent years.

9.3 State-wise Distribution of Industries

The Indian Industrial sector has witnessed considerable expansion as can be concluded from the discussion in the previous section. However it is important to note here that, although the industrial sector in Indian has registered significant growth the data on state-wise distribution of industries reveals that growth in industrial sector has not spread uniformly across the country. According to the latest Annual survey of Industries (ASI) (2004-2005), out of the total 28 states and 7 union territories in India only six states viz. Maharashtra (19.74), Gujarat (13.86), Tamil Nadu (8.30), Karnataka (7.90), Jharkhand (6.46) and Andhra Pradesh (6.13) account for more than 62 percent of the net value added in the organized industrial sector. Thus these states have contributed significantly towards industrial development in India. However other states particularly some northern and north eastern states have lagged behind in the process of industrial development.

Over the years the state governments have taken many measures to provide conducive climate for industrial development. For example the state Government of Andhra Pradesh enacted Industrial Single Window Clearances Act, (effective June-22-02) for speedy processing and issue of various approvals/clearances/ permissions required for setting up of an Industrial undertaking and also to ensure creating an investment friendly environment. The robust growth of industrial sector in few states can in part be attributed to the pro-active and supportive policy regimes, development of infrastructure, labour market flexibility, enhanced factor productivity and improved availability of industrial finance.

In accordance with the Central Governments policy, State Governments have also carried out industrial policy reforms leading to reduction in the industrial licensing requirements, removal of restrictions on investment & expansion. State governments have been encouraged to compete with one another for attracting foreign investment. As a result many attractive incentives are being offered to various industries and investors. For example tax benefits fro industries setup in backward area offered by the State government of Maharashtra; several state governments have set up ‘single-window clearance facilities’ and ‘investor escort services’ to smoothen the passage of investment proposals.

The liberalised industrial climate has also facilitated easy access to foreign technology as well as foreign direct investment. The state-wise information on industrial investment (through IEM, LoI and 100% EOU) for states in India reveals that Gujarat, Maharashtra, Chhattisgarh, Andhra Pradesh are among the most favoured destination for industrial investment in the country. These states account for almost 45.5% of the proposed industrial investment in the country.

9.4 Small Scale Industrial Sector in India

Small Scale Industries form an important segment of the Indian economy not only in terms of their contribution to industrial production and exports but also in terms of employment generation and creation of an entrepreneurial base. Thus, the SSI sector in India has gained significant importance in the industrial policies. The foundation of the policy for small scale industry was laid in the Second Five Year Plan (1956). The development of Micro, Small and Medium Enterprises (MSMEs) was recognised as an effective tool to expand employment opportunities, to ensure equitable distribution of the national income and facilitate effective mobilisation of private sector resources of capital and skills. Hence, small scale sector was guarded with various protectionist measures such as reservation of items for their exclusive manufacture, access to bank credit on priority through Priority Sector Lending Programme, various tax incentives, reservation under the Government Purchase Programme and 15% price preference in purchases. Besides, the Government established the Small Industries Development Bank of India (SIDBI) in 1990, as the apex refinancing institution for small businesses. Reservation of items for exclusive manufacture in MSME sector has been one of the important policy measures for promoting this sector.

While these supportive measures benefited small scale sector to some extent, it increased dependence of small scale sector on subsidies, concessions and reservations for their survival leading to adverse impact on their productivity and efficiency. Therefore, in order to promote, strengthen and liberalise the small, tiny and village enterprises, the government of India announced the New Small Enterprises Policy on August 6, 1991. During the post liberalisation period many initiatives aimed at easing regulations and controls coupled with supportive measures like the Delayed Payment Act, schemes for ISO-9000 quality certification, the Prime Minister’s Rozgar Yojana, credit guarantee scheme, cluster development initiatives etc have been undertaken. The reservation policy was relaxed gradually with an aim to provide SSI opportunities for technological upgradation, promotion of exports and economies of scale. Number of items reserved for exclusive manufacture by the SSI sector has been gradually brought down to 35 items as on 5-Feb-2008. The Micro, Small and Medium Enterprises Development (SMED) Act, 2006 was enacted providing the first-ever legal framework for recognition of the concept of “enterprise” (comprising both manufacturing and services) and integrating the three tiers of these enterprises, viz., micro, small and medium. This act has significantly broadened the definitions and coverage of the MSE sector. Further in February 2007 the Government announced a package for promotion of the SSI sector.

Although the process of economic liberalisation has exposed the Indian Small scale industries to increasing levels of global and domestic competition, it has provided the SSI sector with attractive opportunities of accessing large markets and creating deeper linkages with the larger enterprises.

It is important to note here that, with various initiatives taken by the government the MSME sector has registered robust growth during the last few years. According to the Ministry of Micro, Small and Medium Enterprises, in recent years the MSE sector has consistently registered higher growth rate compared to the overall industrial sector. The below table summarises the growth of the MSME sector: