Business

Here Is Why Indian Manufacturing Is Struggling

Between April 2022 and March 2023, India's trade deficit in manufacturing exceeded $250 billion. This serves as a stark reminder of the challenges and lack of competitiveness of Indian manufacturing. The roots of this decline began in the 1990s and a lack of comprehensive reforms has limited the sector's ability to compete effectively on a global scale.
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A man at work in a plastic recycling facility, Uttar Pradesh, India. © PradeepGaurs / shutterstock.com

July 24, 2023 04:36 EDT
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Following India’s hard-fought independence in 1947, the nation stood at the threshold of a transformative journey toward industrialization. Prime Minister Jawaharlal Nehru proclaimed the ascendancy of factories as the “temples of modern India.”

However, navigating the complexities of this nascent industrialization required a delicate balance between fostering domestic growth and safeguarding against the influx of cheaper imports. To that end, Nehru implemented a policy of imposing high import duties, thereby erecting a protective barrier around domestic industries.40

In the 1990s, India, under the leadership of Prime Minister P.V. Narasimha Rao, confronted a pressing foreign exchange crisis that required urgent action. The government turned to the International Monetary Fund (IMF) for assistance, securing loans that would ultimately have far-reaching implications for the nation’s economic trajectory. The conditions attached to these loans marked a decisive turning point, as they compelled India to embark on a path of liberalization and open its economy to the world.

​​In compliance with the IMF’s prescriptions, India embarked on a momentous journey of economic liberalization, dismantling trade barriers and embracing free trade. Over the span of a mere decade, the government drastically changed its policy. It slashed import duties for industrial goods to the bone. The reduction, however, occurred without commensurate comprehensive reforms.

Amidst the rapid decline in import duties, the manufacturing industry found itself grappling with a confluence of factors that eroded its competitiveness. 

The costs of essential inputs for manufacturing, including furnace oil, power, loans and infrastructure, witnessed a notable uptick. Often, government-backed entities supplied these inputs. The cost escalations imposed a significant burden on domestic manufacturers, impeding their ability to compete on a level playing field.

Further red tape and corruption have plagued the implementation of a number of laws, including the Factories Act and the Environment and Pollution Control Act. This impedes the growth of the manufacturing industry and hinders its potential.

​​To meet local demand, look overseas

In the early 2000s, a noticeable trend emerged within India’s business landscape. An increasing number of domestic companies opted to outsource their manufacturing operations overseas and import products.

This strategic decision aimed at minimizing costs and capitalizing on global supply chains. Simultaneously, however, it contributed to the closure of numerous domestic industries that were unable to compete with the influx of cheaper imports.

Despite its vast size and burgeoning population, India finds itself heavily reliant on imports to meet a significant portion of its domestic demand. This has forced many industries in India to shutter their operations, as they are unable to withstand the onslaught of more cost-effective imports.

A notable example can be found in the calcium carbide industry, where Indian companies have increasingly turned to foreign suppliers for imports. By 2004, this had led to closures in the domestic industry due to the inflow of cheaper foreign sources, despite the presence of a heavy import duty.

The soda ash industry also outsourced production in the early 2000s as many big names like Tata Chemicals and Nirma bought plants overseas and imported soda ash into India rather than expanding their domestic operations.

Another striking example is India’s status as the largest importer of PVC resin globally. There has been no concurrent expansion of domestic companies. Neither have there been foreign companies establishing their own plants in the country.

These dynamics contribute to a business culture in India in which non-technocrats occupy leadership positions; their primary focus often lies in navigating the business environment rather than spearheading technological advancements. 

Subsidies, taxes and red tape

The decline of India’s manufacturing sector can be attributed, in part, to the comparatively higher input costs imposed by the Indian government. This discrepancy in cost has made it arduous for domestic companies to thrive amidst global competition.

A glaring example of this disparity lies in the freight costs incurred for transporting goods. It is almost twice as expensive to ship goods to the north of India from the south of India than it is to ship them from China! This is largely due to the burdensome 100% taxes levied on petrol and diesel.

Remarkably, it is less expensive to fly from Mumbai to Dubai than to travel the same distance from Mumbai to Calcutta. This is due to the exemption of aviation turbine fuel taxes for international flights.

India’s practice of subsidizing the government without yielding significant benefits has also become evident. The case of calcium carbide in the late 1990s exemplifies this. Despite a substantial duty on the chemical, imports of calcium carbide from China are far cheaper than domestically manufactured calcium carbide.

This is due to the exorbitant power costs imposed by State Electricity Boards in India. These elevated power costs significantly inflate the cost of producing calcium carbide domestically, rendering it less competitive compared to its imported counterpart.

India’s high indirect taxes also contribute to the burdensome costs of the manufacturing sector. It should be noted that the World Trade Organization (WTO) has recommended that exports should be exempt from such taxes.

Lastly, the acts and regulations governing the manufacturing industry in India often take on a policing approach rather than fostering a partnership for growth. 

For instance, in the airline industry, companies seeking regulatory approval to operate are not only required to obtain licenses but must also pay the regulation agency’s employees to develop the necessary skills for certification. Generally, these authorities lack the expertise of the industries they oversee.

This necessitates a reevaluation of the regulatory framework in India. By fostering a collaborative and supportive approach, authorities can align themselves with the needs of the sector. This entails developing a deep understanding of the specific industries they regulate and providing necessary guidance.

While I have not exhausted all of the factors, these are the core reasons why manufacturing is less than 15% of India’s gross domestic product. Despite the country’s abundant natural resources and a large pool of human talent, outdated methods of governance have continued to hinder the growth of the manufacturing sector. It is crucial to address these issues comprehensively.

Regulators can do better

Addressing the decline in manufacturing requires proactive measures from the government. 

  • Establishing a collaborative body: Creating a Ministry of International Trade and Industry-style body, similar to post-World War II Japan, can facilitate closer collaboration between businesses and industries.
  • Drastically reducing indirect taxation: Reducing the burden of indirect taxes can significantly alleviate the cost pressures on manufacturers. Additionally, allowing for the set-off of all indirect taxes at different stages of the production process would further enhance their competitiveness.
  • Embracing blockchain technology: Removing regulations and encouraging the adoption of blockchain technology can enhance transparency and efficiency in the approval process. By leveraging blockchain, the government can create a transparent and traceable system that streamlines regulatory procedures and reduces bureaucracy.
  • Incentivizing foreign investment: Providing attractive incentives to foreign companies can encourage them to invest in India’s manufacturing sector. Foreign investment can bring in advanced technologies, expertise and capital, leading to job creation and economic growth. Drawing lessons from Margaret Thatcher’s approach in the 1980s, India should embrace foreign ownership of companies to revitalize the manufacturing sector.

Implementing these strategies requires a change in mindset and a commitment to prioritizing growth. Government officials and policymakers need to adopt a proactive approach that encourages and supports industry rather than excessively regulating it. By fostering a conducive environment for manufacturing, India can move closer to achieving the goal of self-reliance—atmanirbharta—and become a global manufacturing hub.

[Naveed Ahsan edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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