Industrial Growth and Policy

Since Independence

Industrial Scenario in 1950

•Ratio of consumer goods to producer goods – 62:38

•Weak infrastructure

•Lack of government intervention

•Export orientation against the economy’s interests

•Structure of ownership highly concentrated

•Technical and managerial skills at short supply

Policy for industrialisation

•1st 5-year plan•public sector to develop those industries “in wich private enterprise is unable or unwilling to put up the resources required and to run the risk involved”•Formulation of customs and excise tariff structure, import & export policy, investment & technology policy; monetary & financial policy

•2nd 5-year plan•public sector to be “commanding heights of the economy”•Allocation of public resources

Industrial control regime

•Five Year Plan documents

•Import & export controls

•Control of capital issues

•Control of foreign exchange

•Transport controls including allocation of raw materials

•Price controls

•Allocation of credit

Industrial Licensing System

Letter of Intent – Ministry of Industry

Capital goods import license from Ministry of Commerce

Capital goods & raw material import license from Chief Controller of Imports & Exports, Ministry of Industry

Foreign collaboration approval from committee of Finance Secretary & Ministry of Industry

Essentiality & indigenous non-availability clearance from technical wing of Ministry of Industry

MRTP clearance from Department of Company Affairs

SSI reservation

Public sector reservation

Ban on location in large cities

Industrial growth

•Share of industry has increased from 11.8% of GDP in 1950-51 to 24.6% in 1990-91

•Share in industrial value added from 1956 to 1990•capital goods from 4.7% to 23.7%•Basic goods from 22.3% to 28.4%•Consumer goods from 48.4% to 20.5%

Phases of economic growth

•Rapid growth in 1956-65•Value added in organised industry grew at 8%p.a

•Deceleration in 1965-66 to 1979-80•Value added growth rate decline to 5.5%p.a.•Decline more pronounced in capital goods and basic goods•Consumer goods (particularly consumer durables) showed slight acceleration

•Recovery and revival in the 1980s•Manufacturing sector grew at 7% p.a (8-9%p.a in the second half of 1980s)•Consumer durables grew at 14.2%p.a•Capital goods grew at 7.8%

•Beginning from 1991 economic policy reforms•Rate of growth fell in 1991-92, recovered till 1995-96, then decelerated till 1999-2000

Causes of stagnation during 1965-66 to 1979-80

•Slowdown in public investment and the resulting inadequate infrastructure investment (Prabhat Patnaik)•Poor management of infrastructure (Isher J Ahluwalia)•Slow growth of agricultural income and the resulting slow growth in demand for industrial products (K N Raj)•Restrictive industrial and trade policies leading to high cost industrial structure (Isher J Ahluwalia)•Domestic terms of trade for industry (Ashok Mitra)•Oil price shock, agricultural supply shock and political uncertainty in the late 1970s

Demand constraints more important than supply constraints

Demand constraints – slow agricultural growth, high unemployment rate, public expenditure: Nagaraj, Kavita Rao

Supply constraints – low productivity, high costs, low quality of products, obsolete technology – Isher J ahluwalia

Comparative growth rates in the 1980s and 1990s

Avg annual growth rate Avg annual growth rate (1980-81 to 1991-92) (1992-93 to 1999-2000)IIP General 7.8 6Manufacturing 7.6 6.3mining 8.4 3.3Electricity 9 6.6 Use-based classification Basic goods 7.4 6.1Capital goods 9.4 5.9Intermediate goods 4.9 9.1Consumer goods 6 6.3of which i) Consumer durables 10.8 11.2ii) Consumer non-durables 5.3 5.1Source: Economic Survey, 2000-01

Shift in policy regime in the 1980s

•Abid Hussain Committee on trade policy – easing of trade policy

•Narasimham Committee on shift from physical to fiscal controls - from physical and other quantitative controls to fiscal & other macroeconomic management

•Arjun Sengupta Committee on the public sector – greater public sector autonomy in business and operating decisions and the ened for measures for enhancing productivity efficiency and modernisation

Delicensing in the 1980s

•32 groups of industries were delicensed without any investment limit

•In 1988, all industries were exempted from licensing except for a specified negative list of 26 industries subject to investment and location limitations.

•Increased access of exporters to inputs at international prices but tariff protection to industry increased significantly in the 1980s

Effect of policy shift in the 1980s

•Hesitant experimentation in domestic deregulation•Highly protectionist trade policy•Loss making public sector intact

Gross fiscal deficit from 6.2% of GDP in 1980-81 to 8.3% in 1990-91 as the government became increasingly expansionary to support growing government expenditures on interest payments, defence, subsidies and administration.

Higher productivity and higher industrial growth

Following the Gulf War and current account crisis led to deregulation of foreign competition and try to attain macroeconomic balance

Pattern of growth in the 1980s

•All round increase in growth compared to deceleration phase

•Increase in growth rate steeper in consumer durables than in other sub-sectors

•Rise in real incomes of people in the middle income categories gave rise to large demand for consumer durables (pent-up demand)

•Highly import and energy intensive with little potential for employment generation

•Created bias for chemical based industries opposed to metal based industries

Factors for revival in the 1980s•Improvement in rate and pattern of gross domestic capital formation in general and public investment in particular

•Better performance of infrastructure

•Less adverse trends in terms of trade for industry

•Increase in the use of manufactured inputs in crop protection leading to growth in agricultural income by diffusion of green revolution technology

•Changes in industrial and trade policies leading to improvement in total factor productivity

•Import restrictions moved from quotas to tariffs (although still very high) and a steady depreciation of currency in nominal terms

•Greater reliance on private corporate sector with fiscal incentives for stock market based financing of industrial investment

Effect of factors on different sectors

•Response of output of consumer goods to a given increase in autonomous expenditure was greater in the 1980s than in the previous decade

•Response of output of capital goods to a given increase in public investment higher

•Import of capital goods had a negative impact on domestic production while the same had no effect in 1951-59

New Economic Policy of 1991

•Stabilisation policy•To correct weaknesses in the fiscal policies and balance of payments

•Structural reform•To remove rigidities in various segments (industrial licensing, foreign trade, foreign investment, exchange rate management, financial sector

Changes in trade & foreign investment policy

•Reducing tariff rates in stages

•Dismantling quantitative controls over imports

•Foreign investment rules moved from a policy of restrictive and selective FDI mainly through technology transfers to a more open one for better access to technology as well as strategic alliances to penetrate world markets – 100% foreign ownership allowed in many industries in most sectors except banks, insurance, telecommunications and airlines.

Changes in industrial policy

•Removal of industrial licensing for investment

•Opening up of all but a few strategic areas of industries earlier reserved for public sector

•Replace MRTP Act with a new Competition Law

•Many industries dereserved from small scale sector

Growth Pattern in the 1990s•Decline in industrial production in 1991-92, pick up in 1992-93-1995-6, deceleration in 1996-97

•Higher growth rate in 1997-98 with better performance in mining (better performance of crude oil), electricity generation (hydroelectricity); Manufactured growth rate remained the same

•Broad-based industrial recovery in 1998-99 and 1999-2000, contributed by manufacturing and electricity

•Slowdown in 2000-01 and 2001-02 – structural and cyclical factors like business & investment cycles, lack of domestic and external demand, high real interest rates, infrastructure bottlenecks in power & transport, lack of reforms in land & labor markets, adjustment lags of M&As, delays in establishing institutional and regulatory frameworks

Profile of industrial growth

•First phase of reform period (1991-92 to 1996-97)

•While consumer goods industries sustained growth momentum in the 2nd period, basic & intermediate goods fell; capital goods improved in the 2nd phase but fell from 2000-01

•Second phase of reform period (1997-98 to 2001-02)•Decline in capacity utilisation•Decline in potential growth

Manufacturing slowdown (1996-2002)•Satiation of pent-up demand for import-intensive consumer goods: short run demand facilitated by easy access to credit; huge capacity build-up in the first phase

•Credit crunch – unexpected and temporary tightening of liquidity in money markets to contain volatility in the forex markets

•Corporate funds locked up in inventories and receivables. Funds invested in financial instruments also locked up – depressed stock markets inhibited redemption of financial instruments.

•Rising interest rates prohibitive for new projects and investment

•Fall in government capital investment since 1995

•Over-expansion of capacities during the manufacturing boom

•Slump in capital markets for new issues

•Slowdown in rural demand for consumer durables and non-durables

•Slowdown in world trade

Deceleration in the second half of 1990s•Post-reforms, expectation of further reforms led to huge capacity creation.

•Investment boom in capital goods sector, without a corresponding rise in output growth of the user sectors, especially in the consumer durables goods for which the size of the market was found to be smaller than expected.

•Investment in unregistered sector halved, implying that investments are driven by potential size of the domestic market and expectations of liberalisation. E.g, automobile and consumer durables market, driven by FDI.

•Investment in unregistered manufacturing also hurt by high interest rates in the 2nd half of the 1990s.

Structural change in industries

•Shift towards registered against unregistered manufacturing

•Within registered, traditional industries like textiles, jute and other vegetable fiber textiles declined while modern segments like metal products & electrical machinery rose

•Stagnant share of manufacturing sector in GDP

Use-based groups•Capital goods sector grew at 6.7%p.a during 1981-98 and at 5.7%p.a during 1992-98.

•Within capital goods, production of passenger cars grew at 15% during 1981-98.

•Machine tools industry grew at 1.7%p.a during 1981-97 and at negative rate thereafter.

•Share of consumer goods increased from 35% to 42% during the period. Including the unregistered sector, the share is higher.

•Share of basic and intermediate goods went up while that of capital goods increased marginally.

Underestimation of the Capital Goods Sector

•Real price of capital goods and construction has come down with reduction of tariffs and growth of the cement industry (gradual decontrol, entry of new firms and technological upgradation) respectively.

•As price of fixed investment has come down, the share of the machinery sector in total industrial output is lower.

•But, addition to capital stock is more productive.

Long term constraints for industrial growth: different views

•Arthur Lewis: “productivity of farmers whose marketable surplus will exchange for manufacturers”. Land productivity in China 1/3 of China’s and per capita value added in manufacturing 1/4th of that of China’s

•Large countries generally have low trade ratios and depend on the domestic market. K N Raj: in a poor agrarian economy, lack of demand is a binding constraint for industrial growth

•Prabhat Patnaik: Lack of autonomous public investment

Employment effects

•In the 1980s, employment fell despite growth in manufacturing sector as employment fell in cotton & jute textiles

•Employment growth picked up from 0.8% in the 1980s to 2.3% in the first half of the 1990s

•Deceleration of manufactured growth in the second half had adverse effects on employment growth (-2.1% in this period)

•Employment in the manufacturing sector fell because of the shift from unregistered to registered sector.

•Construction sector compensated for the loss of employment in manufacturing sector so industrial sector (manufacturing, mining, electricity and construction) showed a marginal increase in employment

Recovery since 2002-03

•Industrial sector recovered in 2002-03 (5.7%), 2003-04 (7%), 2004-05 (8.4%), 2005-06 (8.2%) and 2006-07 (11.6%).

•Recession since 2007

•Capital goods and consumer goods sectors improved

•Investment-led growth and evenly spread within manufacturing sector

•Rising demand in both domestic and external markets

New Manufacturing Policy, 2011

aiming to increase the share of the manufacturing sector from 16pc to 25pc in GDP within a decade, creating 100 million jobs.aims to be inclusive and sustainable, empowering rural youth and protecting the environment.proposal for National Investment and Manufacturing Zones (NIMZs)rationalized and simplified the Foreign Direct Investment (FDI) procedures, making them more investor-friendly. The approval mechanism has been streamlined, with only projects of over INR60bn requiring to be placed for consideration of the Cabinet Committee of Economic Affairs.

Consolidated FDI Policy, 2011

•FDI in single-brand retail up to 51pc is allowed only for foreign investors who own brands. •The conditions in terms of minimum build-up area, minimum capital requirement, lock-in period, etc. for 100pc FDI in construction activities for schools, colleges, universities and old-age homes have been removed. •FDI limit for terrestrial broadcasting and FM radio has been raised from 20pc to 26pc.

FDI in retail

•Up to 51pc FDI is now allowed in single-band retail while retailing foreign products through Indian companies is allowed. The industry ministry had allowed FDI in multi-brand retail in 2011 but had to roll back the measure in a few days, following severe protests by the opposition as well as coalition partners. DIPP had suggested that a minimum investment of $100mn with at least half in back-end infrastructure including cold storage chains, refrigeration, transportation, packing, sorting and processing. It also suggested that a minimum of 30pc of sourcing from Indian micro and small industry would be mandatory.

National Investment and Manufacturing Zones (NIMZs)

•at least 5000 hectares each, which would be greenfield integrated self-governed industrial township projects with state-of-art energy-efficient technology and infrastructure. Although the policy is sector-neutral, it would be applicable to industries that would are able to operate in clusters.•The first phase of the NIMZs is proposed along the 1483km Delhi Mumbai Industrial Corridor•identified nine investment regions along this corridor that can promote NMIZs. It will also have high speed freight lines, three ports, six airports, a six-lane intersection highway between the political and financial capitals of the country and a 4000MW power plant.

Infrastructure Constraints

•Decline in steel, coal, cargo handling and freight loading

•Improvements in power and communication

•Improvement in telecommunications with decline in unit cost reflecting regulatory reforms and increased competition from private sector participation.

•Real gross capital formation in electricity, gas and water supply, railways declined

•Pace of public investment in infrastructure slowed down

•Response of the private sector has not been adequate in absence of user charges, lack of clarity in regulatory projects

The case of power sector

•High cost of power affect price competitiveness of manufacturing.

•Electricity tariff charged from industrial/ commercial users higher than average cost of supply.

•Issues of pricing, cross subsidy, ownership and regulatory issues.

•Poor recovery of SEBs’ dues and T&D losses

•Poor response of the private sector

Credit growth

•Small firms are largely dependent on bank credit compared to large firms

•Credit off-take from commercial banks declined in the 1990s

•Slowdown in credit growth for segments like exports, SSIs, medium and large industries

•Shift in credit towards iron & steel, electricity, food processing, cement, gems & jewelry, petroleum.

•Industries that had lower credit were metals, engineering, cotton, jute & other textiles, paper, chemicals, leather, construction

•Highest decline in engineering

•Long to medium term financing for greenfield projects and expansion activities also declined

Trend in corporate financing

•Increasing recourse to internal sources of financing against borrowed sources of funds

•More public placements of debt and equity with less stringent disclosure norms, low cost of issuance, ease of structuring instruments and reduced time lag in issuance.

•Reduced industrial credit result of risk-based prudential requirements like capital adequacy and provisioning norms following which banks are deploying funds in government securities

Productivity trends

•Turnaround in TFP in mid-1980s but declined in the 1990s

•Labor productivity low

•TFP decline since the 1990s because of slow structural reforms, infrastructural constraints.

•Production more capital intensive because of inflexibilities in the labor market

Public sector

•Policy of disinvestments and privatisation since 1991-92, when 1/5th of GDP was from the public sector

•In 2004-05, policy shift expressing commitment towards a strong and effective public sector deciding that profit-making PSUs will not be privatised.

•With acceleration of domestic output growth rate since 1980-81, PSUs have contributed additional output growth equally. After peaking at 12.5% of GDP in 1986-87, share came down to 6.4% in 2001-02 as a result of privatisation.

•Share of infrastructure in public sector investment has increased while manufacturing sector has come down.

•Fall in public sector employment growth

Privatisation

•Full or part sale of government-owned companies to private companies•Partnership between public and private sectors

1991-92: disinvest up to 20% of equity in selected PSUs to MFs and Fis in the public sector1996: Disinvestment Commission. Revenues generated would be allocated for education and health and for creating fund to strengthen PSUs.2001: restructure and revive potential PSUs, close down PSUs that cannot be revived, bring down govt equity in all PSUs to 20% or lower, entire receipts to go for social sectors2004: Ministry of Disinvestment became a department in the Ministry of Finance. Case-by-case decision. To retail navratna companies2005: National Investment Fund for investment in social sectors, capital investment in selected profitable and revivable PSUs

Continued importance of public sector•Output of the public sector as % of GDP peaked in 1991-92 at 26% and declined marginally.

•With acceleration of domestic output growth after 1980-81. public sector contributed to output in equal measure.

•With industrial deregulation and import competition, share of public sector in domestic output has remained roughly the same even though gross capital formation in the public sector has halved.

•Share of public sector investment has remained to be more in capital-intensive industries like mining, electricity, gas and water, transport & communication compared to manufacturing sector.

•Productivity in the public sector has improved

Private sector superior to public sector?

•No empiricial evidence

•Non-departmental public sector savings has increased while that of departmental (administration) has decreased

•Degree of competition and regulatory environment rather than ownership is important

•Assets of PSUs need to be put to productive use.

•Public sector employment has decreased

Public sector profitability•PSUs have high depreciation cost since they have to invest not only in plant & machinery but also on social overhead capital for which budgetary provisions are required.

•PSU capital structures are not aimed to maximise shareholders’ investment but provision of goods and services that are not provided by the private sector.

•PSUs usually begin with high proportion of debt

•Gross profit to capital employed is more important, which is rising. But, net of the petroleum sector, profitability of PSUs is rising.

• Revenue to cost ratios are higher because of inefficient pricing autonomy.

Nature of Infrastructure development

•Provision is monopolistic in nature•High upfront costs•Long payback periods•Investments bulky and lumpy•Existence of externalities

Mainly in the public sector in almost all countries

Commercialisation of infrastructure

•Massive investment requirements against fiscal stringency pushing governments to look for additional sources of finance

•Doubt over efficiency of public sector provision of infrastructure

•Global competition putting pressure on efficient infrastructure

•Dynamism and integration of world capital markets has increased the possibility of raising large funds for infrastructure investment on commercial basis

Major infrastructure sectors

•Transport•Roads•Railways•Airports•Shipping

•Power•Telecommunication•Rural infrastructure•Irrigation•Roads

Transport sector

•Roads•National Highway Development Project (Golden Quadrilateral and the North-South East-West Corridors)

•Main source of finance of National Highways Authorities is the fuel cess and budgetary grants

•Public –private partnership: private bidders funding construction of some stretches that promise high toll collections; projects on build-operate-transfer basis

Transport sector

•Ports•12 major ports and 200 non-major ports (60 non-major ports handling traffic)

•Private ports like Mundra coming in

•Bulk cargo like coal, steel, driving port expansion in the private sector

•Multimodal shipping involving coordinating rail and road connectivity between ports and hinterland becoming more important

Transport sector

•Railways•Dedicated freight corridor linking ports on the anvil•Private container operations

•Four mega-terminals at New Delhi, Mumbai, Howrah and Chennai are being considered for overhaul

•Railway wagons for coal transportation a major hindrance for supplying coal to power stations

Transport sector

•Airports•Tremendous growth

•Private airlines account for 76pc of domestic traffic

•Low cost airlines

•Privatisation of airports: Delhi, Mumbai, Hyderabad, Bangalore

Power sector

•Generation capacity is planned to be increased from the present 167,000MW to 200,000MW by 2012.

•Rate of return for the power sector still negative

•Most SEBs are loss-making and depend on subsidies

•Power losses during transmission and distribution 40pc

Power sector

•Nuclear power dependent on imported uranium

•Hydropower•Issues of land acquisition and people displacement•Private participation in small and medium projects

•Thermal power•Coal supplies major bottleneck: coal imports 52mt in 2011, expected to be 104 in 2012•Gas supplies: Dual pricing for domestic gas (APM pricing for ONGC fields, private fields prices also fixed by government), LNG prices highly volatile

Telecommunictaion

•Highly competitive•Problems•Frequent call drops•Poor connectivity•Absence of customer redressal cell•Unwarranted messages and telemarketing calls•Network performance in rural areas poor

Rural infrastructure

•Lack of private participation in roads, telecom, water, power, warehousing, banking•Reliance and Bharti are venturing into commercialising agriculture•Supply chain modernisation•Rural eletrification program•Rural roads

Challenges for infrastructure

•Financing•Land acquisition•Environment•Regulations•Designing of contracts

Delhi Mumbai Industrial Corridor

•covers 6 states, Haryana, Uttar Pradesh, Madhya Maharashtra and Gujarat, which account for 43pc of the GDP, 50pc of industrial production and 40pc of the labor force of the country.

•identified nine investment regions along this corridor that can promote NMIZs.

•high speed freight lines, three ports, six airports, a six-lane intersection highway between the political and financial capitals of the country and a 4000MW power plant