Manufacturing Sector's Recent Performance Indicates Underlying Inertia: Exim Bank
The recent performance of the manufacturing sector has been indicative of an underlying inertia and sector-specific strategies are one facet of the mosaic of elements, which would influence the manufacturing landscape in India, says a research note.
In the report, Export-Import Bank of India (Exim Bank) says, "Encouraging research and development (R&D) and skill development, strengthening industrial clusters, correcting inverted duty structures, utilising public procurement for capacity development, developing efficient customs and port procedures, state-level interventions for encouraging industrial development, creating reliable standards and certification systems and developing robust infrastructure would be the other key tenets of the revitalisation plan for the Indian manufacturing sector."
Manufacturing plays a key role in economic growth and development. A weak manufacturing sector often translates into high import dependence and large trade deficit.
Recent data on India’s manufacturing sector indicates that manufacturing accounted for only 15.1% of India’s gross value added (GVA) in 2019-20, compared to a share of 18.35% in 2010-11. This contraction in manufacturing is in spite of the strong growth in private consumption in the country, which registered an annual average growth rate of 12.7% from 2011-12 to 2019-20.
Prima facie, Exim Bank says, this is indicative of a greater share of the domestic demand being channelled towards consumption of foreign goods and services.
Further analysis of India’s imports by end-use (capital, intermediate, and consumer goods) indicates that nearly 79% of the imports by India in 2019 were intermediate goods, signifying the dependence of India’s manufacturing sector on imported intermediates, it added.
Exim Bank says, "The significant dependence of Indian manufacturing on imports is also corroborated by the analysis of financial data of a sample of 8,558 Indian companies, which shows that foreign exchange spending accounted for 25.5% of the total sales of these companies in 2018-19. The high import intensity in the manufacturing sector also translates into a higher level of foreign value-added content in India’s manufacturing exports. The import intensity of exports is especially high in the case of basic metals, fabricated metal products, computer, electronics and optical products, electrical equipment, and machinery and equipment."
The report identifies eight sectors, capital goods, chemicals and allied, electronics, defence equipment, pulses and edible oil, plastic and products, solar cells and modules and others sectors like iron and steel as the ones with high trade deficit.
The trade deficit in capital goods sector currently stands at around $17 billion. Strategies for indigenisation in the sector could include, encouraging technology transfer and investments in the capital goods sector, fostering innovation-led start-up ecosystem through mechanisms, such as innovation challenge funds and innovation vouchers, support for creation of testing and certification infrastructure and introduction of schemes for refund of expenses incurred on certifications, expanding the scope of public procurement by relaxing conditions of prior supply in the technology-intensive areas, among others.
Exim Bank says, "the government could consider promoting capital goods for intelligent manufacturing through a national policy for adoption of Industry 4.0, which could inter-alia include schemes for facilitating domestic manufacturing of high-technology products like sensors, creation of industry standards for Industry 4.0 products, and incentive schemes for the medium, small and micro enterprises (MSMEs) to encourage adoption of Industry 4.0. The government may also like to look at addressing the issue of inverted duty structure as well as revisiting the duty concessions under free trade agreements (FTAs)."
Further, hi-tech manufacturing zones could be developed by government in collaboration with state governments. Additionally, government could also consider promoting technology acquisitions and technological upgradation by encouraging mergers and acquisitions through an alternative investment fund (AIF), it added.
Chemicals and Allied Products
The chemicals industry has emerged as one of the fastest growing industries in India. While the industry has registered significant growth in the past two decades, India faces significant trade deficit, amounting to $4 billion in this industry. Some of the products in which India has import dependence are: phosphoric acid, styrene, aluminium oxide, and anhydrous ammonia. The study highlights that India has a significant dependence on China for imports of antibiotics, penicillin and heterocyclic nitrogen compounds.
According to Exim Bank, India’s dependence (backward linkage) on China is higher for some critical inputs used by the chemical and pharmaceutical industry. "To reduce the import dependence and boost chemical exports from India, greater emphasis should be laid on enhancing India’s integration into the global value chains (GVCs). Further, the study recommends that the government could enter into strategic partnerships with top global importers like the US, Germany, Japan and South Korea to attract investments, besides providing conducive business environment to manufacture in India," it added.
India was the second largest importer of major weapons in the world during 2015-2019. India’s trade deficit in defence equipment amounted to $7.8 billion in 2019-20.
According to the report, possible strategies for promoting indigenisation in the sector could include: revisiting the foreign direct investment (FDI) limit under the strategic partnership model, removing tax impediments to create a level- playing field, addressing the ambiguity in procurement categories, and bringing out policies to ensure greater accountability, among others.
It says, "It may also be important to carry out some revisions in draft offset guidelines 2020 such as revising the quantum and threshold for offset, considering differential quantum levels for single-source procurement vis-à-vis competitive tendering, and reconsidering the multiplier coefficient for parts and components.
"Further, a defence development fund could be created by the government, which could be managed by Exim Bank, for facilitating medium to long term credit for exports of defence equipment from India. Additionally, the government could also launch a credit-linked capital subsidy scheme through this fund for the players in this sector," Exim Bank says in the report.
India currently has a trade deficit of over $41 billion in electronics. Electronic components, computer hardware and peripherals, consumer electronics, electronic instruments, and telecom instruments are some of the major segments contributing to the trade deficit in the electronics industry.
Some of the plausible steps which could be taken up by the government for boosting domestic manufacturing in electronics include: recalibration of the recently launched production- linked incentive schemes for attracting large-scale GVC (global value chain)-oriented investments, increasing customs duty on select non-ITA (Information Technology Agreement)-1 import items, renegotiating FTAs in the context of electronics, providing thrust to investment in medical electronics and devices, encouraging strategic electronics through adoption of a model similar to the US' trusted foundry model, and promoting innovation and R&D (research & development) through financial and fiscal incentives.
Exim Bank says, "There is evidence that availability of low cost working capital to electronic companies in countries such as China and Vietnam enhances their cost competitiveness. Therefore, the government could consider setting up a fund to provide interest subvention for working capital."
Plastics and Allied Products
India has attained significant diversification in the plastics industry over the past few years. However, the sector has a significant trade deficit of nearly $7 billion.
Exim Bank says, challenges exist especially in the area of sourcing of raw materials needed for plastic manufacturing. "It is suggested that the government may consider production linked incentive schemes for the sector, along the lines as in the electronics sector, which could position India as a viable alternative to countries like China in the long term," it says.
"There is also a need for the plastics industry to be included in a comprehensive economic partnership agreement focusing on technology transfer and investments, besides trade with select countries such as the US, Germany and Mexico that are strong in plastic manufacturing technology."
Pulses and Edible Oils
India runs a trade surplus of nearly $15 billion in the agriculture and processed food category, but faces significant import dependence in products like edible oil (crude palm oil, crude soya bean oil, safflower oil), and pulses (dried shelled lentils). Indonesia and Canada were the largest import sources for edible oils and pulses for India in 2019.
The study notes that backward linkages in India’s agricultural exports are substantially higher than the forward linkages, and there is a need to increase the GVC participation in agriculture, forestry and fishing through forward linkages with the global food processing industry. There is also a need to promote agricultural investments in the CLMV region, as well as the African continent, where opportunities exist.
This would entail long-term assurance towards buying back produce from these regions at a rate not less than the minimum support price for the same produce in India. The government also needs to diversify its import sources and put in place a consistent policy for import of these two key products.
Rare Earth Elements
Rare earth elements (REEs) are needed in various industries such as defence, electronics, and renewables, amongst others. India accounts for 5.8% of global reserves of REEs. The significant requirement of REEs in India is met through imports, particularly from China. As a way forward, India could explore the feasibility of sourcing REEs from other countries such as Brazil, Vietnam, Russia, Australia and the US. India could also collaborate with other countries for joint exploration activities, thereby securing REE assets within India and abroad.
Indian State-run companies can form joint ventures to secure minor mineral assets such as lithium and cobalt that could fuel India’s plan for mass adoption of electric vehicles by 2030. A dedicated overseas strategic investment fund for the purpose of securing RRE assets could be considered, which could be housed and administered by a specialised government financial institution, akin to the Chinese model. The government also needs to promote R&D in order to find better substitutes for priority minerals, as also in the recycling and material recovery areas.
Solar Cells / Modules
India has progressed immensely in the renewable energy sector, but significantly lags behind in manufacturing of photovoltaic cells, and consequently faces a huge trade deficit, with particularly high dependence on China. To reduce import dependence and enhance domestic production, an extension of the safeguard duty on solar cells and modules is required. Further, to stimulate the demand for solar cells and modules in the market, mandatory uptake of domestically manufactured solar devices by the state and Central government offices is also recommended.
Besides, domestic capacities also need to be built up for silicon wafers and ingots used in the manufacturing of solar cells and modules. The government could consider providing a viability gap funding to projects for setting up such facilities.
India has overall trade surplus in the auto-components industry but depends significantly on China for its imports of certain critical components such as drive transmission and steering parts, cooling systems, suspension and braking parts, due to cost competitiveness of China and lower technological competence of Indian players in the segment. To enhance domestic capacities, government could consider setting up technology upgradation fund for facilitating upcoming technological changes in the sector. The resources of the fund could be utilised for incentivising capital investments and low-cost funding.
The government could also consider rationalizing the GST (goods and services tax) levied for auto-components from the current levels of 18%-28% to 5%-12%. The GST could be reduced to 5% on components for electric vehicles (EV), bringing it at par with the GST for EVs.
While India is the world’s second-largest iron and steel producer, it is still dependent on imports. India had the highest trade deficit in iron and steel with South Korea in 2019, followed by China and Japan. India’s deficit in iron and steel with South Korea and Japan has almost doubled in the last decade, since it signed FTAs with these nations.
Going forward, India may like to review the implications of FTAs on the industry. India also needs to raise awareness on the utilisation of preferential tariffs. Better utilisation rate, in the long term, can increase India’s exports and ultimately reduce the trade deficit.
Besides, to produce iron and steel at globally competitive prices, Indian steel producers need to modernise their plants with state-of-the-art technology in order to increase the productivity, improve quality and reduce maintenance costs. The capacity utilisation of the steel industry in India is just over 75%, and needs to be increased substantially, given the demand for steel.