Today's Editorial

20 March 2018

Rethinking make in India

Source: By V Kumaraswamy: The Financial Express

Make-in-India is one of the key cornerstones of the current government to raise growth rates and create employment. It has been almost four years since the initiative was launched, with much hope and fanfare. The government has, since then, initiated several useful steps and reforms to actualise it. The most recent upgrade in credit rating and the 30-odd point jump in the Ease of Doing Business rankings will get us some mileage. However, it is clear that the delivery of Make-in-India is rather patchy.

Several reasons have been advanced for its lacklustre show, including highly overvalued currencyunfavourable ASEAN-India Free Trade Area, tight and unyielding monetary policies, very high real interest rates, high logistics costs, etc. All of them have a degree of truth. But it has to be recognised that beyond all these, an entrepreneur or corporate will invest only if they get remunerative prices and returns are competitive to what the other sectors yield. This last aspect has not been addressed at all by the government or inflation conscience keepers. Had this single factor been corrected, Make-in-India would have had a far better report card to show.

Nature of Indian manufacturing

Indian manufacturing is not high tech where heavy engineeringhigh-end electronicsaircraft and spacecraft, shipbuilding, etc, dominate. It is relatively low- to medium-grade in its maturity. It has a heavy dominance by industries that prepare or convert produce from agriculture for domestic consumption. For example, textiles sector (the biggest industry by employment) is dependent on agriculture for cotton supplies and silk, which can account for about 60% of final product costs.

Similarly, sugar industry is dependent on sugarcane; cigarette on tobacco; beedi industry on tendu leaves and tobacco; vegetable/cooking oil industry on sunflowers, groundnut, sesame; food processing industry on wheat, maize, fruits, fish, poultry; and dairy industry on milk. Roughly 40-45% of the Indian manufacturing sector depends upon agriculture for inputs, and a few more on inputs from mining.

It is important to maintain a balance between input and output prices in these sectors, and they should ideally move in tandem if the manufacturing sector has to stay attractive for investments. In India, since agriculture feeds industry and industrial final goods are sold to those in rural and agriculture areas, any persistent imbalance could hurt both. Our manufacturing prices are down 41% since 2004-05 in relative terms the terms of trade in international trade mean the prices a country gets for its basket of export goods versus what it pays for its imports and how the relative price moves over a period of time.

In domestic trade, it means how the prices that a sector gets for its output moves in relation to the prices it pays for its inputs from other sectors. Since 2004-05, the terms of trade have been relentlessly moving against manufacturing. If the manufacturing sector has had to pay 165% more for its key inputs from the agricultural sector, it has been able to recover just about 57% from its customers. If agricultural input prices are taken as the base, the manufacturing sector is getting nearly 41% less today for what it sells to other sectors compared to what it pays for agri inputs (see chart).

At one level, it helps transfer of income from non-agriculture sectors to rural and agriculture sectors, and thus corrects income skewness. But a consistent increase of this magnitude has continuously eroded the margins of the manufacturing sector to unattractive and unsustainable levels, leading to lack of enthusiasm in investing.

The major reasons

Year-on-year, for almost a decade and a half, agri inflation has been more than parity. This has come about by steep and arbitrary increases in minimum support prices (MSP) announced by the Centre for many crops, especially in 2009-10, 2010-11, 2012-13 and 2013-14, possibly due to electoral compulsions. Although MSPs are restricted to certain crops, farmers tend to gravitate towards higher MSP-yielding crops till the yield per hectare for other crops equalises with that under MSP.

Thus, MSP impacts transmit with a lag on other crops as well. One has witnessed a similar phenomenon in rural wages consequent upon implementation of MGNREGA. On the other hand, the ASEAN-India FTA agreement has more or less put an effective ceiling on the prices that manufacturing can recover for its end-products. Free trade has more or less made recovering cost inflation through domestic price increases an impossibility over the years. India’s overvalued currency has played a spoilsport on top of these.

The need for correction

India’s growth story, to continue, requires the manufacturing sector to expand and diversify, and create employment for those released from rural and agricultural sectors. As a sector saddled with the responsibility of creating jobs for those entering the market, it should be the one that is relatively more attractive. Unfortunately, things are exactly the opposite for the last decade and a half, relentlessly. Ease of doing business can contribute to encourage entrepreneurship by making the state machinery less intimidating, but it cannot alter the base investment arithmetic of Return on Investments (ROIs).

The approach announced in the recent Union Budget, for MSP fixation, might lend stability and certainty. If MSPs are linked to input prices, which should include manufactured items like fertilisers, pesticides, seeds, etc, the inflation of manufactured products would have a decisive say in agri inflation and hence MSPs. They would get interlocked. Details are awaited on the exact scheme. Even if a margin of 50% is built in (which should take care of imputed interest, rent and profit, besides inflation of inputs), it would build some parity and hence rein in persistent deterioration of adverse terms of trade against manufacturing. Even so, the heavy backlog built up since 2004-05 would need to be corrected if manufacturing is to see green shoots again. The states also should have a say in future FTAs; they should have a choice of which industries and products to offer for free imports and which products to seek exemption from our overseas importers. States should also have a say in the fixation of MSPs.



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