Indian infrastructure, manufacturing, quality, and the US$2,400 car

Executive summary

Manufacturing is geared to play an increasingly important role in India’s economy. Despite inflationary pressures that suggest a slight cooling in overall economic growth this year, continued record growth rates in the manufacturing sector will likely help to keep overall economic growth between 8% and 9%.

Industry group representatives give a number of reasons for the surge, but none figure quite so prominently as domestic demand.

For India’s manufacturing sector to continue on this trajectory, several hurdles must be overcome, including inadequate infrastructure, cost-saving demands from price-sensitive consumers, and difficulties in exporting.

Investment in increasing labor productivity and the flexibility of labor regulations will also be crucial to the sector’s continued growth. All of this adds to the unique environment for Indian manufacturers, one that has the ability to develop niche products that will create new markets and expand existing ones. (OEM Exclusive: Request list of EMS/ODM providers anywhere in India)

New highs for manufacturing growth

As the Indian economy steams ahead, manufacturing has grown in tandem, matching or slightly exceeding overall growth rates. Unlike India’s agricultural sector, which has slowly declined in its contribution to India’s GDP over the last several years, manufacturing’s share of GDP has remained relatively constant at 15%, and is likely to increase.

Cygnus Business Consulting and research, a Hyderabad-based business consultancy, calculates that the top five growth industries in manufacturing are gems and jewelry – one of India’s top manufacturers exports, making up more than a quarter of exports to the United States – cement, steel, pharma, and engineering goods.

Foreign direct investment (DFI) has trebled over the previous fiscal year, and the Federation of Indian Chambers of Commerce and Industry (FICCI) estimates that one-third of FDI now goes to the manufacturing sector, and mostly into capital-intensive industry.

Why the sudden surge?

Dilip Chenoy, director general of The Society of Indian Automobile Manufacturers (SIAM), believes the manufacturing surge is driven by “100% domestic demand.” Chetan Bijesure, assistant director with the Federation of Indian Chambers of Commerce &. Industry (FICCI), agrees.

“The middle class is growing”, says Bijesure. “Its income is rising, and its buying power will continue to grow.” India’s middle class is estimated to be between 200 to 300 million and adding 40 million more people each year.

Dr. Sarita Nagpal, manufacturing services head with the Confederation of Indian Industry (CII), says that manufacturing locally is often key to success in the Indian market because of its idiosyncrasies.

“It takes market savvy”, she says, to design the kind of products that will appeal to Indians and function in the market. Dr. Nagpal cited the example of a ceiling fan motor – “only an Indian manufacturer would know to make a fan that can handle India’s wildly fluctuating voltage.”

Reinforcing her point, during a mid-April visit to Delhi, GM chairman Richard Wagoner explained that GM’s local manufacturing unit had to adjust gear ratios for India’s unique traffic conditions and to compensate for differences in India’s fuel quality

Cost-sensitive products – good for domestic market, not for export

While products may be specialized for the market, “Made in India” does not yet evoke images of quality or cutting-edge technology in the rest of the world. (Analysts note that in the acutely price-sensitive Indian market, consumers are often willing to sacrifice quality for lower cost).

Thus, manufacturing growth which is fueled by domestic demand does not translate into tougher standards for quality required to export to lucrative markets like the United States and Europe.

FICCI’s Bijesure observed, however, that the new manufacturing entrants into India will continue to bring greater focus on superior products. Wal-Mart, he says, is a perfect example; “they will not accept products that do not meet their standard, and upon entering the market, will introduce quality goods at a lower cost.”

As another example, investment in the automotive industry is increasing manufacturers’ focus on quality. Global car manufacturers with local plants in India have increasingly sourced from Indian auto part manufacturers. As such, stringent quality demand and the high expectations of foreign entrants to the market have raised the standard of local producers of auto parts, and created world-class quality and huge growth potential in this sub-sector of the industry.

Export potential of manufacturers

Within India, the sheer number of obstacles to trade may still cause some manufacturers to think twice before exporting. Moving goods from Northern industrial zones to Southern ports is expensive and time consuming, due to poor infrastructure (roads, ports), taxes levied by each state at its borders, and inordinate customs delays.

In a discussion panel, one former government of India trade official recalled some sage advice he had received, “India needs a free trade agreement with itself.” Indian states, on occasion, have their own regulations for transshipments and, there are significant waiting times at state borders – detrimental to volume manufacturers.

One manufacturer recently relayed to the Economic Office of the US Embassy (EconOff) that shipping electronics goods from Delhi to the port of Mumbai costs him even more than shipping from Mumbai to the U.K.

However, FICCI and CII both believe that Indian manufacturers are increasingly exploring opportunities in other developing markets. Specifically, they cite sub-Saharan Africa, The Middle East, former Soviet Republics, and the rest of Asia.

The Indian industry groups state that manufacturers are even contemplating the use of India as a manufacturing hub for other markets on the Indian Ocean. SIAM’s Chenoy assessed that Ford was engaged in just such a strategy – utilizing production facilities in South India to aggressively target Africa.

Infrastructure impediments

A lack of adequate infrastructure in many areas in India still hinders India’s manufacturing abilities. Capacity is strained in many of India’s sea ports, while poor road and rail networks raise the cost for the domestic portion the logistics chain. Chenoy laments the lack of adequate water works or sewage treatment, which also negatively affects manufacturing capabilities.

But India’s biggest hurdle to manufacturing may stem from its lack of adequate power.

It is estimated that the lack of adequate power resources reduces India’s overall output capacity by 9%. In fact, power constraints have prompted many manufacturers to set up their own generators and captive power plants. The Indian government is seeking to address the situation, although many new infrastructure projects (and especially those that are power-related) will take years.

Labor shortages and restrictions

Although India is endowed with labor surpluses, FICCI’s Bijesure believes that in the manufacturing sector, skilled labor resources are quickly drying up.

India has tended to see higher growth in capital-intensive industries (e.g., automotive parties, pharma, stell) which require more highly educated engineers, and slower growth in those that are low-skilled and labor intensive (e.g., leather, processed food, textiles).

This has rapidly depleted the market of higher skilled workers – those required to operate more advance machinery – and FICCI sees an immediate need for better training programs and collaboration with universities to keep growth levels high.

Labor regulations imposed by the Indian government also affect the manufacturing sector.

According to Indian law, companies with more than 100 employees are subject to more stringent labor codes, including requiring government approval to layoff workers. These policies provide a disincentive to large-scale manufacturing, and hinder the realization of economies of scale in production.

Many of these regulations are part of the ‘License Raj’ legacy which deliberately promoted small-scale over large-scale manufacturing that included elaborate licenses, regulations, and the accompanying red tape that were required to set up business in India between 1947-1990.

The one-lakh car and things to come

Indian conglomerate Tata’s ‘one-lakh’ (US$2,400) car may be another indicator of the potential from the Indian manufacturing sector to meet domestic demand in the future – an inexpensive and locally specialized manufactured good.

The car, which Tata has pledged to put on the market in 2008, would be entirely sourced from within India, exclusively target the domestic market (and India’s emerging middle class), and aim to come in under the psychologically-important price tag of one lakh (100,000 rupees).

Many analysts doubt Tata’s ability to ultimately sell the car below one lakh, but ther is no question as to the impact such a vehicle would have on driving domestic demand.

Currently, two-wheeled vehicles rule the road in India’s automotive market, as more than 70% of vehicles produced in India are motorbikes or scooters. Only 10% of autos manufactured in India are passenger vehicles. However, FICCI estimates that 30% of the two-wheel market would switch to Tata’s car. Tata has hinted at the possibility of marketing the car in African and ASEAN markets where two-wheelers currently dominate.

Comments

If its manufacturing sector is to become truly world-class, India will have to overcome many impediments that limit manufacturers’ abilities to develop low-cost, high-quality products that can compete in global markets.

To overcome such headwinds, India will need more and better public and private sector investment in human and physical infrastructure. Better education, especially, devoted to basic literacy and skills at the primary level; more roads, ports, and power plants; and a more responsive public sector are all requirements for a strong manufacturing sector that can make use of India’s ‘demographic dividend’ and of agricultural workers moving off the land.

While the government can take a little credit for manufacturing’s recent resurgence, its new-found focus on infrastructure and infrastructure financing are welcome steps. The question remains as to how quickly the government of India will translate this stated policy into concrete actions.

Learn more about India’s electronics manufacturing sector, including a recommended roadmap for success in India.

United States Embassy in New Delhi, Ventureoutsource.com