Industry 4.0 Can Leapfrog Indian Manufacturing
The long-term economic fragility of a developing country can be deciphered from its GDP construct. Manufacturing accounts for 16 % of India's GDP while the same is 40 % for a country like China whose economy is 5 times larger than India! United states manufacturing GDP is 19 % and the size of their economy is many times bigger than China. India does not rank in the top 10 countries of the world in terms of its manufacturing GDP.
This leads to the waterfall question and the one that is most commonly asked - What ails Indian manufacturing? Is there a future? What needs to be done to improve the share of manufacturing GDP? How will Indian manufacturing fit into the VUCA (Volatile, Uncertain, Complex and Ambiguous) economic situation prevailing the world over? Many years ago, the late C K Prahalad made an interesting observation "India has just the 2 priorities - Grow GDP at 10 % and create millions of jobs. However, neither the emotionals or the reductionists know how to accomplish it "
The reductionists are people who want India to focus on its core competence of low cost, high efficiency tech labour and use that strategy to leapfrog and become a service dominant economy like the US (70 %) just now. In their prism, manufacturing should be 'sub contracted' to low cost high productivity destinations like China or some other South Asian nations. These leaders have provided incremental attention to the manufacturing sector in India. The emotionals on the other hand are keen on India experiencing the manufacturing revolution before getting a service warhead on their economy. The justified rationale (and rightly so) is that India should consolidate its foundations in manufacturing and reduce dependency on global manufacturing hotspots. These two think tanks have collectively pulled Indian policy making into different paradigms. It has resulted in 'marginally incremental' focus on Indian manufacturing over the last several decades. That is the bane.
The problem statement
India had a great opportunity in 1991-92 to formulate a manufacturing led growth strategy. We deployed our 'inside out' strategy on services because that was a vacant space, easy to fill and we had the labour market elasticity to deliver that without much ado. China around the same time had accelerated its already buoyant manufacturing program and soaked in all major investments that came its way. This was the time when Chinese manufacturing reduced its dependence on international supply chains and developed their own for critical supply of products to major brands. India on the other hand satiated its economic ambitions through services because it delivered the quick topline GDP numbers. The services business (primarily software) grew at over 18 % consistently for a decade and half. This growth partly blinded India's need to consolidate its manufacturing to sustain long term economic benefits. Manufacturing got constrained by complex regulations, poor policy and a variety of other issues that included labour, taxation, environmental clearances and land availability. Over the last 25-30 years governments across the entire political spectrum of the country have ignored manufacturing sector. In simple terms the governments have ignored the opportunity to 'bite the manufacturing bullet' and have chosen the path of growth through convenience. With services business getting impacted due to a variety of reasons in its consumption geography the direct impact has been felt on India's economic story. The Gross Fixed Capital Formation (GFCF) of India has shown marginal growth in the last quarter but is way below the likes of Australia, Brazil and Canada.
It has now dawned upon India that manufacturing as a sector needs to be addressed with seriousness.
The early moves
Albeit 20 years late, manufacturing has finally been identified as one of the high growth sectors in India that can create sustainable jobs. 'Make in India' program was launched to attract some of the large international players from across sectors to manufacture in India with local participation up to a certain threshold. It was conceived to provide the MSME sector a larger spectrum of opportunity and reduce forex outgo for the country. Far from possible, but the government is hoping India to be the fifth largest manufacturing country in the world by the end of year 2020 through this initiative!
The manufacturing program has been further boosted by reforms like GST and policy initiatives like:
" Bank recapitalization
" The steel policy,
" Re-establishment of coal linkages,
" Establishment of Industrial corridors,
" Formation of the national grid for energy distribution,
" Reduction of income tax rate to 25 per cent for MSME companies having turnover up to Rs 50 crore,
" MAT credit carry forward extended to 15 years from 10 years,
" Modified Special Incentive Package Scheme for proposals (will be accepted till December 2018) or up to an incentive commitment limit of Rs 10,000 crore (US$ 1.5 billion). Etc.
However, a lot more needs to be done.
From an implementation perspective a lot of the above policies and reforms have not been leveraged with high efficiency. Indian public sector banks have virtually stopped lending because of the NPA issue, GST continues to face teething problems with uncertainty on rates and interpretation. The GST backbone - GSTN is not completely robust yet. A large part of the SME that struggled to recover after demonetization got stuck into the GST gridlock. All this is happening as global markets are showing slight recovery and are now consuming more. Indian exports have declined because of all the above-mentioned problems and this has reflected in a higher CAD and reduction in topline GDP.
The world is changing
Financial markets around the world are grappling with the VUCA challenges. The epicenter of VUCA lies in global trade platforms seeing a shift, Re-creation of trading zones, protectionist approach by global leaders, environmental issues impacting business models and finally the commodity prices.
Economists the world over are cautiously optimistic about recovery in 2017-18 after a sluggish 2016. With plenty of risks ahead including geopolitical and economic instability, here are the four main challenges facing the world economy
Protectionist global leaders
The International Monetary Fund has warned that rising populism and protectionism have correlated with stagnating economic growth. In its latest "World Economic Outlook," the IMF's chief economist Maurice Obstfeld warned that "turning back the clock on trade can only deepen and prolong the world economy's current doldrums." The IMF's managing director, Christine Lagarde, has described policies that restrict trade as a form of "economic malpractice" that could choke growth, jobs and wages, and further weaken the global outlook.
Brexit and associated issues
The most significant geopolitical event to occur in 2017, Britain's triggering of Article 50 and the commencement of its slow exit from the European Union has happened. Fortunately, the 'exit' has limited itself to Britain. Thankfully, the electorate of France, Germany and Netherlands have indicated their preference to stay in the Eurozone.
While Britain's influence on global economy has waned with times an event like this creates uncertainty. The longer the saga continues, the longer the associated uncertainty will be priced into currencies, dampening corporate investment and damaging the EU economy.
Monetary policy reaches its limits
Eight years of quantitative easing (QE) since the global financial crisis have increased the balance sheets of the world's four largest central banks from $6 trillion to $18 trillion, most of which consists of their own government's bonds. While QE has succeeded in maintaining short-term liquidity in markets, its diminishing returns mean the end of QE. Monetary tightening will begin.
Commodities recover albeit slowly
Commodity prices will see a modest recovery in 2017-18, according to the IMF's October report. Softer commodity prices have disproportionately hurt emerging economies. While emerging Asia and particularly India have appeared largely resilient, the IMF fears that sub-Saharan Africa, South America, the CIS region and the Middle East will not fare so well. They may improve with the OPEC agreement on production cuts.
Global recovery will be slow but positive over the next couple of years provided the Korean peninsula stays quiet, Saudi 'clean up' does not create imbalance, Refugee crisis is dealt with responsibly and terrorism stays under control.
The solution to manufacturing pick up in India
Manufacturers in India are emerging from three of the hardest tests they were put through in the last 12 months - Inadequate Capital availability, demonetization and main streaming with the GST. It will have allowed them to clean their books, strengthen their market foot print and right size themselves. This will now allow them to make more for the local and global market. Indian economy is demand led and the multinationals desire to diversify their production to include low-cost plants in countries other than China, could together help India's manufacturing sector to grow considerably by 2025. The China alternative for 'right size' production facilities also works in India's favour.
Efficiency in manufacturing has been one of the biggest challenges that companies have faced. Globally, manufacturing is undergoing a paradigm transformation through digital technologies such as the "internet of things" and robotics. Collectively called - Industry 4.0. India's product makers must embrace these global best practices in operations while customizing it to suit the Indian ecosystem. This will lend muscle to local manufacturing and help optimally deliver higher productivity with quality. This will significantly improve the efficiency and output of the country's manufacturing.
India has risen 30 places on the global list of 'ease of doing business' in a recently released report. They wish to make a mark amongst the top 50. The recent elevation to rank 100 amongst 190 countries was primarily due to the Bankruptcy and Insolvency Act, 2017. This act will make it easier to exit or attempt a revival of a business, thereby improving the nonperforming assets (NPAs) dilemma for the financial services sector. This will make it easier for financial institutions and banks to deal with NPAs arising from failed businesses. If India wishes to achieve a top 50 rank, the government must introduce big ticket reforms on land ownership, labor law, and the judicial process.
The job at hand for state and central governments
Indian state and Federal authorities need to aggressively address the following 5 areas that will help its manufacturing sector improve their productivity performance and deliver a superior return on capital:
Embrace Industry 4.0:
India needs to leapfrog into manufacturing attractiveness. This would appeal to both the reductionists and the emotionals! The government can articulate a new policy to incentivize adoption of digital technologies. With smart cities and allied initiatives, the requisite digital ecosystem can be created to augment competitiveness. This will allow for leapfrogging Indian manufacturing into the digital decade. If the ecosystem support structures like Infrastructure, skill development and policy are augmented suitably, Industry 4.0 has the potential to change the face of Indian manufacturing. This will also fit into the larger Make in India initiative
Divest from state owned businesses
The public-sector enterprises are employment hotbeds for the government. In most cases except 2-3 Navratna's the dividend returns for the government is abysmal. Each business has the potential to deliver a significantly higher ROCD compared to current returns. The automobile sector is a strong case in point. When government vacated the space, private capital grew the sector many times over and today Automobile sector is one of the leading exporters of Indian manufactured products. Arrival of international competition further enriched the competitive space and GDP per manufacturing employee grew by a higher factor. Disinvestment not only helped government get higher returns but also helped them improve productivity in the sector and create many more jobs. It enabled a structural shift in performance
Address Land, Registration, Construction & Clearances (LRCC) challenges
Challenges in acquiring land - Aggregating land, high stamp duties and cumbersome regulations are a huge barrier to productivity improvements in India. Further, Bureaucratic delays in granting permission to start a business is another aspect that needs to be ironed out. At every stage of the clearance process - getting clearance, land purchase registration, Utility connections, environmental clearance, obtaining permission from the factory inspectorate and pollution control boards, etc. there are undesired hurdles. The government should create a separate SPV with central participation to streamline this and improve speed. This SPV could be like the SPV's created for smart cities. With e-governance, a single window concept can be introduced where companies can file their application online for permission to acquire land, register property, get a construction clearance, etc.
Rejuvenate Labor laws to suit the digital age:
In the digital age India is saddled with labour laws written decades ago. It is extremely difficult to disengage with underperforming labour under current laws. Stringency makes it difficult for Indian companies to retrench, replenish and restructure their productivity and expand output. Government should consider liberalizing its labour laws by encouraging reskilling programs that could help workers become more productive and prepare them for new jobs. This will require engaging with the unions and working on a breakthrough policy. If demonetization could be done to clean monetary cobwebs, making labour laws to suit the digital age is a worthy argument to pursue.
Infrastructure - more the merrier:
Whilst the present government is providing significant impetus to infrastructure, more is required. Poor infrastructure derails industrial productivity and negates any competitive advantage the country would have by way of innovation, technology, productivity and efficiency. It can make goods expensive to the consumer. Bad roads restrict vehicle movement and increase fuel consumption. Poor ports infrastructure delays supply chain dynamics and production measures like 'just in time'. Government is setting up National Investment and Manufacturing Zones (NIMZs). The encouragement of such industrial clusters is a positive development, since they are a proven way of catalyzing the efforts of the public and private sectors to address infrastructure challenges.
The private sector entrepreneurs have a role to play
Manufacturers need sensitization to fiscal prudence and correctness. There is a strong need for corporate India and MSME to focus on structural enhancement of their finances, labour and products. This will mean sweating every asset at disposal to a very high order.
Make return on capital deployed more attractive:
Research has proven that most companies in India get a lower return on capital deployed (ROCD) in comparison to the weighted average cost of capital (WACC) that is deployed. This will mean stress on cashflows, lower leverage for investments, market creation and lower outlay for process improvements to enhance productivity and quality. It is a continuous & vicious cycle. Companies need to make a call somewhere to set right the imbalance between ROCD and WACC. It can be addressed by rightsizing the business, embracing the digital future and then creating more value-added jobs to grow.
Skilling
Over the next couple of years global manufacturing will see structural shifts. Cost economics of manufacturing will see an additional intervention of automation. Automation and labour will see a balanced optimization for companies to stay competitive. This will help MSME set up facilities closer to customers and negate the advantage of low labour cost based business models. This will allow small businesses to participate with advantages. Digital economy skills, including cross-domain skills, are becoming the most critical factor of production and driver of competitiveness. Continuous employee skilling is the only way to benefit from Industry 4.0.
Focus on exports
India has natural advantages in a variety of industries to address export markets. Some industries are Plastics, Basic Chemicals, Textiles, Basic capital equipment, Metal formations, Industrial electronics, Medical products, Medical consumables, Formulations, Bulk drugs value added paper products etc. By improving productivity, skill, and enabling the business to be industry 4.0 compliant these businesses can achieve considerable export revenues and create jobs.
Manufacturing has never received attention and impetus the way it is now. With India focusing on a fiscal and monetary strategy of clean economy driven by prudence, simplified tax systems, ease of doing business, make in India and related initiatives, a digital push to Industry 4.0 as a policy will allow it to achieve the highs that manufacturing seeks to achieve - 25 % of GDP.
