|
|
|
|
Map of Asia |
CIAO DATE: 2/00
Indian Industry: Growing Pains
The South Asia Monitor
Number 4
December 1, 1998
The previous issue of the South Asia Monitor provided an overview of the Indian economy. This issue will focus on three key sectors: industry, the financial sector, and agriculture. The three sectors, while seemingly unrelated, are key to India’s future.
Indian industry is undergoing unprecedented change as a result of the deregulation process begun in 1991, the recent downturn in the domestic economy, and the crisis in Asia. Established industries are being challenged and new ones are emerging.
The pace of change in the industrial sector has been quite rapid. Half of the top 50 private sector companies four years ago have been displaced by larger newcomers. Provided the basic thrust of reform continues, globalization pressures will likely accelerate this pace. Over the next few years it will become clearer in which sectors the Indian economy is likely to have a competitive advantage. It is probable that the sectors that emerge will be different from the ones that presently dominate Indian industry. Globally competitive high-tech industries, based on skilled labor, are likely to emerge as the front-runners.
Reform in the financial and agricultural sectors has been somewhat slower than in industry. Recent governments have moved cautiously on reform in the financial sector, given the high fiscal deficit and the weakness in the public banks’ balance sheets. State-owned financial institutions, with only limited autonomy, remain the dominant players in the sector. Agricultural performance in India is still dependent on the monsoon, and growth rates fluctuate widely from year to year. Productivity gains in agriculture are held back by severe structural impediments, including lack of irrigation, inadequate roads, and competitive rural capital markets.
Industry
Indian industry has traditionally been dominated by heavy industry. In the post-independence period, there was great emphasis on building up India’s capital goods and heavy industries. Uncompetitive and inefficient industries often were able to survive behind high tariff barriers and lack of private sector competition. Many of them, however, now face greater competition due to deregulation and lower tariff barriers. Competition has resulted in declining prices and profit margins. At the same time, however, these industries are held back by the limited reform measures undertaken thus far: they continue to be hampered by high input costs (often due to high tariff barriers on imports), infrastructure constraints, and an array of restrictive labor, land, and small-scale restriction policies. The recent domestic slump, partly caused by overcapacity in many industrial sectors, falling international commodity prices, and greater competition from Asia in third markets, has particularly hurt cement, steel, vehicles, and capital goods. The only heavy industry thus far unscathed appears to be aluminum.
Manufacturing growth has fallen from 14 percent in 1995–1996 to 6 percent in 1997–1998. The slump is forcing many industries to restructure. Up until liberalization in 1991, businesses had grown by diversifying, resulting in the creation of sprawling family-owned conglomerates, such as those of the Tatas and the Birlas. With rising competitive pressure, these businesses are, however, in the process of restructuring their operations, with an emphasis on strengthening their core competencies and divesting the less profitable lines of operation. Indian industry is in fact witnessing unprecedented consolidations, takeovers, and mergers. The Birla group is consolidating many of its business lines in cement, aluminum, and textiles; the Tata group has divested itself of two consumer product businesses—Tata Oil Mills and Lakme (a popular cosmetic company); the Thapar group has sold its fibers and electronics lines; and in cements, India Cements has taken over Raasi.
While the heavy capital goods industries are in difficulty, software, pharmaceuticals, and consumer goods industries have been flourishing. In 1997, the software industry earned almost $2 billion in export revenues. The industry in India has been built on projects outsourced by international businesses to its low-cost, highly skilled labor. Y2K and the introduction of the euro, problems which Indian software is aimed at addressing, have contributed to a booming industry. Growth prospects appear sound. Phase-in of the euro currency and rising domestic demand will continue to provide revenues. The government also appears to favor the industry. It recently issued a blueprint on making India a “software superpower”. It has allowed the sector the right to issue dollar denominated stock options; its recent ruling to privatize internet access services will give the sector a boost, particularly the smaller software companies. The industry itself is changing. Entrepreneurial Indians returning from Silicon Valley are setting up many new software companies, and there is an increasing trend toward venture-capital financed firms. These new companies are keener to establish their own brand-name products and to provide higher value-added services. To this end, companies such as Infosys and Wipro are seeking a listing on U.S. stock exchanges.
Resilient consumer demand has kept consumer goods industries thriving, and appears not to have been affected by the current slump. The consumer goods industry is likely to grow further, with an estimated increase in middle-class households, from 80 million to 170 million by 2006, and a projected marked increase in spending power in the rural areas. The trend toward branded products, a novelty in India’s consumer market, will be a further spur for the consumer goods companies who can exploit it.
The pharmaceutical sector has also been performing strongly. Two of the main obstacles to its growth—the issues of intellectual property rights and access to technologies—have been partially removed by the government’s recent decision to allow the introduction of exclusive marketing rights for product patents. The government is further committed, as part of its WTO obligations, to introduce full product patents by 2005. The recent decision is significant in that it allows a pharmaceutical company the sole right to sell the drugs it has patented. Thus far, only process patents were recognized, i.e. patented drugs could be reproduced in a slightly different manner and sold by different manufacturers. The establishment of product patents is expected to lead to a surge in foreign investment in the pharmaceutical industry.
Financial Sector:
India’s financial sector is suffering a loss in investor confidence. Public banks heavily dominate the banking sector. Although not burdened with foreign debt, many of them are saddled with non-performing loans, estimated at 20 percent of gross total assets, and are significantly exposed to the heavy industries, particularly steel. Weak performance in heavy industries is expected to increase the bad debts of the banks, particularly of the Industrial Development Bank, India’s largest corporate lender. Recent losses run by the Unit Trust of India (UTI), the country’s largest mutual fund, have exacerbated fears of a meltdown. Fortunately, the financial sector has escaped the worst of the Asian crisis because of its highly regulated state.
The financial sector is, however, being slowly modernized. Most public banks are highly inefficient, with high intermediation costs. Until now, they have been protected from competition by regulations on the activities of private banks. They are, however, starting to face greater competition from foreign private banks. The government is committed under WTO obligations to grant a minimum of 12 branch licenses to foreign banks every year. Furthermore, new rules are being passed that will force the public banks to comply more closely with the more stringent international regulatory standards, affecting their classification of bad loans and their capital requirements. The government has also decided to open the insurance sector to foreign investors for the first time, allowing 26 percent foreign direct equity in private insurance firms. Outstanding issues remain greater autonomy for the public banks (they still have to lend to designated priority sectors) and the establishment of a bankruptcy system for the recovery of defaulters’ assets. The danger is that if the banks’ bad debts mount, the government may be tempted to bail them out. Given the large fiscal deficit, such a policy would have adverse macroeconomic consequences.
Agriculture:
Agriculture accounts for 30 percent of GDP and employs 70 percent of the labor force. Growth in agricultural output has averaged 2.5 percent annually in the 1990s. Productivity gains achieved under the Green Revolution have enabled India to become a food grain exporter. These gains, however, have been highly concentrated by region. Agriculture holds enormous potential for poverty reduction, yet present growth rates in most states, with the exception of Punjab and Haryana, are significantly below their potential. Growth has in fact been held back by misguided policies toward the sector.
The thrust of agricultural policy in India after independence was to maintain low food prices for consumers and to achieve self-sufficiency in food production by providing subsidized inputs to farmers. These objectives resulted in a complex web of trade and price regulations, and a pervasive subsidy regime. And while export restrictions and price regulations on many crops have been eased since 1991, an array of restrictive regulations remains in place for the major crops.
Rice, wheat, sugar, and oilseeds are subject to trade and procurement controls and agro-processing industries remain tightly regulated. A further significant constraint to growth has been the lack of investment in infrastructure. Fiscally burdensome subsidies to users of power, water, and fertilizer have squeezed out public investment in infrastructure. Lower investment has resulted in declining productivity. Many studies have shown that the present universal (or non-targeted) subsidy regime is fiscally burdensome, leads to inefficient input use, and fails to achieve any redistributive objectives, with the larger farmers and intermediary agencies benefiting the most from the subsidies. Higher capital expenditure on infrastructure will be central to boosting growth in the sector and can only be sustainably achieved by scaling back the subsidies. Lack of access to credit by small-scale farmers is an additional constraining factor. Small-scale farmers generally only have access to the local money lender who is able to charge extremely high interest rates. Competitive and self-sustaining rural credit institutions need to emerge.
Notes
The most significant political news in recent weeks has been the reversal suffered by the ruling BJP party at the hands of the Congress party in state elections in Delhi and Rajasthan. The BJP’s losses were attributed to voters’ impressions of economic mismanagement by the BJP, most clearly manifested in soaring vegetable prices. The election results will likely weaken support in the governing coalition for the BJP. They are unlikely, however, to have a significant impact on the thrust of economic policy in the near term.
Email this citation