Lead Story

Can India make it in manufacturing?

The new policy resolves several, but not all issues that hold back manufacturing

Sanjit Kundu

June 17, 2011 was a red-letter day at Mahindra World City in Jaipur. Under the beaming gaze of Roop Chand Jain and officials from the special economic zone (SEZ), the commissioner of SEZs for North India cut a ribbon at the gate of the manufacturing zone, addressed the gathering of 100-odd people and formally released a consignment of knitting needles to the waiting courier company representatives.

Such fanfare isn’t part of the routine here, but this was a special occasion: it was the first export consignment being sent from a unit in the manufacturing zone of the 3,000-acre private SEZ. “We were the first to export from the Noida SEZ two decades and we’re the first here as well,” says Jain, MD of KnitPro International, which came to the Jaipur SEZ in mid-2010. “High real estate costs prevented us from expanding further in Noida. Besides, this place is closer to NH8 [the national highway that connects Delhi and Mumbai] and, therefore, the port. We were the first manufacturing company here.” Nine months later, the distinction has lost its sheen somewhat: KnitPro is still the only manufacturer operating at the Mahindra SEZ.

It’s ironic how the manufacturing sector continues to lag behind in India, despite the government’s grand plans for it. And considering the advantages the country enjoys, there appears to be no reason why those goals shouldn’t be achieved. There’s a massive workforce (440 million people in the 15-34 year age group), a liberalised economy, a decade of high growth rates, below-average worker wages (50 cents an hour, compared with over $2 in China and $7.25 per hour in the US) and robust domestic demand — the setting seems perfect for a manufacturing revolution. But that’s not happened.

The services sector accounts for the bulk of India’s GDP (56%) and agriculture for the bulk of employment (52% of the workforce), while industry (which includes manufacturing) has been languishing for over 30 years at about 16% of GDP, employing 13% of the workforce. Compare that with China, where manufacturing accounts for 34% of GDP; Malaysia, where the sector has a quarter share in GDP’s 25% share; and Thailand (40%). The recently-released Economic Survey indicates that Indian manufacturing has been slowing down for the past 10 consecutive quarters and the net profit margin of manufacturing companies decelerated continuously from 8.1% in Q2FY11 to 5.4% in Q2FY12, which was the lowest in the previous 12 quarters.

If manufacturing is to become a significant contributor to the economy’s finances, it will need more than just investment from the government and private sector — although that will be huge (see: Deep pockets required). Earlier attempts to kickstart manufacturing haven’t really worked and even the SEZ Act of 2005 has met with only limited success — the Mahindra World City example is only one of several. Now, though, there’s a new manufacturing policy that’s more comprehensive in its provisions and even more ambitious in what it aims to achieve. Can the National Manufacturing Policy (NMP) achieve what the SEZ Act could not?

Deep pockets required

Private investments will be needed to boost manufacturing in India

Opening New Doors 

Announced in November 2011, the NMP is the government’s most elaborate policy yet for the manufacturing sector. Primarily, it aims for 14% annual growth in manufacturing (from the current 3.9%), which will take the sector’s share in GDP to 25% as well as create 100 million jobs in the sector over the next decade. While skills gaps are proposed to be met through private-public partnerships, the key proposal in the policy is the creation of national investment and manufacturing zones (NIMZs), greenfield industrial townships spread over 5,000 hectares that will offer a host of incentives to boost manufacturing. 

NIMZs will be oriented towards manufacturing, but not necessarily be focused on exports. They will be developed and managed by special purpose vehicles (SPVs) that will have a government official as head and other stakeholders (such as private players) as members. To begin with, seven manufacturing zones have been identified (See: Road to prosperity) along the upcoming Delhi-Mumbai Industrial Corridor (DMIC), covering a total 2,364 sq km. The smallest is the 84 sq km Shendra-Bidkin region near Aurangabad, Maharashtra, while the largest is the 900 sq km Ahmedabad-Dholera belt in Gujarat. Later, five more regions will be developed in other parts of the country. The zones will be given a slew of inducements to promote industry, including relaxation of labour regulations to ease exit of sick units, streamlining and reducing business regulations and incentives for small and medium enterprises (SMEs), such as waiver of capital gains tax on selling land. 

Road to prosperity

The first seven proposed new manufacturing zones will come up

along the Delhi-Mumbai Industrial Corridor

Exclusive manufacturing zones aren’t a new thought. Kandla port, which came up in the mid-1960s as an export processing zone, is considered the first SEZ in India, although the SEZs Policy wasn’t announced until 2000 and the eponymous Act took another five years. The idea was admirable: help manufacturing and boost exports by creating exclusive, tax-free and hassle-free enclaves that would generate additional economic activity and employment, promote exports and bring foreign investments into these areas. But it’s not worked out quite as anticipated.  

Of the 587 SEZs approved till date, only 154, that is, only a quarter, are operational; the others are notified (that is, they’ve started availing the fiscal benefits), but not operational. Between December 2008 and July 2011, some 33 SEZs denotified and exited, citing reasons such as lack of demand and policy uncertainty. Almost every meeting of the SEZ board of approval, which is headed by the commerce secretary, has at least a couple of developers stepping forward seeking extension of formal approvals or denotification. At the last meeting held on November 29, 2011, close to 20 SEZ developers sought extensions while four wanted to be denotified.

That’s not all. SEZs have failed to break the lopsided sectoral and regional patterns of development in the country. As of March 31, 2011, SEZs had collectively clocked exports worth nearly ₹3.16 lakh crore, a 43% increase over the previous year. But nearly a third of this came from just one SEZ, Reliance Industries’ Jamnagar Refinery. “Petrochemicals and IT continue to dominate the exports from SEZs, making the pattern lopsided,” points out Aradhana Aggarwal, senior fellow at the National Council of Applied Economic Research (NCAER) and author of SEZs in India: Past Experience, Present Status and Future Prospects. Indeed, about 84 of the 154 operational SEZs are in the IT/ITES sector and most of them are concentrated in the better developed states of Karnataka, Gujarat, Tamil Nadu and Maharashtra. Less than 40% are focused on manufacturing and although SEZs have created employment for over 815,000 people till date, since most of these are in the IT sector, the belief is that these jobs would have been created even otherwise. 

Aggarwal says she wouldn’t be surprised if the real numbers relating to employment, investment, FDI and export projections at these zones are far from impressive. “The numbers we have were submitted by the developers. The actual numbers are much lower,” she says. 

The bigger worry now is that NIMZs will face the same problems SEZs did. That includes issues over land acquisition, tussle over tax revenues and incentives, regional inequity, accusations of land grabbing, labour exploitation, environment degradation and the like. “There’s a state-Centre tussle likely to crop up as well,” says Abhilash Kumar, head of the realty and townships advisory at Feedback Infrastructure. Indeed, it’s already started. In November 2011, the Uttar Pradesh government blocked a DMIC industrial city proposal, citing purview and control issues and the state hasn’t even started the process of land acquisition for the DMIC and the zones to be developed as NIMZs. 

The relaxation of labour laws may also create problems. Unlike in SEZs, the policy makes a provision for an exit policy for failed units inside NIMZs by which units can pay workers suitable compensation and lay them off if a unit turns sick. But this is already being seen as a ‘hire and fire’ policy and objections are being raised. “Unions will oppose NIMZs in a big way when it comes to implementation of these relaxed laws,” Aggarwal says. 

Aradhana Aggarwal, NCAERThere’s also a fear that the new policy is unrealistically ambitious in setting targets for the Indian manufacturing sector. According to the latest policy, a 2-4% differential over the medium term growth rate of the overall economy will enable manufacturing to contribute at least 25% to national GDP by 2022. But achieving that in just a decade looks tough: China, for instance, had to clock double-digit manufacturing growth for 30 years to reach a 30% share in total GDP. 

The policy’s other main objective — of creating 100 million jobs over the next decade — also contradicts two clearly-stated aims in the policy: to increase technological depth in manufacturing and enhance global competitiveness of Indian manufacturing. Typically, modern manufacturing systems use fewer, highly skilled people and high-end technologies. Creating 100 million jobs is possible only if semi-skilled or unskilled people are used on manufacturing systems based on low-end technology. Also, as manufacturing productivity increases, job growth stagnates or falls: between 2005 and 2010, when India grew at 8-9% annually, only 2 million new jobs were created.

The trouble with sezs

Before the NMP takes off, though, it’s worth examining why SEZs have proved to be of such limited utility in India — and why NIMZs need to worry. The biggest issues have all centred on land. There are allegations of land grabbing, displacement of farmers from fertile agricultural land and claims that rather than for industrial activity and export generation, SEZs are being used for real estate development. The last argument, especially, gained traction because of the number of realty companies that entered the SEZ space. 

But really, much of the trouble stemmed from the fact that the idea seemed so good on paper that in many cases, developers rushed to set up SEZs having done no feasibility study of the area, no investigation into the demand and supply for such industrial units, accessibility to highways and ports, availability of raw material and employable people, and so on. Not surprisingly, many of those projects have been reduced to gated-walled plots over highways, with only a few dusty signboards bearing testimony to their identity. At Moradabad, for instance, Satpal Pugla, managing director of Globe Metal and Glasses, points out that there’s more grass than industrial activity at the Moradabad Handicraft SEZ. “The few people who remain merely do paperwork from there and continue their manufacturing from factories in the city.” Pugla withdrew from the SEZ a few years ago, citing its abysmally slow progress. Besides, he points out, “transferring units, labour and raw material from the core industrial areas to the distant SEZs is neither easy nor feasible.” 

Two years ago, Rakesh Mahajan mooted the idea of setting up the country’s first sports good SEZ at Meerut, a city that already exports sports equipment worth ₹600-700 crore every year. Mahajan, whose company BDM Sports Goods has made and exported cricket bats for over 50 years, recalls how a society for the Meerut SEZ was formed, a tract of unfertile land identified and a developer, IL&FS, identified. But the news leaked, and the price of the land shot up from ₹400 a sq yard to ₹4,000 a sq yard, rendering the project unviable. “We got no help from the Uttar Pradesh government,” Mahajan charges. “Manufacturing can’t be boosted without the state’s help.”

Indeed, one of the charges against the government is that rather than helping the SEZ cause, it has disincentivised developers by rolling back last year the financial benefits it had offered the zones. Former commerce secretary and architect of the SEZ scheme, GK Pillai believes the ministry of finance is ignoring the long-term benefits of SEZs. “Frequent change of rules confuses industry. Those who have already invested in SEZs must be given their full 10 years of benefits,” he declares. He’s objecting to the decision in the Union Budget last year to impose 18.5% minimum alternate tax on SEZ units and developers while the new direct tax code proposes that only existing, operational SEZs will continue to enjoy fiscal incentives. Others agree that the government’s flip-flop is affecting industry. “Incentives are being taken away and policies aren’t clear. So many more people may opt for denotification,” says Feedback Infrastructure’s Kumar.

GK Pillai, former commerce secretaryNavin Raheja, managing director of the Delhi-based Raheja Builders, is a fervent admirer of the idea of exclusive enclaves for manufacturing. “SEZs are growth engines that have been gifted to industry by government, so that we can compete with the Chinese,” he says enthusiastically. A few years ago, Raheja got approvals for three SEZs in Gurgaon. But he withdrew from all three after the government’s turnaround on fiscal incentives in 2011. He wasn’t the only one to pull out of SEZs — the other biggies who denotified in the past three years include DLF, Essar, Satyam and Bata. 

Big Wins

It’s not as if there are no success stories among Indian SEZs. So, what worked for them and can the NMP learn anything from their experiences? The two biggest advantages of successful SEZs are their location and support from local governments. Feedback Infrastructure’s Kumar agrees. “Getting the MoU [to set up the project] is the easiest part and is only 10% of the work. The rest comes later and many states fail to provide the promised infrastructure, making the developer’s task that much tougher,” he points out.

Navin Raheja, Raheja DevelopersThe success of the Dahej multi-product SEZ in Gujarat is a case in point. Developed jointly by the Gujarat government and ONGC, around 1,200 acres of the available 1,300 acres has been allotted and land is being sought to set up another such project. The presence of a petrochemical anchor has helped draw many petrochemical-related companies to the project as has support from the administration. RJ Shah, CEO, Dahej SEZ, believes NIMZs, too, will succeed if they are developed by the government. “It may not be possible for most businesses to develop such zones. There will be huge investments in land and subsequently, infrastructure.” 

Others also cite the importance of state support in the form of infrastructure for SEZs to succeed. “We can’t think of developing 150 km of road to connect our SEZ with the port. The government has to build that,” says Ravi Reddy, managing director of Sri City, India’s largest multi-product SEZ, located 55 km north of Chennai, in Andhra Pradesh. Once that’s done, though, how the SEZ grows is up to it. Sri City’s proximity to Chennai and its connectivity advantages — two seaports and major rail and road routes close by — has made it a natural choice for ancillary units wanting to tap into the auto hub outside Chennai.

Ravi Reddy, Sri City SEZThe developer is actively encouraging smaller enterprises in its project and about five or six Japanese SMEs have already set up units here on 10- to 30-acre plots. A functional domestic manufacturing zone helps create synergies between units and encourages growth. Some ₹800 crore has been invested in Sri City till date and in the past two years, some 20 companies have begun functioning from the zone. Reddy has been aggressive on marketing front. “We promise the units that their factory will be in production within eight to 10 months of the day they sign in. That assurance gives foreign investors a great deal of comfort,” he points out.  

The Road Ahead

Under the NMP, state governments have been assigned crucial responsibilities to ensure NIMZ projects stay on track. The state will be in charge of selecting land for the NIMZ and its acquisition, if necessary. It will also be responsible for ensuring power and water connections to the plot. Still, 5,000 hectares is a huge chunk of land and given the trouble in acquiring far smaller tracts for the SEZs, how will land acquisition for NIMZs be handled? Clearly, states with ready land banks and better external infrastructure are more suited for these industrial townships — that is, states like Gujarat and Maharashtra. Not surprisingly, other states are worried the manufacturing revolution will pass them by. “Uttar Pradesh has no land bank, so it will lag again,” predicts a gloomy DS Verma, executive director of the Indian Industries Association in Lucknow. 

RJ Shah, Dahej SEZThe government report doesn’t offer any comfort, either. It doesn’t have any concrete plans for beyond the first seven zones, which will come up in the same area that is being developed for the DMIC, and where the state governments have already acquired land. The one saving grace: unlike SEZs, the new enclaves aren’t contiguous or bonded areas, so existing brownfield (already developed) areas can also become part of the zone. 

Meanwhile, the concerns over achieving the targets set in the NMP continue. The success of the first seven manufacturing zones depends entirely on the successful completion of the 1,500-km DMIC and the improvement of ports (which the government has promised in the policy to improve in a timely manner). The DMIC is still in the planning stages and Uttar Pradesh has been holding it up over land acquisition issues — clearly, Centre-state and interstate cooperation will be critical in implementing the NMP. 

Then, if a criticism of the SEZ policy was that it incentivised only a few and left out the rest, the NIMZs aren’t too different. Pillai believes there’s nothing unfair about this. “You are competing against countries like the US and China. They provide tax concessions to their manufacturers and world over, the policy is that taxes are not exported,” he says. Sri City’s Reddy also defends the government policy. “It’s not really incentivising — the government is actually compensating you for going to a backward area. When we came here, there was nothing — not one 3kv power line, road or even water supply. If you build a SEZ in Chennai, you don’t need incentives. Here, you do.”

To its credit, the new policy also addresses a crucial issue that will determine whether India’s dream of beating China at its game can ever come true: India is a laggard both in terms of quantity and quality of skills required for manufacturing. The NMP proposes fiscal incentives and viability gap funding to encourage the private sectors’ efforts at skill upgradation. 

It suggests short-term courses for minimally educated workforce; relevant vocational and skill training through the establishment of Industrial Training Institutes (ITIs) through public-private partnerships; specialised skill development through establishment of polytechnics and the setting up of an instructor’s training centre at each NIMZ. But not everyone is concerned this will be enough. “There was a similar public-private partnership attempt in 2004 as well, but that remained on paper. One can only hope it works this time round,” says out NCAER’s Aggarwal. 

For all its obvious flaws, the new policy is a brave attempt to set right all that ails the manufacturing sector in India. But for it to succeed not only does it have to make a conscious attempt to not repeat the mistakes of the SEZs, it also needs to temper its ambitions with a healthy dose of realism. KnitPro’s Jain adds another condition: “The government has to learn to deliver on its promises.” 


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