ECONOMIC UPDATE

3rd November, 2011

National Manufacturing Policy

The Planning Commission recently released the draft of the countrys first ever National Manufacturing Policy, aimed at boosting the countrys share of industrial production, employment, development of world-class infrastructure and investments in Indias manufacturing space. While the Indian economy saw a structural shift in the composition of economic activity from agriculture in favor of services in the 1990s, the share of the manufacturing sector has been stagnant all through at 15-16%. Now, with the share of services in the overall GDP increasingly seeing signs of stagnation, the onus is falling upon the manufacturing sector to ensure the sustainability of the economic growth trajectory of the nation. Moreover, Indias manufacturing share and productivity lags behind those of some other Asian economies in similar stages of development, all of which have bearing on the countrys competitiveness in the globalized economy. It is in this backdrop that the NMP has been formulated Key Constituents of the NMP: Increase the share of manufacturing in the countrys GDP from the current 16% to 25% by 2022 Create 100 million additional jobs in the next decade Industrial training and skills development programmes Establishment of National Investment and Manufacturing Zones equipped with world-class infrastructure that would be autonomous and self-regulated developed in partnership with the private sector Flexible labor laws and simplified & expeditious exit mechanism for sick units Relaxation in environmental regulations Financial and tax incentives to small and medium enterprises Incentives to states for infrastructure development Incentives for Green Manufacturing Rationalization of business regulations to reduce burden of procedural and regulatory compliance on businesses Increased focus on employment intensive industries, capital goods industry, industries with strategic significance and those in which India enjoys a competitive edge and the SME sector. Make industrial land (land acquisition) available through creation of land banks by states

NATIONAL MANUFACTURING POLICY Focus on SMEs

November 2011

Contact: Madan Sabnavis, Chief Economist madan.sabnavis@careratings.com 91-022-67543489 Kavita Chacko, Economist kavita.chacko@careratings.com 91-022-675343626 Krithika Subramanian, Associate Economist krithika.subramanian@careratings.com 91-022-675343521

The new plan is expected to give a fillip to the stagnant share of Indias manufacturing sector. Although the sector has registered a decadal growth of 8.5% until FY11, performance of this sector in FY12 has not particularly been encouraging. Growth in the manufacturing sector as suggested in the IIP has been only 6.0% in FY12, so far (April-August). The New Manufacturing Policy proposes to attain more than double this growth rate (12-14%) over the medium term in a bid to propel overall economic growth. The attainment of the qualitative and quantitative objectives of the new policy would however require synthesizing growth in raw materials production, energy generation and access to credit to ensure complete passthrough via forward and backward linkages.

Table 1: Sectoral Composition of GDP Year FY09 GDP 41,62,509 Agri & allied 6,54,118 Industry* Services 11,68,920 -----------23,39,471 6,55,775 (15.75) 12,61,999 -----------25,74,769 7,13,428 (15.88) 13,61,263 -----------28,16,190 7,72,960 (15.85)

FY10

44,93,743

6,56,975

FY11

48,77,842
Source: MOSPI

7,00,390

Of the industrial sector production, manufacturing contributes about 56-57%

Focus of Manufacturing Policy: SME segment

The Small and Medium Enterprises (SME) segment of manufacturing has in particular attracted due attention in the new policy as can be seen from the various financial and development incentives that have been envisaged therein. The need for special focus on the segment arises from the fact that currently, 8% of overall GDP, 45% of manufacturing output and 40% of the countrys exports originate in more than 26 million SME units across the country. These SME units are engaged in the production of more than 6000 products, 22% of which are food products, 12% are chemicals and chemical products, 10% basic industry metals, 8% metal products, 6% each of electrical and machinery parts and rubber and plastic products (36% of miscellaneous products). SMEs: Access to Finance The major challenge faced by SMEs is the lack of access to adequate and timely finance owing to the non-formal nature of business, lack of adequate financial information that makes it difficult for the segment to comply with regulatory requirements, few financial managerial skills and other structural shortcomings inherent to the sector all of which make SMEs to rely heavily on the promoters equity and loans from financial institutions that come at higher costs, all of which constrain growth.

SMEs account for 45% of manufacturing output

The lack of access to adequate and timely finance have been constraining growth of the SME sector

The formal credit market for MSMEs is restricted and nascent at this point as the size of each business unit is small. A gradual but steady transition has to be made to make available other sources of funding such as venture capital, private equity, angel investors and capital markets. In view of all the above, the NMP has listed a number of proposals and fiscal incentives for improving access to finance for SME. The incentives would however be given on a case to case basis. Some of these proposals are Relief from Long-term Capital Gains Tax on sale of a residential property if the proceeds are invested in setting up a new SME firm in the manufacturing sector or for buying new plant and machinery Setting up of a stock exchange for SMEs Liberalization of RBI norms and IRDA guidelines for investment by banks and insurance companies in Venture Capital Funds with a focus on SMEs in the manufacturing sector Lending to SMEs engaged in manufacturing to be included under priority sector Tax pass through status for Venture Capital Funds with a focus on SMEs in the manufacturing sector Creation of a separate fund with SIDBI using shortfalls against MSE credit targets for commercial banks and Strengthening the equity base of National Small Industries Corporation (NSIC) to give the demand side impetus to MSME units SMEs and Productivity Concerns A major drawback in the functioning of SMEs is the nature of business. MSMEs, primarily being family owned businesses are characterized by weak organizational structures, poor management decisions, limited access to working capital and inefficient allocation of limited capital; all of which manifest in the form of low productivity. Juxtaposing production of SME units against fixed investments indicates that both production and investment have grown commensurately over the last three years. An ideal expectation in the growth stage of MSME life cycle would be that production grows faster than investments. Improving access to funding for MSMEs is the need of the hour.

Exhibit 1: Investment v/s Production

1,200,000 1,000,000 800,000 600,000 400,000 200,000 Rs crore 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Fixed invt

Production

Source: MSME Annual Report 2010-11

In other words, the trend observed in the last three years is broadly suggestive of stagnation in the productive efficiency of this sector. The policy provides for some encouraging initiatives in this regard The provision for establishment of a Technology Acquisition and Development Fund (TADF) is an incentive to SMEs to improve the application and use of appropriate technology Access to patent pool and/or part reimbursement of technology acquisition costs along with patents could boost the return on investments and productive efficiency of installed capital Rebates on environment and water conservation audits ensure the linking of financial incentives with regulatory prowess in the use of technology. Patent pools and technology acquisition incentives could boost productive efficiency of fixed investments

Additionally, the SME sector being labour-intensive has much higher labour-capital ratio when compared with larger capital-intensive industries. Enhancement of skill sets and training would in particular determine technological efficiency in the SME segment.

Training and development of skill sets crucial

SMEs and Employment The greater emphasis of the policy on the SME sector also stems from the crucial role that the SMEs play in the area employment. The SME sector is expected to be the main contributor to the 100 million additional jobs that the NMP aims to create by 2022. Given that the SME sector currently employs more than 60 million people, provides nearly 10 lakh additional jobs each year and is the largest employer after agriculture, going forward too it would be this segment that has the capabilities of being an employment generator. Additionally, a great advantage of employment in Micro Small and Medium Enterprises (MSMEs) is the geographical dispersion of SME units that allows for inclusive growth prospects. MSMEs is one of the largest employment generators in the country

The employment intensive sectors, capital goods manufacturing industries are amongst those likely to see favorable growth commensurate with additional measures undertaken to increase their efficacy

The beneficiaries of the NMP Although the policy is by and large sector neutral, it does emphasize on some focus sectors, chiefly employment intensive sectors, which could see specific policy interventions and additional measures to increase their efficacy. These sectors can consequently be expected to see commensurate growth. Industries such as textiles, gems & jewellery, leather & footwear, food processing, machine tools heavy electrical equipments, heavy transports, earth moving and mining equipments , automotive, pharmaceuticals, aerospace, shipping, energy, power, electronics hardware are a few that are likely to see favorable growth in the medium to long term. The proposal for the creation of large national investment and manufacturing zones would be a positive for the domestic manufacturing sector that would help them achieve economies of scale and global competitiveness. The land acquisition and development policy in the draft would benefit industry as a whole as it would take away the burden business for the same.

The National Manufacturing Zones would help the manufacturing sectors to achieve economies of scale and global competitiveness

The land acquisition and development policy in the draft would benefit industry as a whole

-------------------------------------------------------------------------------------------Disclaimer The Report is prepared by the Economics Division of CARE Limited. The Report is meant for providing an analytical view on the subject and is not a recommendation made by CARE. The information is obtained from sources considered to be reliable and CARE does not guarantee the accuracy of such information and is not responsible for any decision taken based on this Report.