Bifocal, Please: 'Make in India' Needs to Lean on Both Exports and Domestic Demand

S&P Global CRISIL
Written By: Dharmakirti Joshi, Abhijit Hirani, Adhish Verma and Pankhuri Tandon
S&P Global CRISIL
Written By: Dharmakirti Joshi, Abhijit Hirani, Adhish Verma and Pankhuri Tandon

Executive Summary

The Make in India program does draw inspiration from the high export-led growth achieved by the Asian tigers in 1965-1990, and by China later.

Be that as it may, the reality of today is that the external environment is far less conducive to trade and domestic challenges continue to constain India's export competitiveness in many sectors. We believe that India can nurture growth in its manufacturing sector only if it strikes a balance between export-led and domestic demand-led growth. And that will require relentless efforts at improving the competitiveness of our manufacturing sector.

The post-financial crisis world is witnessing a sharp slowdown in trade and a tilt towards protectionism. Since 2012, global trade has grown by only 3.1%, half the rate attained in the previous three decades. Not only is trade slowing down, its intensity with respect to global growth has also come down - trade grew faster than GDP before the crisis, but there has been a reversal of this trend since then.

Then there are the adverse distributional aspects of trade. Not every advanced country has benefitted from free trade, though at the aggregate level it has benefitted both importing and exporting nations. This is now breeding discontent in the segments that have been left out, leading to a backlash against trade. The slide in investment demand too is limiting global trade opportunities. Using exports to prop up manufacturing growth is, therefore, unlikely to be as easy for India as it was for east Asian economies.

However, India cannot put the entire blame on the global environment for its poor export performance. While India's share in global exports is falling, those of Bangladesh, Vietnam and China is still rising despite the adverse environment. Also note that even though China's export share in its own GDP is slipping, it still looms large because its share in global exports continues to rise.

As China moves up the ladder of sophistication in manufacturing, it is slowly vacating space in low-end manufacturing. Capturing this low-end segment could particularly benefit Indian economy, since it has the potential of providing employment to low-skilled workforce. However, India seems to be lagging behind Vietnam and Bangladesh in the race to capture this space.

For instance, in readymade garments sector, while Bangladesh's share in global exports increased to 6.7% in 2015 from 2.5% in 2005, and Vietnam's share tripled to 5.3% in this decade, India's share increased by a mere 0.8 percentage points. India's export competitiveness has been impacted by lack of market access compared with these economies, lack of adjustment to changing global demand towards manmade fibre-based garments, small scale of operations, low labour and machinery productivity. There are other sectors also where India seems to be lagging: textiles, toys, footwear, leather products etc.

It is hard for Indian manufacturing firms to be competitive, given constraints such as inadequate physical infrastructure (reliable power, water), inflexible labour laws and an opaque land acquisition system. And once the goods are produced, they are faced with other inefficiencies in the system, such as logistical bottlenecks.

But there is light at the end of the tunnel.

Some green shoots are emerging in the form of improved global competitiveness, as indicated by India's rankings in World Economic Forum's Global Competitiveness Index, World Bank's Ease of Doing Business and Logistics Performance indices, and Transparency International's Corruption Index.

Another clear positive for India is the large size of its domestic market. Not only is India the third largest economy in Purchasing Power Parity terms, it is also currently the fastest growing large economy. Empirical evidence suggests that when economy is in the middle income phase, demand for manufactured goods accelerates with every unit increase in income. For India, which has recently entered the middle income segment and is the fastest growing large economy, this implies that its domestic market is at the cusp of an expenditure boom.

However, to realise the potential of the domestic market for India's manufacturing sector, the government should focus on improving the purchasing power across all sections. Unlike exports which are primarily determined exogenously through external demand, components on domestic demand -are dependent on domestic income. Hence policy measures that ensure distribution of income growth to all sections will sustain domestic demand-led growth. This need not be achieved by merely subsiding the poor, but also by empowering them to participate in the growth process. Measures such as financial inclusion, education, fair property rights, and price stability can serve as catalyst in ensuring equitable growth.

Even while catering to domestic demand, domestic firms must ensure that their goods are competitive in the global market. Since India is open for international trade, rise in domestic demand without commensurate rise in competitiveness and adaptability of domestic firms will raise the country's imports.

Hence, even if India wants to grow its manufacturing by catering to domestic market, it must continue to focus on improving its manufacturing for exports. The maximum possible growth for manufacturing sector can only be realised if it strikes a balance between export-led and domestic-demand led growth.

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