Make in India spoilt by persistent low manufacturing inflation

A Copy of this appeared in Financial Express on 12-03-2018. Link:

V Kumaraswamy

Make in India is one of the key cornerstones of the current government to raise growth rates and create employment. It has been almost 4 years since the Make in India was launched with much hope and fanfare. The Government has initiated several useful steps and reforms to actualise it. The most recent upgrade in credit rating and 30-odd points jump in Ease of Doing Business will get us some mileage.

But it is clear that the delivery of Make in India is rather patchy. Several reasons have been advanced for its lacklustre show – highly overvalued currency, unfavourable ASEAN FTA, tight and unyielding monetary policies, very high real interest rates, high logistics costs etc. All of them have a degree of truth.

But it has to be recognised that beyond all these, an entrepreneur or corporate will invest only if they get remunerative prices returns are competitive to what the other sectors yield. This last aspect has not been addressed at all by the Government or inflation conscience keepers. Had this single factor been corrected, Make in India would have had a far better report card to show.

Nature of Indian Manufacture

Indian manufacturing is not high tech where heavy engineering, high end electronics, aircraft and space crafts, ship building etc. dominate. It is relatively low to medium grade in its maturity. It has a heavy dominance by industries which prepare or convert produce from agriculture for domestic consumption.

To give a few examples: Textile sector (the biggest industry by employment) is dependent on agriculture for cotton supplies and silk which can account for about 60% of final product costs, Sugar industry on sugarcane, Cigarette on tobacco, Beedi industry on Tendu leaves and tobacco, Vegetable/ cooking oil industry on sunflowers, groundnut, sesame, Food processing industry on wheat, maize, fruits, fish, poultry and Dairy industry on milk. Roughly 40-45% of Indian manufacturing sector depend on agricultural for their inputs. And a few more for inputs from Mining.

It is important to maintain a balance between input and output prices in these sectors and they should ideally move in tandem, if the manufacturing sector has to stay attractive for investments.  In India since agriculture feeds industry and industrial final goods are sold to those in rural and agriculture areas, any persistent imbalance could hurt both.

Our Manufacturing Prices are down 41% since 2004-05 in relative terms.

Terms of trade in international trade means the prices a country gets for its basket of export goods versus what it pays for its imports and how the relative price moves over a period of time. In domestic trade it means how the prices which a sector gets for its output moves in relation to the prices it pays for its inputs from other sectors.

From 2004-5, the terms of trade have been relentlessly moving against Manufacturing. If the manufacturing sector has had to pay 165% more for its key inputs from agricultural sector, it has been able to recover just about 57% from its customers. If Agricultural input prices are taken as the base, the manufacturing sector is getting nearly 41% less today for what it sells to other sectors compared to what it pays for agri inputs. (see Chart)


At one level it helps transfer of income from non agriculture sectors to rural and agriculture sector and thus corrects income skewedness. But a consistent increase of this magnitude has continuously eroded the margins of the manufacturing sector to unattractive and unsustainable levels leading to lack of enthusiasm in investing.


Year on year for almost a decade and half, Agri inflation has been more than parity. This has come about by steep and arbitrary increases in Minimum Support Prices (MSP) announced by the Centre for many crops, especially in 2009-10, 10-11, 12-13 and 13-14 possibly due to electoral compulsions (see Table). Although MSPs are restricted to certain crops, farmers tend to gravitate towards higher MSP yielding crops till the yield per hectare for other crops equalises with those under MSP. Thus MSPs impact transmits with a lag on other crops as well. One has witnessed a similar phenomenon in rural wages consequent upon implementation of NREGA.

On the other hand,  ASEAN FTA agreement has more or less put an effective ceiling on the prices that manufacturing can recover for its end products. Free trade has more or less made recovering cost inflation through domestic price increases an impossibility over the years. India’s over-valued currency has played a spoil sport on top of these.

Need for Correction

India’s growth story to continue requires Indian manufacturing to expand and diversify and create employment for those released from rural and agri sector. As the sector saddled with the responsibility of creating jobs for those entering the market, it should be the one which is relatively more attractive. Unfortunately, things are exactly the opposite for the last decade and a half relentlessly.

Ease of doing business can contribute to encourage entrepreneur by making the state machinery less intimidating but it cannot alter the base investment arithmetic of Return on Investments (ROIs).

Year Wise Inflation for Mfg and Agri Products                     (2004-05 = 100)
Year Mfg Inflation Agri Inflation Agri Inflation / Mfg Inflation
2005-06 2.4% 3.4% 140.3%
2006-07 5.7% 8.8% 155.4%
2007-08 4.8% 8.0% 167.0%
2008-09 6.2% 9.9% 160.9%
2009-10 2.2% 13.1% 589.6%
2010-11 5.7% 17.0% 297.9%
2011-12 7.3% 7.8% 107.6%
2012-13 5.4% 10.0% 185.5%
2013-14 3.0% 11.2% 370.7%
2014-15 2.4% 4.7% 195.8%
2015-16 -1.1% 3.4% NA
2016-17 2.6% 5.0% 195.0%


The approach announced in the recent Budget for MSP fixation might lend stability and certainty. If the MSPs are linked to the input prices which should include manufactured items like fertilisers, pesticides, seeds, etc. the inflation of manufactured products would have a decisive say in the agri inflation and hence MSPs. They would get inter locked.

Details are awaited on the exact scheme. Even if a margin of 50% is built in (which should take care of imputed interest, rent and profit besides inflation of inputs), it would build some parity and hence rein in persistent deterioration of adverse terms of trade against manufacturing.

Even so the heavy backlog built up since 2004-05 would need to be corrected if manufacturing is to see green shoots again. The States also should have a say in the future FTAs; they should have a choice of what industries and products to offer for free imports and what products to seek exemption from our overseas importers. States should also have a say in the fixation of MSPs.

Demystifying GDP numbers – as articulate a statistician as you will ever find

Demystifying the confusion around GDP figures

Attended an address today by Dr Pronab Sen, former Chief Statistician of India and Chairman National Statistical Commission. I must admit despite his slightly absent minded looks, he is the most articulate economist I have heard in a long time. Some excerpts. He threw a lot of light of issues generating lots of heat in the press nowadays. (Errors in figures if any is entirely mine).

Should we believe the new GDP growth rates reported

People confuse output for income. GDP is not the sum of turnover but income. A consumption good may be traded at 4-5 intermediate stages before it reaches the final consumer. Then GDP is not the summation of the turnover of the 4 intermediate trades but just the income (Value added) at each of these stages. Example: if an auto mfgr imports components of Rs 30, assembles and sells the car at Rs 55, the dealer to retail showroom at Rs 70, and the retailer to customer at Rs 80… the GDP will be Rs 50 (25+15+10) not Rs 235 (30+55+70+80) or Rs 205 (55+70+80).

Thus GDP is not summation of  Value of Outputs (VO) but summation of Value added (VA) at each stage.

GDP = ∑VA  or = ∑VO * (VA/VO). i.e output into Value Added ratio at each respective stage.

In India the long term average (1950-1998) VA ratio was 16% for manufacturing industries. Between 1998 & 2003 it increased to 18%. By 2011-15 this has increased to 22.5%. Thus a lot more value addition is taking place in our output than anytime in the past. Even if our output may not have grown at higher rates, the value added component in that output has gone up … giving higher GDP numbers. This is what is being witnessed now.

2             Typically in a downturn, industries invest in efficiency improvements rather than investments in physical assets. In Boom time they invest in physical assets (may be indiscriminately). During 2 crunch times of 1998-2003 credit squeeze and 2011-2015, India has invested and become far more efficient and is achieving higher VA in its output. We are lot more competitive globally today than 10 years back.

3             China also invested heavily in physical assets during boom years. Their VA/VO ratio was also fortunately high in mid-20s which has fallen and stands over the last decade to 19% now, less than India’s in several sectors – a sign of over investment. They are now investing in efficiencies and technologies. The World average (long term) is 18-19%. India is well placed now on cost competitiveness and more industries should identify their strengths and grow; they should not worry too much about our size being 1/5th or 1/10th of China’s in their industry.

Why corporate profitability is low in spite of higher value added

4             The VA  has 2 large components – (i) what is paid out as wages and salaries (WS) and (ii) other operating surplus(OS) (paid out as interest, dividend, retained surplus, etc.). In the last 5 years the average rate of growth in WS for India as a whole is 17% p.a. meaning far more is paid out as salaries and wages and the share of OS is 10% p.a. of which the share of interest has been high. Dividend payout has also increased dramatically affecting Corporate profitability and retained surpluses. Wages and salaries in rural India has risen faster than in urban areas/industries.

Shift in manufacturing profile

5             The share of unlisted firms is growing faster than listed companies. Unlisted firms are growing at 12% CAGR while listed firms output is growing at 7% CAGR. The share of informal sector has quietly reached 40% today.

India is becoming more entrepreneurial. It would not be surprising to see that in the next 5/10 years, the top 20 of the 40 construction companies will be totally new and unheard of now.

6             Black money distorts asset allocation.  Most of it is kept in black assets – gold and real estate. Now that there is drive against black money, real estate is suffering.

On Why IIP numbers (index of Industrial production)  don’t reflect our higher growth    

7             IIP numbers are constructed from select industries. Those mfg industries/product which contribute at least 2% of total is selected first. Some of these may have 8% some 5% and so on. 14 such products contribute 80%.

For these products/ industries, just the top 6 firms (turnover wise) are selected. Their rate of growth is taken and averaged and reported as IIP numbers. The index we are using has a base 2004.

During the last 10 years between 2004/5 and now, the small and medium scale sector in these industries have grown far faster (at 14% p.a) than the corporate sector (7% p.a) and the sample 6 have grown even slower. The share of small firms have grown from 30% to 50% in the last 10 years – a fact not captured by the index.

Construction of any index is a time consuming and costly exercise based on extensive surveys. Thats why they are not done frequently. A new series with base 2011 is in the offing, which might set right the anomaly between GDP and IIP numbers.

Why Indian industry is not investing even if it is growing

7             Informal sector which is growing the maximum does not have much savings – it is squeezed out by the money lenders – their main source of finance.

More is paid out as wages and salaries, who may not have the same investment urges as retained earnings.

and of course the High interest rates (see below)

Interest rates

8             Indian interest rates are very high. It attracts a lot of portfolio flows which come in and keeps Rupee artificially high and un-competitive. The way to correct it is to let the interest rates fall which will enable the industries to invest and absorb these flows. If the flows are properly absorbed the currency will find proper level ($ may be Rs 72/75 instead of being Rs 67-68) and portfolio flows will be moderated. This has not been allowed to happen and our real interest rates have been kept artificially high.  We are just accumulating reserves instead of putting it to productive use.

9             Indian industry is crying hoarse on high real interest rates. What they should be screaming at is the differential interest rates. Between 2008 and now these have moved significantly against India.

Our corporate interest rates were 9% average towards end of last decade when the global interest rates were 4.5 % – a gap of 4.5%. Today our interest rates are 10.5% when the global interest rates are kept at 1.5% a gap of 9%. Not an ideal situation for investments. It is better to invest overseas, even if to supply to India.

Thus Indian industry is caught between artificially high interest rates and artificially high forex rates which does not enable them to raise prices in line with costs.

Difference between Planning Commission and the current NITI AAYOG.

10           The previous planning commission had a 15 year, 5 year and 1 year plans/horizons.

15 years – There was a broad perspective plan which was not generally well known or publicized.

5 years – Better known as 5 year Plans. This was an approach paper.

1 year – laid out the expenditure for various programmes.

The NITI AAYOG has a 15, 7, 3 year cycles.

15 year. Vision document – the Government has asked the Niti Aayog to come up with this.

7 year – plans and programmes.

3 year – implementation plans for the above.


11           The current NPA is entirely that of Corporate sector. The priority sector NPAs have remained at their usual 1.5%.

12           From financing just working capital needs from retail savings our Banks are now financing long term loans from the retail savings. More than 50% of lending today is for long term loans.  This is inherent mismatch. Our commercial Banks are not just designed to deal with NPAs.

13           It is not that we were without NPAs earlier. The long term loans were earlier met by DFIs (IDBI, ICICIs, IFCIs) which financed themselves with long term Bonds (15 year types) and were far better able to deal with temporary fluctuations in business and time taken to rectify/reconstruct even bad decisions. It is simply not feasible to deal with them on a quarterly basis, which is what the banks are expected to do now.