Government's woes = Government's Control

There's no gainsaying that India bypassed a crucial stage in its development. The last decade has seen a preponderance of policy prescriptions targeted at India reconciling with its manufacturing past or rather lack of it. And that has now come to haunt the policymakers across the country. I could be more liberal with my words, but India's current stance speaks the opposite; the move toward protectionism. This move by the Government is ostensibly aligned with its alleged nationalist rhetoric. However, it is also not the whole but only part scope of the discussion in this blog. As much as the rhetoric seems adverse, it is not the entire truth. And we should not fall prey to the fallacy of composition, and in this blog, I try to identify the root cause of the problem.

Kaldor, Verdoon and Krugman have posited the importance of the manufacturing sector for the growth of an economy. The three of them have propounded their ideas in a similar vein that when the economy passes a certain critical level of production, it fosters sustainable economic growth. And India seemed like an exception, but as the lotus blossomed, it came to submerge under the mud. India has failed to improve labour force participation, which stands true for all types of labour. India's failure at establishing labour-intensive units is apparent. Its move away from the government-led industrial growth before 1991 to leaving it up to the market has not been fruitful. To say that the shift from state-led development wasn't successful would be naive, for India did see economic growth spurred by the service sector. After IBM lost a foot in India, the domestic market, with English-speaking labour, in response to the vacuum, engendered the success of the tertiary industry in India. India's economy has piggybacked on the service sector, and nothing has changed.

The manufacturing sector's contribution to the country's GDP has declined over the past decade. After a brief surge from 17.4% in 2011-2012 to 18.36% in 2017-18, it (GVA) declined to 17.1% in 2019-2020, which further dwindled to 16.9% in 2020-2021. While in a Globalized world, under the free market economy, it is not essential to manufacture everything in the home country, but a country must increase its national capacity. And it should not come at the expense of paying heavily for indigenously manufactured goods that the country could obtain at lower prices globally.

Indeed, the import of goods has to pass other measures such as the current account balance. It is imperative in an emerging economy's interest to keep the value of exports higher than imports. Still, notwithstanding that, it is essential to increase the country's national income to boost economic growth. This points to efficient utilization of factors of production and, income distribution facilitated by those factors. It follows from this that a need to go back to the basics of macroeconomics is where the answer lies to the dwindling manufacturing sector; Labor, Capital and the spirit of entrepreneurship. India has first and the last in abundance, but it lacks the Productive Capacity that arises from Capital. It would be instead depreciating to attribute the cause to the lack of Capital in India, for India is the world's 5th Largest economy. If we delve deeper, access to Capital emerges as the bigger problem.

The 1980s saw growth in the industrial sector, but that was short-lived. Until the Government introduced the reforms, the growth of the manufacturing sector was predominantly dependent on the supply of Capital from the State. And the Indian State had realized the Capital as the mainstay for development. The latter 5-year plans of the 1980s targeted manufacturing sector growth, led by Development Financial Institutions (DFI) like the Industrial Development Bank of India (IDBI). After the liberalization, the Government shut down the DFIs, and the only way left to avail credit was from the market.

The liberal reforms spur industrial growth in its initial stages, followed by a fall during the Asian Crisis, subtle rises in the mid to late 2000s, and further decline in the past decade. It is vital to notice that credit growth has seen sporadic periods of stagnation or decline in the manufacturing sector. The absence of a consistent supply of funds, I argue, is one of the biggest causes of the degenerative performance of India's manufacturing sector. Of Course, there are other limiting factors, such as suboptimal public infrastructure or regressive labour laws, but I see them more as enabling factors. Once the number of units in the manufacturing sector grows, it would have spillover effects in other areas such as infrastructure and labour laws.

Credit and economic growth have an established causal relationship. But access to credit is a deterrent in India. It is cumbersome or sometimes even impossible to avail of loans for a new business. Or the grants of credit came at a higher premium. And the debt from the loan only supports short-run financing requisition. For the long-run requirements, the businesses aim at debt accrual in the form of bonds or equity. To the dismay of the companies, the penetration of the corporate bond market is also negligible in the manufacturing sector. The corporate bond market predominantly serves infrastructure and financial services companies in India. And Sovereign Bonds dominate the private corporate bond market, while the private bond market constitutes only 27% of the whole market. While banks are laden with NPAs, the Government is doing little to increase confidence in the private corporate bond market. The introduction of G-sec has rather led to the crowding out. It has been three decades since the Government surrendered the idea of state-led development, yet it has not been able to distinguish between intervention and imposition. The question is not about intent, which is certainly well placed, but the path between intent and delivery. The bond market suffers a supply and demand lacunae in India. While there are regulatory restrictions on demand, crowding out dampens supply. For sustainable economic growth, the economists suggest the Credit to GDP ratio be higher than 100%, and the current value in India is 56%. Compared to its fast-progressing Asian Peers, India lags far behind in terms of this Indicator.

Policies such as National Manufacturing Policy and Make in India overlooked this crucial aspect for starting plants. The business owners need to finance their fixed costs to set up a manufacturing plant but hardly have the means or access to Capital.

We need more private sector participation and the vast supply of credit that follows from it. Thus, it is incumbent upon the Government to let the manufacturing be contingent upon credit from the private sector, and it plays the role of facilitating the same. It must identify the nature of expenditure that leads to crowding out. I believe the Government should reintroduce the Development Financial Institutions of the past, however, with a different outlook. While the role of DFIs should be to facilitate the flow of credit in the market, the Government should not participate directly as the benefactor of credits. The Government should divert the public expenditure toward Credit Guarantee Schemes, which would discount the risk of defaults. A safety net such as this would promote confidence in private bond markets and boost manufacturing sector growth. The Government introduced a similar scheme, namely the Emergency Credit Line Guarantee Scheme, as a stimulus package to soften the blow of COVID-19. However, only the MSMEs with turnover over Rupees 250 Crores were eligible to avail of the benefit. Such emergency schemes are temporary fixes and must be turned into long-term policy solutions to safeguard the interests of manufacturers and that of investors as well.

The goal is to increase national capacity by significantly increasing the manufacturing sector's contribution. I firmly believe that growth in credit to the sector would substantially spur its development, and India could achieve it in numerous ways. There certainly are roadblocks, and the Government's hegemonic control is one of them. I want to discuss more ways of increasing the availability of funds, but I'll do that in subsequent blogs. For now, I want to say to the Government, "Let the market have it".