PRIVATE INDUSTRIAL SECTOR, ROLE OF

PRIVATE INDUSTRIAL SECTOR, ROLE OF India faced a severe balance of payments crisis in 1990–1991. Thanks to this crisis, fairly substantive economic reforms have been introduced since 1991 to stimulate India's economy, especially its industrial sector. Import duties have been slashed, dropping from 47 percent in 1990–1991 to 16 percent in 2001–2002. Since this average duty of 16 percent is for all products, if one excludes agricultural products, the average import duty is lower still. By 2006–2007 the peak import duty is likely to be 20 percent for consumer durables and no more than 10 percent or lower for all other manufactured products. Most quantitative restrictions on imports have, moreover, disappeared, and income tax exemptions on export profits are being phased out. Barring a few strategic sectors reserved exclusively for the public sector, foreign direct investment in all other manufacturing activities is permitted, with no equity caps. However, equity caps continue in many services sectors, and foreign investment remains prohibited in agriculture. The Reserve Bank of India no longer administers the exchange rate, which is now market-determined, and India's rupee is already convertible on the current account, some steps having recently been taken toward capital account convertibility.

Historically, protected markets at home had led to inefficiencies and outdated technology for costly Indian industry, scant attention being paid to customer needs. Since such inefficient industry could not compete in the global market, export incentive "crutches" supported it. Now these are gone, or are in the process of being scrapped. Modern India's market-determined exchange rate no longer cushions the Indian economy from foreign exchange fluctuations. Simultaneously, with exchange controls eased, it has now become easier for Indians to borrow and invest abroad.

Private industry legitimately complains, however, that domestic reforms have not kept pace with external sector reforms, making it difficult for private investors to compete, even though industrial licensing has ended. Historically, such licenses had long been required for expansion, or for setting up fresh capacity. Additional licenses were required by companies that were under the purview of India's Monopolies and Restrictive Trade Practices Act or the Foreign Exchange Regulation Act. Such licensing is over, and in that sense, the so-called license raj has ended. There has also been a spate of reforms in the financial sector.

Nonetheless, other vital domestic reforms still remain to be implemented, starting with needed infrastructure improvements in power transmission, as well as repairs to roads, ports, and telecommunications systems. Proper targeting of subsidies and levy of right-user charges has not generally been possible. Because of high fiscal deficits, central and state governments were in no position to invest adequately in physical and social infrastructure. Downsizing of government expenditure has not as yet occurred. Because governments borrow, often at artificially high interest rates, interest rates for industry remain high. Indirect tax reforms are required, since—with a multiplicity of taxes—that structure is nontransparent and leads to costly cascading effects. An integrated value-added tax has been talked about for quite some time, but its implementation keeps getting postponed. Nor have necessary agricultural reforms occurred. These are urgently required to stimulate income and consumption growth and to dispel the myth that reforms are pro-rich and anti-poor. In the absence of agricultural reforms, industry has neither the requisite demand nor the inputs required for industrial production. Thus, the evolution of India's food-processing industry has been totally inhibited. In India, "small-scale" industry is still defined by investments in plant and machinery being below a certain threshold, as elsewhere, not in terms of employment. Reservations of certain sectors for production by small-scale industries hence prevent those sectors from improving their technology or reducing costs. India's legal framework also needs reform. Some of this is statutory, such as the Industrial Disputes Act, which prevents retrenchment, lockouts, or closure without government permission, discouraging the use of labor-intensive techniques. Other laws are not statutory, but executive, leading to an "inspector raj," characterizing all three steps of private industrial entry, functioning and exit. The old licensing raj may be dead, but the inspector raj is still alive, and leads to deterrent procedures, bribery, and rent seeking. Finally, dispute resolution does not work fast enough, although a new Arbitration and Conciliation Act was passed in 1996 and a new Civil Procedure Code was amended in 2002.

The private industrial sector needs to be defined, since it is not a uniform or heterogeneous category. A broad distinction is sometimes drawn between the "organized" and the "unorganized" sectors. However, this definition is ambiguous, and there are at least three definitions of organized versus unorganized. First, any factory that employs ten or more workers and uses power (or twenty or more workers but does not use power) comes under the coverage of the Factories Act. This is the first definition of organized. Thus defined, around 8 percent of the labor force works in the organized sector, while 92 percent works in the unorganized sector, which of course includes all self-employment and agriculture. Second, there is a definition of small-scale industry, defined through investments in plant and machinery, and there is a similar definition for khadi (hand-spun cotton) and village industries. These are therefore equated with unorganized industry, and all other industry is organized. Such unorganized industry is exempt from some labor laws. Data for organized sector industry are obtained through the Annual Survey of Industries. Subject to this data, around 45 percent of industrial output (with similar figures for exports) is estimated to originate in the small-scale sector. Third, depending on threshold levels of turnover, some units do not have to pay indirect taxes. Those outside the ambit of indirect taxation are referred to as the unorganized sector. There is strong correlation between these three different definitions of organized and unorganized, but the definitions are not identical. Also, to avoid paying indirect taxes or to circumvent labor laws, units deliberately stay small by fragmenting production.

There are some 140,000 factories, of which India's factories employ fewer than one hundred workers. In number, most factories are in sectors like food products and small machinery, but in terms of value of products, most are in sectors like basic chemicals, heavy machinery, and electricity. Some factories are in the public sector, run by the central, state, and local governments. There are a few that are jointly public-private. However, 92 percent of all factories are completely private, more than 3,500,000 begin small-scale units. More than 250,000 units are estimated to be "sick," their loans overdue to banks and financial institutions that cannot enforce claims on collateral. But a new Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act—enacted in 2003—should make that much easier.

India's labor force in 1999–2000 was around 365 million. Because of unemployment, the working force was slightly lower, around 335 million. Of this 335 million, 59 million worked in industry, which does not mean only manufacturing but also includes mining, quarrying, construction, electricity, gas and water supply. Of the 59 million who worked for industry, 41 million worked in manufacturing; 28 million worked in the organized sector (19 million of those in the public sector and 9 million in the private sector). Because of reforms and a reduced role for government, growth in the public sector has stagnated.

There are significant differences across the Indian states. The pre-1990 industrial licensing policy sought to ensure that jobs were created where there was adequate workforce. Since the onset of reforms, however, the public sector has much declined in importance, and many "sick" units are in the eastern states, which have had little private sector employment. Faster growing, richer states are usually in the north and the west.

India's manufacturing sector began to recover in 1992–1993 and through 1995–1996 enjoyed a heady annual average growth rate of almost 12 percent. A deceleration began in 1996–1997, however, and from that fiscal year to 2002–2003, annual growth averaged less than 6 percent. This deceleration may finally be over in 2003–2004, but it is uncertain whether this recovery is sufficiently broad-based and robust.

The reasons for the manufacturing (and industrial) deceleration were that initial growth in the immediate wake of reforms was sustained through demand for consumer goods and cheaper consumer credit. Once this demand was satisfied, growth ran out of steam. Government capital investments then declined, triggering a negative effect. The initial boom led, moreover, to greatly expanded capacity, and once the boom was over, investments flagged. Increasing real interest rates and a slump in India's capital market from 1995–1996 made the situation worse, especially for new investments in the unorganized sector. Manufacturing growth was sustained through a very high rate of export growth, which slowed down from 1996–1997, thanks to the crisis in Asia, a global slowdown, and a real appreciation in the value of the rupee.

Deceleration was also attributed by some to a widespread scare that Indian manufacturing would be swamped by cheaper Chinese products. Chinese costs of production were half or even one-third the costs of comparable Indian products. Two-thirds of Indian anti-dumping investigations (and actual antidumping duties imposed) were then levied against Chinese products, including chemicals, pharmaceuticals, toys, athletic shoes, and batteries. Though the Chinese paranoia has dissipated, the Chinese competitive advantage still remains, partly due to lower infrastructure costs of power and transportation in China, nontransparent input prices, and labor market flexibility combined with lower interest rates. Chinese advantages are no different from those articulated in global competitiveness yearbooks, but the Chinese also have better technology and economies of scale. This underlines the lack of adequate private sector investments in India. India missed the export bus in exports of low-tech consumer goods. Indian manufacturing often sought to relocate to China, especially in sectors like services and pharmaceuticals. India's official targeted annual real gross domestic product (GDP) growth figure is 8 percent. By the twenty-first century, industry accounted for 25 percent of Indian GDP, services accounted for 50 percent and agriculture for the remaining 25 percent. Industry is thus on the low side, especially when compared to East Asia. Industry's contribution to Indian GDP ought to be around 35 percent, if not higher.

Without domestic reforms, such an increase is hard to imagine, because the industrial sector (which increasingly means the private industrial sector) is still constrained. However, individual private companies have become much more competitive and efficient, although no remarkable productivity increases are detected for industry as a whole. There are now globally competitive Indian companies, not just in information technology, biotechnology and pharmaceuticals, but also in garments, jewelry, auto parts, bicycles, and electrical machinery. Competition consequent to reforms triggered such efficiency, one of the reasons since 2002 that Indian exports have tended to do so well, despite the rupee appreciating somewhat. Investments undertaken now are more efficient than investments undertaken before the mid-1990s, at least in the organized private industrial sector.

Bibek Debroy

See alsoIndustrial Growth and Diversification ; Industrial Policy since 1956

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