That India needs manufacturing is well understood. Initiatives like Make in India have tried to revive the Indian manufacturing sector. The government also realises that micro, small & medium enterprises (MSMEs) are the critical drivers of manufacturing growth.
Despite these efforts, manufacturing remains sluggish, MSMEs remain lethargic. What ails Indian manufacturing? Why is it not a big contributor to the Indian growth story?
Manufacturing in Japan, east Asia and China were export-oriented. The Japanese and East Asian model subdued the domestic demand and focused on global markets, mainly the US. China followed a slightly different track. Chinese manufacturing was State-sponsored import-substitution on steroids. China directed the enterprises to recreate global products at very low cost for the domestic market. Then, they targeted exports. As soon as China saw traction, she scaled these enterprises to unbelievable scales. In many goods, the Chinese installed capacity is more than the entire global demand. This manufacturing strategy depended on large corporates and it was easy to manage.
India’s Large Corporates Failed To Address Global Demand
The first opportunity for manufacturing expansion came after 1991. Being constrained hitherto by the license-raj, Indian corporates were eager to expand. However, their eagerness caused overcapacity that resulted in slowdown in the late 1990s. During this time, Indian corporates should have increased their share in the global demand. To an extent they did. India did well in outsourced manufacturing strategies—in auto-components, pharmaceuticals, textiles, etc.
But Indian corporates did not invest in innovation. Hence, new products are not coming from large corporates. They merely sought to be factories for the foreign players. That means Indian large corporates have no advantage over the competition. Even in automobiles, our product design was sourced from European design studios.
There is nothing stopping the Mahindras or Tatas to design a small utility vehicle (SUV) for US markets. But they are busy selling Indian products to the US markets. As India got better at innovating traditional automobiles, the game changed to electric vehicles and autonomous vehicles. Here, again, tariffs on electric vehicles have prevented the development of Indian capacity and technology in this space.
To add to this, the Western economies used non-tariff barriers to effectively neutralise lower Indian wage cost. For example, Indian pharmaceuticals companies find themselves under the US Food and Drug Administration (FDA) investigation time and again. This has increased international risks for Indian large corporates.
Thus, our large corporate manufacturing faces a higher risk and is, hence, not expanding globally in the current uncertain environment.
Indian Large Corporate Failed To Address Local Demand Too
India large corporates failed to innovate to identify and address the Indian demand. Our large corporates were busy customising international products to local tastes. In this too, their pace is modest. Even today, we do not see international cosmetic brands aligned to Indian skin tones, or the fast moving consumer goods (FMCGs) aligned to Indian tastes, or consumer durables keeping Indian realities in mind.
Indian large corporates are not innovating domestically because of the protection they enjoy on the domestic front. Instead of licences pre-1991, this protection is in the form of brand equity and distribution networks. These corporates are content targeting the domestic demand.
Another protection is afforded by our policy of aversion to foreign companies (with cutting-edge technology) setting up plants in India. In many products, Indian capacity is not able to meet Indian demand. For example, Indian steel-makers cannot produce auto-grade steel. In the face of such facts, resistance to POSCO plant, etc, seems even more bizarre.
This is not aversion to technology but implicit protectionism. It is hurting Indian consumers and MSME manufacturers too.
The result is that large corporates are focused on improving penetration of international products. To be fair, they are targeting the low hanging fruit. But their lack of interest and pace in the developing rest of demand spectrum prevents manufacturing growth.
Indian Manufacturing Is Different
First, Indian manufacturing is domestic market driven. India is a hub of small car manufacturing because India is a user of small cars. The same goes for motorcycles. For manufacturing to develop, the companies must first target domestic demand.
Secondly, because of the fragmented nature of our domestic demand, the opportunity will be small at first. However, that does not mean that while addressing that demand Indian manufacturers can never become global players. Once the business model is tested, both national and international demand can be targeted. And, indeed, they must.
Thirdly, radical innovation will be required to expose the variety of niches within the Indian and global markets. These will require agile teams working on products and business models that evolve very quickly. Radical innovation rarely comes from established corporates. It usually comes from MSMEs that are able to take higher risks to overtake the established players. And there lies another part of the problem.
Constraining the MSMEs
MSMEs are the best vehicles to exploit domestic demand. Ideally, MSMEs would have exposed the niches in Indian markets and exploited these profitably. We should have seen MSME proliferation between 2003 and 2009. That would have sowed the seeds of a manufacturing revolution. But it did not happen: mainly because of corruption and risk-aversion in banks causing crowding out of SMEs by larger corporates.
Further, whatever seeds of manufacturing revolution were sowed, they did not flourish. For that, MSMEs should grow large. However, Indian laws prevent small companies from becoming large because compliance costs increase drastically.
This anti-large corporate mindset should be discarded. Goods and Services Tax (GST), bankruptcy and insolvency code, are good, well-intentioned steps that should allow companies to grow big. The way they are executed, however, leaves a lot to be desired. Land laws, labour laws and other compliance requirements are big hurdles in MSME expansion. The existing MSMEs find it very costly to expand.
MSMEs find opportunity in the products where large corporates do not compete with them. However, here, we have allowed global value chains to allow global MSMEs to reach the domestic markets. So, as soon as Indian MSMEs discover a niche, it is easy for global value chains to address that demand. Thus, instead of Indian MSMEs replacing imports, imports are replacing MSMEs.
Thus, Indian MSMEs remain profit-constrained as there is constant assault on their margins by large corporates. They remain investment-constrained as debt is crowded out by large corporates and listing requirements are tough. They are risk capital-constrained (venture and seed funding) because of lack of proper development of these financial avenues. Finally, they are also risk effort-constrained as much of the corporate bandwidth is occupied by compliance. They are unable to innovate and, hence, unable to create a moat, something Warren Buffet wants successful businesses to have.
How To Fix It?
To fix it we need a second wave of liberalisation. It should proceed on twin tracks—push improvement in global competitiveness of large corporates and unshackle the MSMEs to compete globally.
We need to liberalise the tariffs and let the large corporates fight out for their share of domestic demand. However, adequate notice has to be given to the Indian corporates. Let the policy-makers state that most of the tariffs will be abolished on a certain date, say 31 December 2020. That gives them enough time to prepare.
Make SME compliance easy and strict. If compliance is easy, it is easier to make it strict, if it is complicated then you are pushing them to fail. For example, all cashless SMEs should have no compliance requirements except a declaration that they are cashless and that their accounts should be on the cloud with authorities having read-only access. If any cash is found on the premises, then penalties should be hefty.
Make it easy for MSMEs to target global demand. They could do it through Amazon or Walmart; but we need value chains that extend globally at very low cost. This will mean that either MSMEs themselves or Amazon / Walmart will have to deal with foreign exchange related compliances. We may encourage ventures that build these value chains for Indian companies.
Improve credit availability to SMEs—treat the bank branch managers like debt fund managers and let them sift through the SMEs to identify the real gems.
However, that means you will have to compensate and regulate them accordingly.
Simplify access to risk capital—venture and seed capital should be easily accessible. Remove tax on venture capital. Set up an arbitration body for dispute resolution for SME investment disputes.
Ease listing norms and inform equity investors of the risk. At present, accessing equity capital for innovation and growth is too costly. The compliance for the same should be made easy. It should be possible for one-person finance department to take care of the entire compliance after listing.
The solution to Indian manufacturing problem is multi-dimensional. We need to improve competitiveness of large corporates by pushing them to compete globally.
We should fix problems faced by MSMEs to unleash them to address the global demand. Indian manufacturing will be complex. It will be diverse and messier. It cannot be managed or controlled like in China but it can definitely be encouraged.
(Rahul Prakash Deodhar is a private investor and Advocate, Bombay High Court. He can be reached at [email protected], on twitter at @rahuldeodhar or at his website www.rahuldeodhar.com.