Since time immemorial, there have been three modes of economic development:
Countries like UK, Germany, Japan, and France developed their economies rapidly by plundering their colonies (the bounties helped them in kick-starting the industrial revolution). West Asian countries improved their standard of living by exploiting their natural resources, whereas the Asian Tigers (Hong Kong, Singapore, South Korea and Taiwan) took to low-skilled manufacturing. However, the Indian growth story has been completely different, India’s agrarian economy leapfrogged into a services dominated economy, skipping over the industrial growth.
Since 1990’s, the Indian growth story has been chalked by the dynamism of the service sector, which contributes to more than 50% of India’s GDP. Manufacturing, on the other hand, contributes to only 17% of the GDP.
Although the Indian economy has emerged as one of the fastest growing economies in the world, the services-led growth model raises a number of questions, such as:
1) Is this services-led growth sustainable?
2) Is this growth equitable and employment oriented? Is it exploiting India’s demographic dividend?
3) Is it high time for India to shift its focus from services to manufacturing? Does structural transformation necessarily requires manufacturing to be the growth engine?
The First Move – National Manufacturing Policy
In 2011, the UPA Government approved a National Manufacturing Policy, the first of its kind in the country. The policy was launched with the aim of enhancing the manufacturing sector’s share in GDP to 25% within a decade and creating 100 million jobs by 2022.
The policy could not achieve most of its targets, till date, manufacturing activity contributes to 17% of India’s GDP and only 4 million additional jobs have been created since 2010.
Course Correction – National Capital Goods Policy
The present government attempted to address the above concerns by drafting the “National Capital Goods Policy, 2016”.
The Policy being an offshoot of Prime Minister Narendra Modi’s ambitious “Make In India” campaign reiterates the fact that the manufacturing sector has to be the new growth engine.
It states, “a strong manufacturing sector is critical to sustained growth of the economy as it generates employment potential – exploiting India’s ‘demographic dividend‘ and builds strategic self-reliance in key industries thereby promoting a favourable trade balance”.
The policy emphasizes that in order to boost the manufacturing sector the focus should be on capital goods industry, as it is one of the key contributors to value added manufacturing and is significant for overall economic development of India. The policy aims at increasing the share of capital goods in total manufacturing activity from 12 per cent at present to 20 per cent by 2025.
Understanding The Capital Goods Industry
The policy defines capital goods as plant machinery, equipment and accessories required, either directly or indirectly, for manufacture or production of goods or for rendering services, including those required for replacement, modernization, technological upgradation and expansion of manufacturing facilities.
In simple words, capital goods are the goods which are used by businesses to produce other goods and services for the ultimate consumers.
The Capital Goods sector is a Rs 2.3 lakh crore (2014-15) industry in India covering 10 sub-sectors in the Indian manufacturing space. It is also a major employment driver, directly employing 1.4 million people across the sub-sectors and creating indirect employment for 7 million people.
Performance – The Lion is Moving at a Snail’s Pace
The capital goods sector has been suffering from sluggish growth, the domestic market size is de-growing at 3.6% per annum and production has grown at a 1.1% p.a. over the last 3 years. This is in stark contrast to the erstwhile Planning Commission’s targeted growth rate of 16.8% p.a. during the 12th Five Year Plan period (2012-17).
Capital Goods Market Size and Total Production (Rs Cr)
|Sub-sector||Market Size (2014-15)||3 yr CAGR||Production (2014-15)||3 yr CAGR|
|Heavy Electrical Equipment||157,522||–5.8%||136,953||0.3%|
|Process Plant Equipment||24,149||–0.2%||18,900||-1.6%|
|Earthmoving & Mining Machinery||21,671||–7.1%||17,000||-1.9%|
|Food Processing Machinery||15,600||4.4%||12,180||5.4%|
|Dies, moulds & Press Tools||15,100||–0.3%||14,647||3.0%|
Source: Sub-sector Associations, DGCIS data.
A wide range of issues such as, inadequate growth of domestic market, sub-optimal capacity utilization, fragmented industry have slowed down the growth of capital goods production in India.
1. Falling demand for domestically manufactured capital goods
Among the specific policy issues, the single most important issue is the permission to import second-hand machinery. Under the compulsions to reduce the carbon footprint, manufacturers in the developed world are replacing older machines with new ones, these used machines are entering into the developing countries like India at a cheaper rate and this hurts the domestic industry.
This is prevalent even inside SEZs, where old machines are imported without the payment of duties and taxes.
Another important issue is India’s trade agreements with several countries which have comparative advantage over India.
For example, India’s Free Trade Agreement with ASEAN is hurting the Indian capital goods industry. India had imposed anti-dumping duty on Chinese injection moulding machines in 2009, since then few big Chinese manufacturers have set up plants in ASEAN countries to exploit India’s FTA.
2. Growing imports amid capacity underutilization
During 2014-15, India had an overall trade deficit of more than Rs 8.5 lakh crore, out of which the import of capital goods amounted to Rs 1 lakh crore (appx.). Around 40-45% of our demands are met by imports, while capacity utilization of domestic manufacturers is only 60-70% across sub-sectors!
Above all, Indian capital goods manufacturers have failed to effectively tap the global market. India’s share in global exports of capital goods is 0.8% only!
Key challenges faced by Indian capital goods exporters are:
- Inadequate availability of short term and long-term financing.
- Non-tariff barriers imposed by various countries in the form of biased qualification clauses, and requirement of testing the quality outside India.
- Inverted duty structure prevalent in areas such as turbines, boilers, and electric transformers.
India: Net importer of capital goods (Cr)
|Year||Exports (Appx)||Imports (Appx)|
3. Low technology depth, uncompetitiveness coupled with fragmented industry structure
The amount of money spent on R&D in India stands at 0.9% of the GDP which is extremely low, this results in lack of technological depth. Another challenge is human resource development. For instance, with the development of IT, it is becoming extremely difficult to recruit people to the machine tool industry.
Low technology depth & lack of skilled manpower coupled with fragmented industry populated with many small scale units operating at uneconomic scale makes Indian capital goods industry uncompetitive.
R&D and Competitiveness Indicators
|Country||R&D as a % of GDP1||GCI Rank2|
Source: 1) 2014 Global R&D funding forecast, Battelle and R&D Magazine.
2) 2014-15 Global Competitiveness Index (GCI) Indicators –World Economic Forum.
Capital Goods Policy, 2016 – Key recommendations
Expansion of market
- Regulation of imports of old machines by insisting on actual user license and country of origin certification.
- To allow such imports through designated ports only.
- To initiate trade agreements with countries where India has competitive advantages (Middle east, central and Latin American countries)
- To ensure no preferential treatment under FTA with partner countries.
- To provide incentives for large infrastructure projects with high domestic sourcing of capital goods.
Promotion of exports
- Focussed line of credit for key export markets through EXIM bank.
- To train diplomats for sustained engagement in India and export markets for networking and advocacy for Indian business.
- To correct existing inverted duty structure anomalies.
- To create an enabling scheme as a pilot for ‘Heavy Industry Export & Market Development Assistance Scheme (HIEMDA)‘ with a view to enhance the export of Indian made capital goods.
Improving the technology depth
- To increase the research intensity in India from 0.9% to at least 2.8% of GDP.
- Promoting promising start-ups through a new ‘Start-up Centre for Capital Goods Sector’. Ensuring strong foundation of such start-ups by providing pre-incubation, incubation and post-incubation services.
- To update curriculum of Industrial Training Institutes (ITI), Polytechnics and other technical institutes to match skill requirements of industry.
- To set up 5 regional State of the Art greenfield Centres of Excellence.
What will it take to achieve the targets?
A close observation of the minute details of the policy (especially the targets) renders it too ambitious. For instance, the policy aims to triple the capital goods sector from Rs 2.3 lakh crore to Rs 7.5 lakh crore within 10 years! We would need a 13% growth over the next 10 years to achieve this target. Moreover, two biggest short-term concerns which demand immediate remedy are low aggregate demand and low capacity utilization.
However, the fact that after being independent for 69 years, the country decided to have its own capital goods policy itself is a great achievement. The policy undeniably seems to be a unique government-led and industry-driven initiative having the aim of scripting a new growth narrative in the history of industrial development in India. If the government successfully implements the policy recommendations both in letter and spirit, it may usher a new phase in capital goods industry in India.
Sector stocks – Quick overview
1) Bharat Heavy Electricals ltd. (BHEL)
2) Larsen & Toubro (L&T)
This report is strictly meant for educational purpose and it may be of interest to researchers as well as students. The Astute Investor acknowledges the fact that a couple of estimates/figures provided in this report have been sourced from various financial news websites (Reuters, Money Control, 4-traders) and research reports available in the public domain.