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Students Corner - A Decade of Economic
Reforms in India - A Review

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A Decade of Economic Reforms - Review by RBI
[Source: RBI Report on Currency and Finance 2001-2002 dated March 31, 2003]

Module: 1 - Real Economy - Growth, Saving and Investment
(The issue of manufacturing sector slowdown, along with the underlying short and long-run
constraints for the industrial sector is examined in the articles relating to Industry.)

Performance of Industry during the Decade - An Assessment

The industrial sector in the reform period (1992-93 to 2001-02) reported a slowdown in all its major segments. The manufacturing slowdown noticed since the latter part of 1996 had its origin in the cyclical slowdown of exports and subdued agricultural performance. The slowdown persisted in the subsequent period due to inadequate industrial restructuring and the resultant loss of competitiveness. The lack of institutional and structural reforms, which affected the pace and content of industrial restructuring operates as the major binding constraint on manufacturing growth in a liberalised trade regime. The manufacturing slowdown has possibly been reinforced by the observed decline in productivity growth in the 1990s and the cyclical downturn in demand, both in the domestic and external markets.

Industrial performance continues to be hampered by physical infrastructure bottlenecks with demand-supply imbalances persisting during the reform period. The deteriorating infrastructure services have been a direct fall-out of shrinkage in infrastructure investment in the context of inadequate availability of internal resources of public infrastructure entities and dwindling Plan outlay earmarked for infrastructure. The declining public investment in infrastructure has not been offset by the private investment on account of inadequate institutional reforms. There are, however, signs of improvement in a few sectors, like communication.

The credit flow from the banking system has significantly slowed down for SSIs and medium and large industries in the second phase of the reform period. The deceleration has been more pronounced for the SSIs. Besides, disbursements from the all India financial institutions (AIFIs) to industry have witnessed a considerable slowdown. Such developments on the credit front need to be assessed in the context of increasing recourse to internal resources and private placement by corporates, high real cost of credit coupled with its downward inflexibility, and prudential requirements such as capital adequacy and provisioning norms for banks and financial institutions, as well as the existing structure of the credit delivery system. The high real interest rate for industrial sector, ruling above industrial growth rate, also seems to have inhibited investment and capacity build-up in industry.

The increase in competition resulting from the reform measures viz., delicensing, opening up of trade has had a mixed impact on the industrial sector. This is evidenced amply in the fact that the manufacturing inflation in the late 1990s was around 3 per cent as against 10 per cent in the early 1990s. The sharp decline in the manufacturing prices has impacted adversely on the profit margins of companies. Further, inadequate industrial restructuring has hampered industrial growth. Adequate flexibility in industrial restructuring involves more rapid bankruptcy procedures, easier reallocation of capital, faster transformation of urban land use and flexibility in labour use.

The reservation for SSI producers has created an anomalous situation where foreign producers irrespective of size are able to bring in reserved products but existing SSI producers are not allowed to expand investment and scale to economically efficient levels to compete with imports. Therefore, there is a need for dereservation in select products with strong export potential (Government of India, 2001).

Increase in competition denotes that any rise in the input costs is difficult to cope with. The dwindling public investment on infrastructure in the latter half of the 1990s, caused by deterioration in Government capital expenditure, has clearly impacted on the availability as well as the quality of infrastructure services. Simultaneously the high cost of infrastructure, particularly power and railways freight, has been loaded on to the industry. Together, the prevailing high real interest rates have adversely impacted the price competitiveness of the industrial sector. Exchange rate appreciation witnessed in the late 1990s increased further pressure on the competitiveness. Generally exchange rate adjustments compensate for the rise in input costs, but the large capital inflows into the Indian economy during the late 1990s have prevented such an adjustment.

Industry - Introduction

The adverse impact of the crisis of 1991 was perhaps most pronounced in case of the industrial sector in India, which experienced a negative growth of 0.6 per cent in 1991-92. Following the reform measures, there was an initial turn-around in the industrial growth profile. However, it was short-lived, and deceleration has set in the industrial sector since 1996-97

Structural factors inhibited productivity and cost efficiency and hence, the overall growth of the industrial sector until the 1980s. These included myriads of controls and regulations, lack of technological development and restricted access to foreign technology. This resulted in a situation where the impetus to technological upgradation emanated primarily from the public sector. The controls on industry through licensing, MRTP, thus, inhibited competition. Further, institutional rigidities prevented restructuring in the manufacturing sector. It is against this background that a set of policy measures having a bearing on the industrial sector was introduced. Elements of the new industrial policy sought to increase competition by abolishing restrictions on MRTP companies, terminating the phased manufacturing programmes, freeing foreign direct investment and import of foreign technology and dereservation of sectors hitherto reserved for public sector. The thrust of these measures was to create a competitive environment as a means to improve productivity and efficiency. These measures created a favourable environment for the industry to upgrade its technology and build-up its capacity through imports in order to cater to growing domestic and external demand. The industrial sector responded favourably to the initial phase of structural reforms, but later industrial deceleration set in. The manufacturing sector, which accounts for more than half of the overall industry, was affected the most with its growth decelerating not only to lower than the first phase of reforms but lower than the 1980s as well. Given the contribution of manufacturing to GDP growth and its sectoral linkages, the persisting slowdown has raised several concerns. The poor performance of the manufacturing sector, apart from being influenced by business cycles, is strongly affected by supply side bottlenecks, which are emerging as major constraints to productivity growth and competitiveness of the industrial sector. Such constraints are operating primarily through infrastructure - both in terms of unstable supply as well as higher unit cost, financing constraints, and lack of adequate institutional and structural reforms to facilitate the required degree of industrial re-structuring

Against this backdrop, the growth performance of industry, with particular reference to the manufacturing sector, and its changing production structure is analysed in the present Section. The manufacturing slowdown has been examined both in terms of cyclical factors operating through aggregate demand as well as structural factors, reflecting the supply constraints, with a view to ascertaining their relative roles. In view of the growing importance of structural factors in posing a binding constraint on manufacturing, the provision of infrastructure and finance as also the issue of manufacturing productivity have been examined.

Profile of Industrial Growth

The actual industrial growth during the latter phase of the reform period fell below the potential growth, indicating a decline in the capacity utilisation over the medium-term. Besides, there have been distinct signs of the potential growth itself slowing down compared with the first phase of the reform period and the latter half of the preceding decade. This can be attributed to a deceleration in growth across all sub-sectors, i.e., registered manufacturing, mining and quarrying as well as electricity, gas and water supply. An analysis of industrial slowdown as per the use-based classification reveals that while the consumer goods industries sustained growth momentum to some extent during the latter part of the reform period, substantial decline in growth was witnessed in basic and intermediate goods segments. The demand for these goods in the face of sustained consumption demand in the latter period of the reforms implies that industry may be undertaking inventory adjustment created by the initial phase of capacity creation and overproduction. Although production of capital goods witnessed an improved average growth during the latter phase of the reform period, a rapid decline was observed from 2000-01 onwards, indicating the impact of weakening investment demand in the economy.

The 1990s witnessed a shift in the production structure in favour of the registered manufacturing as against the unregistered one. While the share of registered manufacturing in industrial GDP increased from 38.6 per cent in 1990-91 to 41.5 per cent in 2001-02, the share of unregistered manufacturing declined from 22.5 per cent to 21.6 per cent during the same period. Even within registered manufacturing, traditional industries such as textile, jute and other vegetable fibre textiles witnessed a decline in their respective shares in the reform period while the modern segments like metal products and electrical machinery forged ahead. The relatively low growth in productivity, lack of technological improvements and reduced access to credit have, inter alia, possibly acted as a more binding constraint in respect of the traditional segment vis-à-vis the modern one.

During the 1980s, although the average growth in value added in the manufacturing sector was relatively high at 7.3 per cent, it was not reflected in the commensurate growth in employment mainly on account of reduction in employment in cotton textiles and jute textiles, which were high employment generating industries. The employment growth in the organised manufacturing sector rose to 2.3 per cent in the first half of the 1990s from 0.8 per cent in the 1980s. This may be attributed to increased employment in small and medium size factories as a result of liberalisation of industrial and trade policies (Goldar, 2000). The deceleration in the manufacturing growth rate in the latter half of the 1990s had, however, adverse implications on employment growth. This was visible in employment growth turning negative (-2.1 per cent) in the latter half of the 1990s.

While the emerging production structure of industry bodes well for the economy, the stagnant share of manufacturing at around 17 per cent of GDP during the 1990s is a matter of concern. Other emerging market economies have exhibited a rising share of manufacturing and industry at similar levels of developments, with these sectors being the lead growth centres. The contribution of industry to GDP in such developing countries is placed in the range of 28 per cent to 51 per cent in 2000, much higher than 25 per cent in India. As a matter of fact, the fast growing East Asian countries witnessed a rise in the share of industry in GDP between 1990 and 2000. The differences in the nature of industrial policy and their implementation are found to be critical to the industrial success of such countries. Important elements of industrial policy in these countries included flexibility of labour use, build up of large and efficient social infrastructure, favourable attitude towards international technology transfer, substantial investment in public technology institutions and competitive pressures resulting from exports (Box III.3). Given the stagnating share of industry in GDP in India, the issues of manufacturing slowdown, productivity and competitiveness need further examination, which is attempted next.

- - - : ( Industry - The Manufacturing Slowdown ) : - - -

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