The highlight of the recent growth up-tick in the economy has been the sterling performance of the manufacturing sector. The manufacturing sector has consistently improved its growth performance since 2002-03 -- the longest stretch of healthy growth in the past decade.
In 2004-05, the manufacturing sector grew at 8.9 per cent and the momentum has continued into the first five months of this fiscal, when the growth went up to 9.8 per cent. The performance becomes even more laudable when one considers the environment in which industry is operating -- the restrictive labour laws, red tape and, last but not the least, infrastructure constraints.
Another notable feature of the current manufacturing recovery is its resilience in the face of volatility in agricultural performance and a significant oil shock.
The growth in the manufacturing sector has been aided by both domestic and external demand. The impetus to domestic demand has been provided by rising incomes, a growing middle class, lower cost of borrowings, and easy access to retail credit.
What really stands out in the manufacturing recovery is the role of external demand. The adjoining chart plots the growth in manufacturing output and corresponding growth in exports (in $) during the past decade.
During 1994-95 to 1996-97, when the manufacturing sector was growing over 10 per cent a year, the manufacturing exports grew at a slightly higher rate of 14 per cent, supported by a massive devaluation of the rupee.
In the following five years, both output and exports in the manufacturing sector fell sharply. In the recent up-tick in manufacturing from 2002-03 to 2004-05, manufacturing exports grew at over 20 per cent a year, almost thrice the rate of growth of manufacturing production.
Consequently, the export intensity of manufacturing production (measured by the share of manufacturing exports in manufacturing output) increased at 5 per cent a year in comparison to a growth rate of about 1.5 per cent a year in the preceding seven years.
One might note that this push to exports has been possible with no help from the exchange rate. The rupee, in fact, appreciated from 48.4 (Re/ $) to 45 between 2002-03 and 2004-05. This points towards the increasing competitiveness of Indian exports.
The superstars of the current phase of manufacturing recovery are iron and steel, machinery and equipment, including transport, and basic chemicals sectors. More interestingly, we observe that most of the sectors that have witnessed a rise in production have, in fact, witnessed a growth in exports, which has grown at a much higher rate.
During the past three years, the engineering goods, chemicals, and iron and steel witnessed 33 per cent, 25 per cent per and 62 per cent annual growth in exports, respectively.
The Reserve Bank of India (Annual Report, 2004-05) notes that the key drivers of manufacturing growth were exports of engineering goods that were buoyed by technology intensive items such as metal and instruments, transport equipment, electronic goods, and iron and steel due to pick up in external demand, specifically in east Asia, China and non-traditional markets such as Latin America and Africa.
How critical is the sustenance of manufacturing export growth for India? What are the implications of the increasing role of exports in the manufacturing sector? Does this imply the rekindling of the manufacturing activity in India?
There is little doubt that a significant pick up in the Indian manufacturing sector growth is vital for providing a solution to India's unemployment problem. The problem will be further exacerbated by the rising share of working population in India.
A recent study commissioned by ministry of commerce points that exports from the manufacturing sector (particularly in textiles, handicrafts and garments) create far more jobs that the services sector, which has been India's growth engine thus far. The study shows that export-led manufacturing pick-up has a potential to create about 13.6 million jobs in the next five years.
From this point of view, the recent recovery in the manufacturing sector and its increasing export orientation is a healthy development. Further, the increasing role of exports in the recovery of Indian manufacturing has allowed the manufacturing sector some hedge against the slackening of domestic demand, arising particularly out of volatility in agriculture.
Also, as the exports are diversifying to Asian, Latin American and African countries, they have become more resilient to the slowdown in export destinations that was earlier concentrated in the US and OECD nations.
But it must be remembered that we are starting from a relatively-low base of manufacturing, particularly in comparison to China. The manufacturing sector has remained quite subdued in India over the past couple of years. The share of manufacturing in India's GDP has come down from 17.1 per cent to 16.1 per cent between 1990-91 and 2004-05.
This compares quite unfavourably with 35 per cent share of manufacturing in China and higher manufacturing intensity in other fast-growing east Asian economies. In 1965, the share of manufacturing in overall GDP in Korea, Malaysia and Thailand was 18, 9 and 14 per cent, respectively.
By 2002, it had sharply increased to 29, 31 and 34 per cent, respectively. But in India's case, the share of manufacturing in GDP has stagnated in the range of 14-16 per cent in the past 35 years. Also, the export intensity of Indian manufacturing, although rising, is quite low in comparison to its peers.
Therefore, despite the recent strides, Indian manufacturing has a long way to go before its exports truly become an engine of growth.
Dharmakirti Joshi is senior economist and Radhika Anand trainee economist at CRISIL. The views expressed are personal.