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    An India auto rickshaw driver on a busy road in Jaipur.
    An India auto rickshaw driver on a busy road in Jaipur.

    The Indian advantage: Asia’s next manufacturing juggernaut

    Published On: 18 August 2014

    According to Deloitte’s Global Manufacturing Competitiveness Index, India is currently the fourth most competitive manufacturing destination worldwide and is forecast to become second only to China by 2018. Although India’s appeal as a manufacturing and sourcing jurisdiction comes primarily from its labour cost advantage, the country’s poor infrastructure and complex regulatory environment have hindered manufacturing sector growth in recent years. With Narendra Modi’s BJP now in control of the country’s first majority government in three decades, India will soon be poised to undermine China’s manufacturing edge through the introduction of policy and labour reforms, investment incentives, and improvements to the country’s outdated transportation and power supply networks.

    Infrastructure and regulatory obstacles aside, India features nearly all of the key ingredients necessary to transform its economy into a manufacturing juggernaut: a demographic dividend, attractive domestic market, comparative advantage in shipping and labour costs, an inexpensive currency relative to the dollar, and low political risk. As the BJP mulls an overhaul of India’s antiquated labour laws and the introduction of China-style manufacturing incentives to the country’s 2015 finanical year budget, India’s competitiveness as a manufacturing and sourcing jurisdiction is set to increase substantially in the near to medium-term.

    The Indian manufacturing sector is commonly divided into organised and unorganised segments that correspond with what economists traditionally refer to as ‘formal’ and ‘informal’ sectors in developing economies. Organised manufacturing refers to activities carried out by businesses that are officially registered with the government, while unorganised manufacturing is conducted by smaller, unlicensed enterprises and often features low wages, unstable and irregular employment, and weak or nonexistent government protection for labourers.

    Despite recent progress towards modernisation, India’s unorganised sector still accounts for around 80 per cent of all employment in manufacturing—emblematic of many developing economies which typically feature around 90 per cent of all workers in the informal sector. It is India’s organised manufacturing sector, however, that is of primary interest to foreign investors and which—despite employing significantly fewer labourers—generates over two-thirds of the country’s total manufacturing output.

    Accounting for 15 per cent of India’s total GDP, the manufacturing sector has grown steadily in recent years as rising costs in China and elsewhere have led foreign firms to seek out alternative locations for manufacturing and sourcing operations.

    Between 2006 and 2011, India’s manufacturing sector sustained a compound annual growth rate (CAGR) of 17.1 percent, principally in textile goods, engineering goods, automobiles, and chemicals.

    At the current growth rate, the McKinsey Global Institute projects that by 2025, the sector will reach a value of US$1 trillion, account for 25 to 30 percent of the country’s overall GDP, and generate up to 90 million new domestic jobs.

    India’s labour costs consistently rank among the lowest worldwide and are often cited as the country’s principal advantage as a manufacturing base. According to the US Bureau of Labor Statistics, average labour compensation (including pay, benefits, social insurance, and taxes) in India’s organised manufacturing sector have only increased marginally in recent years, from US$0.68 per hour in 1999 to around US$1.50 per hour today, and from US$0.53 to US$1.00 among production workers over the same period.

    When compared with an average compensation of US$3.00 per hour in China’s manufacturing sector (a 20 percent year-on-year increase fuelled by an annual 13 percent rise in China’s minimum wage), India’s labour cost advantage places the country in more direct competition with emerging manufacturing jurisdictions such as the Philippines and Vietnam over now-declining China, Thailand, and Malaysia.

    In addition to being extremely cost competitive, India’s nearly 500 million strong labour force offers manufacturers access to not only a substantial population of unskilled workers, but also a rich talent pool of English-speaking scientists, researchers, and engineers capable of lending cost-effective research and development support to manufacturing operations. After more than 37 million workers chose to leave India’s agricultural sector for better-paying manufacturing jobs between 2005 and 2012, a slowdown in manufacturing activity last year (a 0.7 percent contraction) stranded a large segment of the population in low-wage, rural employment. Partly as a result of this contraction, the demand for manufacturing-based employment has never been higher, and pressure has begun mounting for the Indian government to take concrete steps to foster the creation of enough manufacturing jobs (roughly 12 million per year) to absorb the country’s impending demographic dividend.

    Over the next decade, two key policy areas—labour reform and retrospective taxation—are likely to determine the future appeal of India’s manufacturing sector to foreign investors. Initially created to enhance worker welfare, India’s outdated labour laws have often had the opposite effect by encouraging manufacturers to stay small and operate primarily in the unorganised sector to circumvent legal regulation. India’s terms of work, hiring and firing, and working conditions are stipulated by the Industrial Dispute Act of 1947, Factories Act of 1948, and Contract Labour Act of 1970. These are among several prominent labour laws that continue to drive up costs for midsized firms and typically lead to the hiring of unskilled contract workers in informal sector operations.

    Fostering a stable and transparent economic climate for foreign investment—partly through the abandonment of India’s controversial retrospective taxation policies—has been identified as a key area for reform by the Modi administration. With several multi-million dollar tax disputes still in limbo, standardising India’s fiscal, tax, and policy regimes alongside the timely resolution of these disputes could deliver the business confidence needed to expedite the migration of manufacturing operations to India.

    As Narendra Modi settles into office, foreign investors are optimistic that the BJP’s rare parliamentary majority will provide respite from the coalition deadlock that has obstructed tangible policy reform for more than three decades. If the BJP’s promised labour and FDI reforms come to fruition, the meteoric growth of India’s domestic market, combined with US$1 trillion in planned infrastructure investment and an ambitious National Manufacturing Policy (NMP), is set to reap significant dividends for the manufacturing sector later this year. Aiming to increase the sector’s share of GDP to 25 percent by 2020, the NMP outlines a roadmap for streamlining investment and taxation policies while improving core infrastructure such as railways, roads, and ports. With growth in India’s manufacturing sector outpacing China’s in June and reaching its highest rate of expansion since February 2013, it is more than possible that India’s rise has already commenced.

    This article was first published on India Briefing.

    Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam, in addition to alliances in Indonesia, Malaysia, Philippines and Thailand, as well as liaison offices in Italy and the United States.

    For further details or to contact the firm, please email info@dezshira.com or visit www.dezshira.com.