Hurdles to growth

Print edition : October 23, 2009

A worker sprays water on fabric during a power cut in a dyeing unit at the SIPCOT Industrial Estate at Perundurai in Coimbatore. Fabric has to be kept wet until power supply resumes to prevent colour variations.-K. ANANTHAN

LATEST statistics show an improvement in Indias industrial growth, which had been very low or negative for several previous months. Is this improvement sustainable? Conditions of enterprises and workers in the industrial town of Coimbatore, in Tamil Nadu, indicate that it is not. The structural factors that slowed down industrial production in recent times are still at work.

Industrial growth in India has exhibited wide fluctuations since 1991. According to the Annual Survey of Industries, the industrial sector expanded at relatively fast rates for four years after the start of economic reforms in 1991-92. Subsequently, output growth decelerated and jobs were lost in most industries between 1996-97 and 2001-02. Industrial growth revived from the second quarter of 2002-03. A surge in exports was a key feature of this revival.

However, the revival of industrial growth in India since 2002-03 appeared to have lasted less than five years. The growth of the Index of Industrial Production (IIP) was on a downhill from April 2007 notably, months before the financial crisis began in the United States, not to speak of its global spread since August 2008 (see Figure 1). The onset of the global financial and economic meltdown in August-September 2008 compounded the problems faced by Indian industry. Export-oriented industries such as garments, textiles, leather and engineering have suffered a sharp fall in the demand for their products in Western countries. Year-on-year growth of Indias exports was negative for 11 continuous months, from October 2008 to August 2009, the latest month for which data are available (see Figure 1).

To tide over the economic slowdown, the Indian government and the Reserve Bank of India have initiated a number of policy measures since September 2008. Banks have been encouraged to lend more, especially housing and automobile loans. The expansionary monetary and fiscal policies have produced a visibly positive impact on domestic demand, notably demand for consumer durables, since April 2009. They also contributed to the revival in the growth of industrial production by June 2009 (see Figure 1).

At the same time, there are clear indications that the problems affecting Indias industrial growth are deeper than those triggered by the worldwide economic slowdown. First-hand evidence of some of these problems is available from Coimbatore.

Coimbatore has long been an important centre for micro, small and medium enterprises in textile and engineering industries; the latter include pumps, motors, auto components, valves, metal castings and textile machinery. According to the District Industries Centre (DIC), micro, small and medium enterprises engaged in manufacturing and services in Coimbatore district number around 48,500; the total employment in these enterprises is approximately 500,000. The DIC also pointed out that these figures pertained to registered enterprises and that it was likely that there were an equal number of unregistered enterprises in the district.

The leaders of industry associations observe that there has been a modest improvement in orders for their products since June 2009. However, M. Ilango, president of the Coimbatore District Small Industries Association (CODISSIA), says industrial units in the district continue to be confronted by a number of problems, which include power shortage, fluctuations in rupee exchange rate and in the prices of key raw material such as steel and cotton and inadequate availability of credit.

Industrial enterprises have reportedly been facing acute power shortages since October 2007. Between November 1, 2008, and May 25, 2009, the Tamil Nadu government imposed a 40 per cent cut on base demand and energy for all HT (high tension) industrial establishments and 20 per cent cut on energy for LT (low tension) and LTCT (low tension current transformer) industrial units. In addition, restrictions were imposed on drawing power during the peak-hour period between 6 p.m. and 10 p.m. Several textile and engineering firms operated at 50 per cent or even less of their production capacities during this period.

The government later announced some relaxation in the power cut for industries with effect from June 15, 2009. This relaxation has come as a result of additional power generation from wind energy sources during May-July, and is likely to be only temporary. Entrepreneurs fear that the power situation in Coimbatore will become worse again by October.

The poor power availability in Tamil Nadu has hit the micro and small firms hard. Almost every entrepreneur I met in Coimbatore observed that they paid Rs.4.30 or more per unit (or kilowatt hour) of electricity and still suffered production losses owing to power interruptions. At the same time, the production facilities of multinational companies such as Hyundai located in Chennai are offered uninterrupted power supply at cheaper rates as per the memorandum of understanding (MoU) signed by these companies with the State government.

The growth of installed power generation capacity in India decelerated from a compound annual rate of 4.8 per cent between 1989 and 2000 to 3.8 per cent between 2001 and 2009. Between April 2007 and January 2008, the peak power demand-supply deficit was 15.2 per cent in the country as a whole, while it was 15.4 per cent in Tamil Nadu and Punjab, 26.2 per cent in Gujarat and 26.4 per cent in Maharashtra. Recent reports indicate that power shortages have crippled the growth of industry in Punjab, particularly the textile and engineering units in Ludhiana.

The rupee-dollar exchange rate appreciated sharply from Rs.44 a dollar in February 2007 to Rs.40.6 a dollar in May 2007 and remained at levels close to Rs.39.40 a dollar until April 2008. The appreciation of the Indian rupee reduced the sales revenues and profits of export-oriented industries.

But with the spread of the global financial crisis, the rupee depreciated equally sharply from Rs.42.9 a dollar in August 2008 to Rs.48.6 a dollar in October 2008. Such sudden depreciation of the rupee did not benefit Indian industry. Many exporters had already entered into contracts in forward exchange markets, and, in any case, their sales revenues were being depressed by the falling demand in export markets. At the same time, imports of machinery and raw material became costlier. Also, firms that had availed themselves of foreign currency loans incurred heavy losses as they repaid these loans in the depreciated rupee. Pricol, the auto component manufacturer in Coimbatore, attributed its losses in 2008-09 mainly to the depreciation of the rupee.

Global and domestic steel prices stayed at high levels between March and August 2008. But, in the wake of the economic recession, steel prices were on a sharp downward trend since September 2008. The owners of engineering firms in Coimbatore observed that the high volatility in the prices of raw material was one of their biggest challenges.

The marked rise in the prices of cotton from 2007-08 has dealt a heavy blow to the textile mills and power looms in Coimbatore, Erode and other regions of Tamil Nadu. A joint statement by textile manufacturers noted that in 2007-08, domestic cotton prices rose by 45-50 per cent despite a bumper cotton crop of 31.5 million bales in India. This, the textile manufacturers allege, has occurred owing to the export of and speculative trading in cotton (Business Line, July 6, 2008).

India allowed futures trading in a range of commodities, including steel and cotton, in 2003. There has indeed been a noticeable upward shift in the domestic prices of commodities such as steel after futures trading began in these commodities. G. Soundararajan, president of the South India Small Spinners Association (SISSPA), squarely blames speculative trading in cotton for the problems faced by the textile industry in the State.

The increased volatility in the rupee exchange rate and commodity prices are clearly linked to the progressive opening up of Indias financial and external sectors. There has been a creeping movement in the direction of capital account convertibility (which relates to the freedom of capital flows into and out of the country) in India in recent years, according to D.M. Nachane, Professor and Director of the Indira Gandhi Institute of Development Research (IGIDR), Mumbai. The limits for foreign institutional investors to invest in India and for Indian companies to invest abroad have been revised steadily upwards.

There were large inflows of foreign institutional investment (FII) into India between April 2007 and January 2008. With the deepening of the global financial crisis, there have been equally large FII outflows from India between February 2008 and March 2009. Such sharp FII movements were the main cause of the volatility in Indias exchange rate during this period (see Figure 2). Unregulated flows of foreign institutional investments have other adverse impacts as well. They reduce the monetary authorities control over interest rates, thus raising the cost of capital for industry.

J. James, Coimbatore district president of the Tamil Nadu Association of Cottage and Micro Enterprises (TACT), observes that more than 80 per cent of the micro enterprises in the district do not even have a bank account in a nationalised bank. To open a current account, most nationalised banks require firms to maintain a minimum balance of Rs.3,000 to Rs.10,000, but that is too large a sum for micro entrepreneurs.

Therefore, the majority of micro enterprises in Coimbatore turn to private banks and private finance companies such as HDB, Citibank, ICICI Bank, Kotak Mahindra and Cholamandalam Finance. Entrepreneurs receive personal loans from these banks at rates of interest ranging from 28 per cent to 36 per cent and use these funds for their working capital needs. Viswanathan, an executive of TACT, said that until a few months ago when industry was on the upswing, agents of private banks used to approach micro entrepreneurs with offers of loans without any collateral.

Currently, as their businesses are going through difficult times, entrepreneurs find it difficult to repay the high-interest loans they have taken from private banks. But private banks show little understanding of their problems and quickly initiate debt recovery measures, including confiscation of machinery and buildings.

Compared with micro enterprises, small and medium enterprises have easier access to credit from nationalised banks. However, a few small entrepreneurs told this writer in December 2008 that they had been facing severe shortages of working capital owing to delayed payments from their client-firms in India and abroad that had purchased their products. Yet, according to these entrepreneurs, banks did not lend them adequate credit to tide over the crisis.

Further, the interest rates charged by scheduled commercial banks on small firms have been high. These rates were 13-15 per cent in December 2008. Interest rates for small enterprises have now come down to 10-12 per cent. Nevertheless, owners of small firms say that big companies receive bank loans faster and at considerably lower interest rates (currently around 8 per cent).

In the aftermath of the economic slowdown, banks in India have indeed been cautious in their lending because of the fear of creating bad loans, even as the RBI has been unleashing a number of policy measures to increase liquidity in the economy.

Indian banks have been investing a larger share of their funds in less risky government securities rather than lending to the commercial sector. Yearly growth of bank credit to the commercial sector declined to 16.3 per cent between July 2008 and July 2009 from 25.5 per cent between July 2007 and July 2008.

The policy of social banking in India opened with the nationalisation of commercial banks in 1969 has been under attack ever since banking reforms began in 1991. There has been a gradual decline in targeted lending to priority sectors such as agriculture and small-scale industries. Further, since the 1990s, there has been a reduction in the share of credit channelled to the industrial sector as a whole and a corresponding rise in the share of personal loans disbursed. National Sample Survey (NSS) data indicate that only 3.6 per cent of all unregistered manufacturing enterprises received loans from institutional sources in 2005-06.

The generation of employment in India slowed down sharply in the 1990s. Between 1999-2000 and 2004-05, employment growth recovered in the country but substantially large numbers of the new jobs were in low wage, low value-adding occupations. Of the 9.5 million workers recruited in the manufacturing sector (organised and unorganised sectors combined) during these years, 4.2 million or 45 per cent of the workforce, were women a high proportion compared with the previous periods.

The manufacture of garments (4.4 million), cotton textiles (1.9 million), bricks and other non-metallic mineral products, furniture, gems and jewellery together accounted for close to 90 per cent of the new manufacturing jobs (data from the National Sample Survey Organisation).

The manufacture of garments, textiles, furniture, gems and jewellery has been affected, to varying degrees, by the worldwide economic slowdown. Studies by the Labour Bureau on the effect of the economic slowdown in select sectors have estimated that the total job losses in India in these sectors between October 2008 and June 2009 were 0.33 million. The study pertains to the organised sector alone. It is likely that many more jobs have been lost in the unorganised sector.

It is also likely that wages have declined and the working conditions have worsened in the aftermath of the economic downturn. Contract workers, as a share of all workers in the organised factory sector, increased from 20.4 per cent in 2000-01 to 26.5 per cent in 2004-05. The Labour Bureaus report has noted an increase in the share of contract workers and a fall in workers earnings from April to June 2009.

K.M. Selvaraj of the All India Trade Union Congress notes that enterprises in Coimbatore have increasingly been employing contract workers and migrants from Bihar and Orissa. This is proving to be difficult for effective labour organisation in the region.

Meanwhile, orders have improved since June 2009 but the engineering firms in Coimbatore are facing a shortage of skilled labour. Workers who were rendered jobless for the past several months owing to power shortages and the economic slowdown have either returned to their villages or taken up odd jobs such as working in restaurants or driving autorickshaws.

There are a number of long-standing problems that retard the growth of Indian industry. Power shortages are paralysing industrial activity in otherwise dynamic industrial clusters such as Coimbatore and Ludhiana. The sharp fluctuations in raw material prices and the rupee exchange rate, both a consequence of hasty external sector reforms, increase the uncertainties for entrepreneurs. Micro enterprises in particular face enormous difficulties in obtaining credit at relatively low interest rates.

Policy attention is required for a quick and effective industrial growth revival in India. Failure to do so will only bring more hardships for the millions of Indias labouring poor, who have been the worst hit by the recession and, now, by the deficiency in monsoon rainfall.

Jayan Jose Thomas is with the Madras School of Economics, Chennai.

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