PRINT THIS PAGE Manufacturing in India - opportunities, challenges, and myths30/08/2006. Source: KPMG.
India represents an economic opportunity on a massive scale, says KPMG. China and India are likely to be the world's two biggest economies by mid-century, and although India has underperformed in the first lap of the growth race, there was a strong possibility that India may well move ahead. Although India is still seen by industrial investors as an economy where risk is higher and the business environment more problematic than in rival Asian investment locations, India also offers some advantages in the region. The legal framework that protects investment is one of the best in Asia. The economy offers an abundance of technical and managerial talent, often with international experience. Geopolitical risk is diminishing consistently, in contrast with some of India's emerging economy rivals in Asia. And above all, India has a demographic advantage that should see its working age population continue to grow well into the century, increasing wealth and reducing cost.
The political economy
India is changing from a command economy focused on self-sufficiency to becoming a key link in the global economic chain. But India's ambition to catch up with other high-growth Asian economies is not always matched by its ability to implement change.
Nation and state
India is a federation of 29 states, and highly politicized. This means that an investment decision in India is quite likely to be affected by politics, and that needed changes in regulation and infrastructure development are often undermined by conflict and competition between state and federal governments. However, competition between states means that the total tax incentive package can be high.
Licensing, law, and reform
Central government has succeeded in opening many sectors of the economy to foreign investment, while reserving others to state or local business. These continuing restrictions impose costs on manufacturers even though many manufacturing sectors (apart from strategic industries like defense and aerospace) are open for investment. According to the World Bank, the burden of licensing and bureaucratic administration has significantly reduced since 2000. In terms of companies' perception of the burden, India scores better than either China or Brazil on business regulation, better than either on the burden of tax and customs administration, and better than Brazil on the perceived level of corruption.
Investment procedures
Investments in some economic sectors are now given automatic approval by the Reserve Bank of India. In other sectors the government has attempted to streamline the process of approval through the Foreign Investment Promotion Board (FIPB). In practice companies report that decision-making can still appear arbitrary. Manufacturing investors can incorporate in India as Indian companies or foreign companies. Indian companies may be joint ventures or wholly owned subsidiaries, and foreign equity ownership can be up to 100 percent. However, foreign equity caps apply to several sectors.
Labor
Some companies say that labor legislation remains a significant drag on business. Other companies point out that location tends to determine the quality of labor relations. Many complaints focus on the rigidity of firing regulations - only Mexico is considered equally restrictive. Nevertheless, the labor pool is exceptionally rich, with nine million new entrants a year. It takes on average fewer days to fill skilled job vacancies in India than in either China or Brazil; remuneration costs are also at the low end of the emerging economy scale. India is marginally more costly than China for most senior managers, such as directors of HR and manufacturing, and CFOs. But costs are significantly less than in other emerging economies such as Brazil and Mexico.
Taxation
Corporate taxation is high compared to European and U.S. rates, but average in world terms, and has been significantly reduced in the last 15 years - the top basic rate fell from 48 percent to 35 percent in 2004. The indirect tax burden varies from state to state: the federal government has current plans to introduce a unified VAT at two lower rates of 4 percent and 12.5 percent; (20 of the 29 states have moved to the new VAT regime starting April 2005). Companies say this can bring a significant reduction in operational costs. Tax-related industrial incentives include tax holidays, 100 percent deductible R&D and capital expenses, accelerated depreciation and exemptions or deferral of state sales taxes. The government is also committed to rapidly expanding the number of concessionary Special Economic Zones (SEZs) where tax is significantly reduced. A new SEZ bill was passed in Parliament in May 2005.
Location and market
In recent years almost all foreign direct investment in India went to a small privileged group of states and territories: according to the World Bank's Investment Climate Report 2004, over 80 percent of FDI in 2000-2003 went to Delhi, Maharashtra, Karnataka, Tamil Nadu, Chandigarh, Gujarat, and Andhra Pradesh. But investment patterns are changing, say companies, with many looking further afield to less congested and cheaper states.
Domestic markets
The consumer market is remarkably undeveloped. Consumer goods penetration is very low compared to other emerging economies, partly because potential consumers are more difficult to reach. India has a lower proportion of urban households compared to Asian competitors: it is estimated that around 70 percent of Indians live in the countryside, compared to around 60 percent in China. Consumption patterns are also different: as Indians have grown richer, discretionary spending has become focused outside the home. Unlike other Asian consumers, Indians have tended not to greatly increase their spending on clothes, personal care, and household goods.
Infrastructure
Infrastructure is top of the agenda for corporate planners in India. By far the most significant infrastructure constraint for manufacturing is the unreliability of power supply. On average a company can expect nearly 17 significant power outages per month, against one per month in Malaysia and fewer than five in China. At the same time costs are higher. Transport is also a constraint, and companies focus on the weakness of ports and the road network (the deterioration of the rail system means that companies have moved most of their distribution to road). However, new road investment is bringing significant improvements, and public-private partnerships are beginning to be struck in infrastructure development projects.
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KPMG Corporate Finance - Global independent advisors to the middle market. www.kpmg.co.uk
© 2006 KPMG Corporate Finance
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