Manufacturing Sector: Machined for Growth

Despite the worries revolving around the geopolitical conflicts and the threat of the re-emergence of the pandemic, Bhavya Rathod and Armaan Madhani elucidate how the Indian manufacturing sector is poised to take a big leap forward, propelled mainly by the government’s initiatives and strategies like ‘Make in India’ the PLI scheme. This report highlights how this growth story will take shape 

The year 2022 will be remembered primarily for the outperformance of banking stocks, which demonstrated their sheer strength, with PSU banks leading the rally. Nifty Bank index increased by more than 21 per cent, compared to a 4.5 per cent increase in Nifty index, with Nifty PSU Bank index increasing by more than 61 per cent. This massive rally in banking stocks is largely due to an increase in credit growth, which is at its highest level in over a decade – 15 per cent year on year. 

Fuelled by robust credit demand in 2021-22 and so far in 2022-23, the consolidated balance-sheets of India’s scheduled commercial banks (SCBs) registered double-digit growth in 2021-22 after a seven-year hiatus. This was led by credit growth, which accelerated to a ten-year high in the first half of this fiscal year ending March 2023. As for the manufacturing sector, the December manufacturing PMI pointed to robust growth in the health of the sector, which was the best since October 2020. 

Despite slowing growth in global economy coupled with higher inflation and economic uncertainty, the Indian economy remained resilient with manufacturers scaling up production at the end of 2022. 

Slowly and steadily as the economy picked up pace in 2022, all critical pieces fell in the right place for banking sector which resulted in massive outperformance in banking stocks across the board. Now entering into 2023, a similar pattern seems to be emerging for the manufacturing sector. Let us delve deep to gain better understanding of recent trends emerging in the sector, growth drivers at play and a few key sectors that investors should focus in this year. 

Overview of India’s Manufacturing Sector

As per Indian Brand Equity Foundation (IBEF), India’s gross domestic product (GDP) at current prices was USD 694.93 billion in the first quarter of FY22, as per provisional estimates. The manufacturing GVA at current prices was estimated at USD 77.47 billion in the third quarter of FY22 and has contributed around 16.3 per cent to the nominal GVA of the past 10 years. India has the potential to become a global manufacturing hub and by 2030 it can add more than USD 500 billion annually to the global economy. As per a survey conducted by the Federation of Indian Chambers of Commerce and Industry (FICCI), capacity utilisation in India’s manufacturing sector stood at 72 per cent in the second quarter of FY22, indicating significant recovery in the sector. 

The manufacturing sector in India is gradually shifting to a more automated and process-driven manufacturing setup which is expected to increase efficiency and boost production. The country is gradually progressing on the road to Industry 4.0 through government initiatives like the National Manufacturing Policy which aims to increase the share of manufacturing in GDP to 25 per cent by 2025 and the PLI scheme for manufacturing which was launched in 2022 to develop the core manufacturing sector and bring it on par with global manufacturing standards. Manufacturing has emerged as one of the high-growth sectors in recent years. 

A globally competitive manufacturing sector is India’s greatest potential to drive economic growth and job creation this decade. Due to factors like power growth and long-term employment prospects, India has significant potential to engage in international markets. Several factors contribute to this potential. First off, these value chains are well-positioned to benefit from India’s advantages in terms of raw materials, industrial expertise and entrepreneurship. Secondly, foreign players can take advantage of four key market opportunities: expanding exports, localising imports, internal demand and contract manufacturing. 

Manufacturing Gains Momentum

India’s manufacturing industry finished 2022 on a strong note. As per the S and P Global India Manufacturing Purchasing Managers’ Index (PMI), India’s manufacturing sector recorded its highest uptick in output in 13 months in December 2022 with new orders rising at the fastest pace since February 2021 despite selling prices surging more than input costs for the first time in 2.5 years. The seasonally-adjusted PMI reading for the month of December 2022 increased to 57.8 from 55.7 recorded in November 2022, reflecting what the S and P Global India firm called ‘a robust improvement in the health of the sector that was the best seen since October 2020’. 

For the October to December quarter, the PMI averaged 56.3, the highest in a year. A reading of 50 on the PMI indicates no change in business activity levels. A reading above 50 indicates overall expansion compared to the previous month and a print below 50 points towards an overall decrease. The index is compiled from responses to questionnaires sent to purchasing managers in a panel of around 400 manufacturers. To quote Pollyanna De Lima, Economics Associate Director at S and P Global Market Intelligence, “Demand strength took centrestage among the reasons provided by firms for improvements in many measures. Additional materials were purchased and extra workers hired as companies sought to supplement production and maintain healthy levels of inventories.” 

Also, in its latest employment outlook report, human resource solutions providing platform Team Lease revealed that the employers within the manufacturing sector have shown an increase in the hiring intent. Up to 60 per cent of the employers wanted to hire and expand their talent and resource pool in the last quarter of FY23. With demand buoyancy in place along with less challenging supply-chain conditions, the recent PMI data furnishes a distinct indication that the Indian economy is better placed than many other emerging economies to weather the impact of a potential global slowdown. 

Key Growth Drivers

Outlined herewith are some of the growth drivers that have taken the Indian manufacturing industry forward in recent times: 

China Plus One Narrative — The China Plus One story is something that is being widely discussed by stock market experts lately. It is also widely perceived that several key sectors in India stand to benefit from the new development in the diversification of the global supply chain in the post-pandemic scenario. Developed economies do not want to rely solely on China as the world’s supplier for various finished goods and key raw materials. The process has already been set in motion and on ground there are several sectors that are witnessing a shift in demand from China to India. 

Companies from countries and regions that already have trade agreements with India seem to be more inclined to consider India as an alternative to China. Manufacturing is the backbone for any reasonably sized country. India is no exception. The manufacturing sector can absorb skilled workers and accomplished professionals and hence remains one of the most important sectors for the India growth story to turn into reality. At present, India is in a good position to benefit from China’s declining competitiveness as a result of its corona virus woes, substandard product quality and other problems. 

Government Initiatives — To enhance India’s manufacturing capabilities and exports, the Union Budget 2021-22 announced the Production Linked Incentive (PLI) scheme for 13 key sectors. At present, there are a total of 14 sectors under the PLI scheme that involves a total outlay of ₹ 3 trillion. The Indian government’s persistent efforts in recent years have provided the thrust on capex, fresh investments as well as ease of doing business. The PLI schemes are aimed at improving capacity utilisation, increase manufacturing gross value addition and boost sales across key sectors, resulting in an overall increase in exports. 

As per a report by Bain and Company, growth led by the PLI schemes will show up most in the electronics, pharmaceutical, automotive, advanced chemistry cell (ACC) battery, solar and white goods (home appliance) sectors, with a cascading multiplier effect on other sectors over the next five years. Also, the PLI schemes, coupled with FDI policies and new FTAs, will further incentivise companies to increase export-led manufacturing. 

Strong Export Growth — Exports have seen phenomenal growth over the last two years. India has reached USD 418 billion of manufacturing exports in FY22. Though India contributes 3.1 per cent of GDP, our export contribution to the world has been a mere 1.6 per cent. Bain and Company expects that by 2028, India will reach USD 1 trillion of manufacturing exports. Manufacturing’s share of GDP in India is estimated to increase from 15.6 per cent currently to 21 per cent by 2031— and, in the process, double India’s export market share. 

Recent data by Morgan Stanley showed that MNCs’ sentiment on the investment outlook in India is at an all-time high. Buoyed by the government’s robust policy impetus, initiatives like PLIs and fresh investments that are pouring over the threshold into the country’s core industrial sectors, the manufacturing sector’s share of GDP in India could increase from 15.6 per cent currently to 21 per cent by 2031—and, in the process, double India’s export market share. 

Capex-Led Growth — India’s capex cycle is expected to fasttrack in the wake of post-pandemic economic growth. The Indian government has budgeted a 35 per cent year-over-year increase in capex for FY23 to USD 100 billion. Private sector capex has seen an uptick in FY22 and is expected to be elevated in FY23 and FY24. Increased demand visibility, diversifying global supply chains, foray into newer products and healthier balance-sheets are some of the key factors that are encouraging various domestic industries to add newer capacities. 

As per Ratings Round-Up published by CRISIL Ratings in October 2022, the estimated total capex from FY22 to FY24 amounts to approximately ₹ 10 lakh crore, the highest in any three years’ stretch so far. Growth and high-capacity utilisations and projected next five years’ capex being six times higher than the last five years is a strong indicator of increased manufacturing activity across sectors. 

I N T E R V I E W 

Amnish Aggarwal, Head of Research, Prabhudas Lilladher (P) Ltd. 

"India can emerge as a formidable manufacturing hub" 

What is your take on the current scenario in the equity markets? What is your outlook for 2023? 

We remain optimistic about the Indian equity markets with a one-year view. However, the near-term outlook is uncertain given headwinds like rising global interest rates, high inflation, geopolitical uncertainties and falling growth in developed markets. The ensuing scenario will create high volatility in the coming months, more so as India has hugely outperformed all the major developed and emerging markets last year. However, the structural story in India remains intact and we remain bullish for the medium to long term. We expect double-digit returns in 2023. However, these are expected to be back-ended and might coincide with a peak out of interest rates globally.
 

After establishing its leadership in global IT services exports, can India emerge as a global manufacturing hub in the coming years? Can you highlight the key drivers for the same? 

The Indian IT services’ journey has spanned over the past 30 years while India’s manufacturing story has started just a couple of years back. The first priority behind ‘Make in India’ is the need to reduce dependence on imports of essential goods, defence, electronics, etc. As we develop competitiveness and expand our manufacturing base, India can emerge as a formidable manufacturing hub. We believe favourable government policies, huge domestic demand potential, skilled manpower and stable economic and political environment are the key drivers for revival in manufacturing focus. Global realisation of broad-based sourcing bases beyond existing countries due to recent turmoil has also added to India being looked upon favourably for imports and sourcing. India is on the right track but it is a long journey to emerge as a key global manufacturing hub.
 

Which three sectors from the manufacturing theme are well-positioned to make the most of China Plus One and Europe Plus One strategy and why? 

While China Plus One is being termed as a big theme and India has everything to gain, as of now countries like Taiwan, Thailand, Indonesia and a few others are grabbing much higher investment by global MNCs in manufacturing. However, we expect strong growth in domestic manufacturing and gains by Indian corporates in the coming years. We believe defence, specialty chemicals, engineering and processed foods can emerge as major gainers from the manufacturing push. 

Defence can gain from this given India’s success with indigenous programmes of LCAs, naval frigates, missile systems, etc. over the years. Specialty chemicals can gain due to focus on niche segments and small batches while China has been focusing on bulk chemicals. India has one of the largest outputs of agricultural and horticulture crops which will go a long way in benefitting the food processing sector in India. 

Sectors in Focus 

Here are some of the sectors that investors should keep a close eye on: 

Automobile

Due to a growing middle-class and a large proportion of India’s population being young, the two-wheeler segment dominates the Indian automobile industry in terms of volume. Demand for commercial vehicles is rising as the logistics and passenger transportation industries expand. New trends such as vehicle electrification, particularly for three-wheelers and small passenger automobiles, are expected to drive future market growth. Moreover, to improve India’s manufacturing capabilities, the government approved a PLI scheme worth ₹ 26,058 crore in September 2021. India is also a significant automobile exporter with export growth expected to accelerate in the near future. 

Furthermore, the Government of India’s initiatives in the Indian market, such as the Automotive Mission Plan 2026, scrappage policy and the PLI scheme, are expected to position India as a global leader in the two-wheeler and four-wheeler markets by 2022. With an emphasis on urban transportation reform, the government is working to develop an integrated electric vehicle (EV) mobility ecosystem with a low carbon footprint and high passenger density. In response to rising customer demand for cleaner transportation options, the government’s strategies and policies are designed to encourage greater adoption of electric vehicles. 

Tata Motors in the PV domain, Ashok Leyland in the CV domain and Escorts Limited in the tractors field were notable outperformers within key categories. Vehicle registrations totalled 23.8 lakh units in November 2022, up 5 per cent MoM, and averaged at around 135 per cent of the pre-pandemic levels, compared to 129 per cent in October 2022. With a solid order book helped by a flurry of new launches, a healthy replacement demand on the horizon, increased fleet utilisation and profitability, and an oncoming pick-up in sales volume, it is anticipated that the PV and CV space in particular would experience an upward spiral. With development and longevity in the offering in this market, the tilt towards premium category in the two-wheeler space is anticipated to continue. 

Chemicals

Trade disagreements have erupted on a global scale, most notably between China, the United States and Western Europe. Following the imposition of tariffs by the US on Chinese imports, China retaliated by imposing levies on US goods. As a result, many countries in Western Europe have imposed levies on Chinese products. The US, EU, and Chinese economies would all suffer from tariffs on trade. As a result, many international downstream companies that formerly sourced the majority of their chemical requirements from China may choose to diversify their supply. Due to this, Indian firms will have a fantastic opportunity to take advantage of the available market share and maintain their position as industry leaders on a worldwide scale with the support of the Indian government. 

The National Programme on Advanced Chemistry Cell (ACC) battery storage Production Linked Incentive (PLI) scheme was approved by the government with a budgetary outlay of ₹ 18,100 crore. Its goal is to improve India’s manufacturing capabilities by achieving a manufacturing capacity of 50 Giga Watt hours (GWh) of ACC. The strategy predicts a monetary investment that will support domestic manufacturing, promote the growth of stationary storage and battery storage demand, build a completely domestic supply chain and attract foreign direct investments to the country. 

Indian chemical exports increased by 106 per cent between 2013–14 and 2021–22 to a record high of USD 29.3 billion in 2021–22. The surge in shipments of organic, inorganic, agrochemical, dyes and dye intermediates and speciality chemicals have contributed to the rise in chemical exports. The ‘Make in India’ campaign has aided India’s chemical sector in becoming a significant player in the world arena and a major exporter for the country. India is the sixth-largest chemical manufacturer in the world and the third-largest in Asia. India is ranked 14th in the world for chemical exports. India currently produces more dye than any other country in the world, and in 2021– 2022 it will export between 16 per cent and 18 per cent of that production. 

Electric Equipment 

India witnessed a substantial spike in demand for electronic products in the last few years. This is mainly attributed to India’s position as the second-largest mobile phone manufacturer worldwide and surge in internet penetration rate. Exports of electronic goods stood at USD 8,287.75 million from April- August 2022. Electronic motherboards’ demand in India is expected to grow by over six-fold to reach USD 81.5 billion by 2026, according to Manufacturers Association for Information Technology report. Between FY21 and FY26, India is expected to generate cumulative export revenue of USD 101 billion and by 2030, the Indian government expects the electronics manufacturing sector to be worth USD 300 billion. 

The government has started working on chip manufacturing in India and is in discussion with Taiwan to bring a USD 7.5 billion fabrication unit in India. In December 2021, the government approved a ₹ 76,000 crore Production-Linked Incentive (PLI) scheme, a first of its kind, to boost semiconductor and display manufacturing in the country. With the latest China’s virus outbreak, the world is involved in deciding who is going to dominate semiconductor manufacturing, which is already affected with supply chain issues in the post-pandemic period. 

Currently, almost all the semiconductor demand in India is met by imports from countries such as the US, Japan and Taiwan. With the budget coming in the next few days, it will be interesting to see how the government aims to tackle the supply chain issues in global semiconductor market. Currently, India only has expertise in designing of chips and mainly depends on imports for other key segments. With a larger outlay and to boost the ‘Make in India’ initiative, it is expected that the government would lay huge emphasis on creation of in-house manufacturing capacities in the forthcoming Union Budget. 

Defence 

Over the last five years, India has ranked among the top importers of defence equipment in order to gain technological advantages over competitors such as China and Pakistan. The government has taken several initiatives to encourage ‘Make in India’ activities through policy support initiatives in order to modernise its armed forces and reduce reliance on external defence procurement. India targets to export military hardware worth ₹ 35,000 crore in the next five years. The defence and aerospace exports in FY 2021-22 have witnessed a treble jump to ₹ 12,815 crore from ₹ 4,682 crore in just five years. Recently, the defence ministry told the parliament that foreign procurement in defence has risen to ₹ 50,061 crore in 2021-22 from ₹ 37,030 crore in 2017-18. 

Overall, India’s defence budget for FY 2022-23 witnessed a 9.82 per cent increase from FY 2021-22 to stand at ₹ 525,166 crore. This budget introduced multiple provisions to boost selfreliance in the defence sector. A similar kind of uptrend is expected in the coming budget for FY 2023-24 as the government continues to keep its focus on indigenisation and ‘Make in India’ approach. The drone industry was upbeat in 2022 with Finance Minister Nirmala Sitharaman launching ‘Drone Shakti’ to put emphasis on making India a drone hub by the end of the decade. 

The manufacturing potential of the drone industry in India is estimated to be around USD 23 billion by 2030, only possible with repeated government intervention and incentives. In 2022, the country observed direct dynamic impact in the usage of drone in various fields. For example, drones were used to deliver vaccines in Arunachal Pradesh in November. Madhya Pradesh Power Transmission Company Limited announced in September that it would deploy drones to monitor 10,000 high voltage towers.

The following table shows the strong order book for the sector as on January 5, 2023: 

Conclusion

With global economy expected to be cloudy with high inflation and slow economy growth, Indian economy, on the other hand, is poised to show strength and is set to remain on steady ground. As per Reserve Bank of India, the global economy is projected to grow by a mere 2.7 per cent with even key developed economies facing recession and being exasperated by their central banks policies of monetary tightening. India is set to register economic expansion between 6.8-7 per cent in the financial year 2022-23. Currently, India is regarded as the second most popular country in the world for manufacturing. 

The development of industrial clusters, the automatic route’s allowance of FDI up to 100 per cent, the accessibility of bank loans and other factors are driving India’s manufacturing sector’s expansion. To expand at an exponential rate, Indian manufacturers must concentrate on creating cutting-edge products and seize export prospects while focusing on productivity and efficiency through technology implementation. They must target global volumes to obtain global cost-competitiveness.