Economy Matters Oct Nov 14

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ECONOMY MATTERS 2


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1

FOREWORD

OCTOBER - NOVEMBER 2014

The G-20 Summit held at Brisbane, Australia saw a gathering of world leaders. A gamut ofdecisions were taken on a range of measures that will help make the global economy more

resilient to future shockslike the recent global recessionand protect both business and

consumer interests. To protect against these shocks, the G20 decided to endorse measures

that would strengthen nancial institutions, protect taxpayers from having to fund bailouts

if too big to fail nancial institutions run into diculty, address shadow banking risks, and

make derivative markets safer. It was decided that Sydney will now be home to a Global

Infrastructure hub, which will assist increasing global investment in infrastructure. Addition -

ally, G20s commitment to deliver a plan to address tax avoidance called the Base Erosion and

Prot Shifting (BEPS) Action Plan was reiterated.

On the domestic front, despite the GDP slowing down in the second quarter of the currentscal, the rst-half GDP gure of 5.5 per cent did seem to indicate that growth has sustainably

bottomed out. Deceleration in the second quarter was on expected lines, and growth could

have slipped further if it was not for surprisingly healthy performances by agriculture and

government spending components. Nevertheless, the H1 growth has placed the economy on

track to achieve our expectation of full year growth of 5.5-6.0 per cent given that the second

half is likely to be better. However, in order to provide a llip to growth, it will be crucial for

the new government to implement the announced policy measures in right earnest. We are

already seeing a lot of pro-active reforms being considered by the government in areas of

labour, land and taxation, among others, which promote ease of doing business in India. An

accommodative monetary policy stance by the RBI will also help in cushioning growth.

Exports have played an increasingly important role in Indias economic growth in the last two

decades. Although, the pace of exports growth was punctuated twice by sharp slowdown in

world economy during 2008-09 and during the last two scal years, Indias trade prospects

have continued to grow over time. In the current scal, cumulative exports have grown by

4.7 per cent in the seven months so far. However, exports registered their rst decline in this

scal in October 2014 due to global headwinds. For growth to reach a higher trajectory, its

pivotal that exports play an important role. The Foreign Trade Policy of the new government

which is expected to be put in place by early next year will help in this endeavour.

Chandrajit Banerjee

Director General, CII


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3 OCTOBER - NOVEMBER 2014


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5

EXECUTIVESUMMARY


Global Trends

After the 7.5 per cent growth in second quarter, GDP

growth in China for the July-September 2014 quarterstood at 7.3 per cent from the year-ago period, slowest

since global nancial crisis. It now risks missing its ocial

target for the rst time in 15 years growth of 7.5 per

cent in 2014, adding to concerns of becoming a drag on

global growth. Central Banks world over are using am-

munition at their disposal to ward o the dual problems

of deation and slowing growth. Bank of Japan plans to

pump trillions of yens and expand its asset-buying pro-

gram by 33 per cent in order to control deation. In a

similar league, and somewhat desperately, the European

Central Bank intends to expand its balance sheet by 1 tril-

lion euros (US$1.25 trillion). The Fed has indicated that

the benchmark interest rate would remain near zero and

it may hang onto the bonds for years, giving a QE-like

boost even after QE itself has been tapered out. Reduced

forecasts for economic growth worldwide and risk of de-

ation continue to trouble the policy makers.

Domestic Trends

Despite the GDP slowing down to 5.3 per cent in the sec-

ond quarter of the current scal from 5.7 per cent in theprevious quarter, the rst-half GDP gure of 5.5 per cent

did seem to indicate that growth has sustainably bot-

tomed out. Deceleration in the second quarter was on

expected lines, and growth could have slipped further if

it was not for surprisingly healthy performances by ag-

riculture and government spending components. The

latter may not be sustained for remaining months of the

year as government is likely to cut its spending in order

to rein in the scal decit target for the year. Fiscal decit

in the period April-October 2014 stood at 89.6 per cent

of the budgeted gure for the entire nancial year. The

Index of Industrial Production (IIP) in rst-half of the cur-

rent scal (April-September) registered a growth of 2.8

per cent, compared to anaemic growth of 0.5 per cent

in the same period last year. Providing some cheer for

the economy, ination is slowly and steadily coming near

the comfort levels of the central bank. Both CPI and WPI

based ination moderated sharply to 5.5 per cent and 1.8

per cent respectively in October 2014, which, if sustained,

may help RBI to shift its focus from controlling ination

to accelerating growth.

Sector in Focus- Make in India: TurningVision into Reality

The Indian manufacturing sector is a classic example ofan industry that has had great potential, but one that has

been systematically done in by political ineectiveness,

entrepreneurial myopia and sheer ignorance of what it

takes to succeed. Over the last 20 years, Indian manufac-

turing has by and large grown at the same pace as our

overall economy. Our share of global manufacturing has

grown from 0.9 to 2.0 per cent during this period while

our GDP share has grown from 1.2 to 2.5 per cent. Despite

this en-couraging growth, however, the relative share

of manufacturing in the Indian economy has remained

unchanged, dashing hopes of an economy based on

manufacturing-led growth. In this context, the recently

announced Make in India policy by the new government

aims to push manufacturing growth to the next level. In

the recently concluded CII 13th Manufacturing Summit

2014, a report titled Make in India: Turning Vision into

Reality prepared by CII and BCG was released. We cover

the crucial ingredients required to make this vision into

reality as discussed by the report in this months Sector

in Focus.

Focus of the Month - Trade : Policy &Performance

India saw its foreign trade expand remarkably in the past

decade. Although, the pace of exports growth was punc-

tuated twice by sharp slowdown in world economy dur-

ing 2008-09 and during the last two scal years, Indias

trade prospects have continued to grow over time. In s-

cal year 2003-04, Indias exports were worth US$64.0 bil-

lion. By 2013-14, they more than quadrupled to US$312.6

billion. In the current scal, cumulative exports have

reached US$189.8 billion in the rst seven months of the

scal (April-October 2014) as compared to US$181.2 billion

in the same period last year, thus registering a growth

of 4.7 per cent. On a monthly basis, exports shrank for

the rst time in seven months in October 2014, temper-

ing hopes for an export-led recovery. Going forward, the

governments new foreign trade policy (2014-19) to rev

up exports is expected to be put in place by early next

year and will have a strong thrust on manufacturing to

bring it in sync with the Prime Minister Narendra Modis

Make in India goal. Given the importance of rejuvenat -ing exports to have sustained growth, this month, the

focus is on the same. Eminent experts discuss the vari -

ous nuances of having a trade policy in place which would

give adequate thrust to exports growth.


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ECONOMY MATTERS 6

GLOBALTRENDS

Chinas Economy Grows at a Sluggish Pace

in Q3 2014

Chinas economy grew at its slowest pace in more

than ve years in the third quarter, suggesting

that the governments targeted easing meas-

ures to boost economic growth have not yielded ex-

pected results. Gross domestic product growth for the

July-September quarter came in at 7.3 per cent from the

year-ago period, after the 7.5 per cent growth in second

quarter. This is the slowest reading since the rst quar-

ter of 2009, when Chinas growth rate slumped to 6.6

per cent amid the global nancial crisis.

China now risks missing its ocial target for the rst

time in 15 years, adding to concerns the worlds second-

largest economy is becoming a drag on global growth.

The governments goal was for the economy to grow

about around 7.5 per cent in 2014. Policy makers have

stepped up their eorts to nurture economic growth

over past few months, including easing mortgage re-

strictions and accelerating infrastructure investment.

While 7 per cent plus growth would be the envy of most

countries, China has said it needs at least 7.2 per cent

growth to create some 10 million jobs annually for its

huge population.

The worlds second-largest economy grew a seasonally-

adjusted 1.9 per cent last quarter from the previous pe -

riod, compared with the 1.8 per cent median estimateof analysts and 2 per cent in the second quarter. GDP in

January to September climbed 7.4 per cent, led by a 7.9

per cent expansion in services. While the growth gure

for the agricultural industry stood at 4.2 per cent, the

secondary industry including mining and manufacturing

grew 7.4 per cent.


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GLOBAL TRENDS


While factory output rose 8.0 per cent in September

2014 from a year earlier, beating expectations for a 7.5

per cent increase and up from Augusts six-year low of

6.9 per cent, it was the sole positive update. Industrial

production also increased 0.91 per cent in September

from August, when it rose 0.2 per cent from preceding

month. Fixed asset investment, a key driver of the Chi-

nese economy, was weaker than expected. It climbed16.1 per cent in the rst nine months compared with the

same period a year earlier, compared with the median

estimate for 16.3 per cent growth and the 16.5 per cent

pace in January-August period. Retail sales rose 11.6 per

cent in September from a year earlier, below predic-

tions of 11.8 per cent and down from previous months

11.9 per cent. Meanwhile, property data for September

showed that the slowdown deepened with real estate

investment rising only 12.5 per cent in rst nine months

compared a year ago, down from annual rise of 13.2 percent in rst eight months.

A weakening property market continued to weigh on

broader activity in the third quarter, with revenue from

property sales revenue and new construction tumbling

in the rst nine months of 2014, blunting the impact of

earlier stimulus measures and a long-awaited pick-up in

exports. Housing sales fell 10.8 per cent by value dur-

ing the rst nine months of this year. With house price

declines spreading to a record number of cities and newconstruction tumbling, the government last month cut

mortgage rates for some home buyers for the rst time

since the global nancial crisis. Chinas property sector

accounts for about a quarter of GDP when related in-

dustries such as steel, appliances and construction are

included. As China has relaxed property purchase credit

rules, property sales may pick up in the fourth quarter,

but concerns regarding improvement in sectors like

heavy industry fuel the expectation that the economy

will continue to slow down.

Even though the ination has cooled to a near ve-year

low, highlighting sluggish domestic demand and a lack

of pricing power for rms, the government maintains

that there is no danger that consumer prices would fall

in coming months.

Exports, one of Chinas few economic bright spots,

grew faster than expected in September. Growth in

combined exports and imports accelerated to 3.3 per

cent in the rst three quarters from a year earlier, up

from 1.2 per cent in the rst six months of the year. Al-

though it is believed an unusually sharp increase in ship-

ments to Hong Kong may include transactions designed

to circumvent Chinas strict capital controls.

While authorities have oered a steady stream of aid

to more vulnerable sectors of the economy, they have

ruled out massive stimulus as the country is still strug -

gling with a mountain of debt, the hangover from 4 tril-

lion yuan (US$650 billion) of stimulus rolled out during

the 2008-09 crisis. Government economists have said

that if growth looked like dropping below 7 per cent,

authorities may take bolder and broader steps such


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ECONOMY MATTERS 8

GLOBAL TRENDS

as interest rate cuts. Low ination gives policy makers

more leeway to continue pursuing an accommodating

monetary policy through the end of the year. Conse-quently, Central Bank of China cut its benchmark 1-year

deposit rate by 25 bps to 2.75 per cent, and reduced the

1-year lending rate by 40 bps, to 5.60 per cent. It also re-

laxed the ceiling on deposit rates and allowed Chinese

banks to pay as much as 120 per cent of the benchmark

deposit rate, up from 110 per cent previously

The International Monetary Fund on October 7, 2014

cut its outlook for global growth in 2015 to 3.8 per cent

from a July forecast of 4 per cent. The U.S. will expand

3.1 per cent next year, compared with 1.3 per cent for

the euro area and 0.8 per cent for Japan. China is pro-

jected to grow 7.1 per cent, its slowest since 1990, ac-

cording to IMF data.

The National Bureau of Statistics said that industriali-

zation and urbanization will continue to drive Chinas

expansion. It recognized the economic slowdown due

to structural reforms in the nation, a sagging housing

market and higher comparison gures from a year ago,

but noted that although economic growth had slowed

in the third quarter, the employment and ination situ-

ation were generally stable, meaning the economy was

still operating in a reasonable range. Concerns wereraised on what conclusions the Chinese policymakers

would draw from slowing growth: need to nd other

sources of growth or further trials to stimulate, even

though the latter just reinforces the cycle that has pro-

duced the distortions seen in the economy.

Premier Li Keqiang has stated repeatedly that authori-

ties will tolerate growth slightly below target and rely

more on reforms to generate new growth drivers as

they try to reshape the economy so it is driven moreby domestic consumption and less by exports and in-

vestment. Li said that a complex and changing exter-

nal environment and large downward pressure posed

diculties for Chinas economy and that it would take

time for Chinas reformative measures to be fully eec-

tive. He has indicated that the leaderships bottom line

is maintaining employment to ward o social unrest, a

policy priority. Li also said that China will launch major

investment projects in information networks, water

conservancy and environmental protection this year,and pledged to policy adjustments made when needed.

While conventional monetary policy has reached its

zero lower bound, as far as interest rates are concerned,

there is no consensus on the eectiveness of quantita-

tive easing. The worlds Central Banks are increasingly

concerned that very low ination will tip into outrightdeation crushing fragile borrowers by raising the real

interest rate on their loans, which would load weak

banks with a new round of defaults on loans.

A risky move by the Bank of Japan, in its bid to rid Japan

of deation, to pump trillions more yen, jolted global

markets. The Bank would expand its asset-buying pro-

gram by 33 per cent and diversify from government

bonds to stocks and real-estate funds. It will be buying

at a level well beyond what the Federal Reserve andother Central Banks have purchased in their stimulus

programs. As a result, even though the yen fell to its

lowest value against the dollar in almost seven years,

it failed to boost exports as many Japanese manufac-

turers had shifted production oshore during slow

growth period. Even before the decision, the BOJs

asset holdings were nearing 60 per cent the size of Ja-pans economy, over twice the relative levels reached

by the Fed and the Bank of England. Japans sovereign

debt is more than twice the size of the economy, the

highest ratio in the world, and the pension funds de-

cision to move some of its assets away from Japanese

government bonds imply that the bond market will be

more dependent than ever on purchases by the Central

Bank. Japanese stocks and foreign stocks will each now

take up 25 per cent of the funds holdings, up from 12

per cent each previously. The ratio for overseas bondswill rise to 15 per cent from 11 per cent. The Bank will

triple the pace of its purchase of stock and property

Major Central Banks Inject Stimulus to Hasten Recovery


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GLOBAL TRENDS


funds, extend the average maturity of its bond holdings

by three years to ten, and raise the ceiling of its annual

Japanese government bond purchases by 30 trillion yento 80 trillion yen. The Banks board was deeply divided

over the unprecedented measures due to concerns that

the BOJ is underwriting Japanese politicians heavy bor-

rowing, threatening to undermine the credibility of its

public nances, and the perceived independence of the

Central Bank. The pension shift has also stirred contro-

versy as most global pension funds are paring back risk

at this point and not adding it.

In a similar league, and somewhat desperately, the Eu-

ropean Central Bank (ECB) is engineering a powerful

monetary stimulus to jolt the agging Euro zone econo-

my, concerned by worrisomely low ination that is both

a symptom and cause of the 18-nation euro currency un-

ions inability to achieve any sustainable growth at all. If

the current policies, which include some purchases of

corporate bonds, do not end the threat, the Bank would

alter the size, pace and composition of its purchases.

At issue is whether it will follow its peers around the

world in buying government bonds on a large scale. TheECB, in September, cut its main interest rate target to a

rock-bottom 0.05 per cent, and reduced its deposit rate

to minus 0.2 per cent, eectively charging banks for

leaving unused funds. It has been buying private-sector

loan assets since early October and has announced

longer-term low-interest loans to banks in an eort to

restart lending. The Bank intends to expand the size of

its balance sheet by 1 trillion Euros (US$1.25 trillion). Ex-

pectations that it will increase the supply of Euros in the

market led investors particularly as the Fed has begunreining in its own bond-buying. The path to employ-

ing wholesale bond-buying is not an easy one. There is

signicant opposition to such a policy in Germany, for

instance, apart from questions on whether the Euro

zone in which each country, rather than the bloc as

a whole, issues bonds is the appropriate venue for

quantitative easing.

Even as Japan and the EU embark on fresh rounds of

quantitative easing to ward o deation, the Peoples

Bank of China is holding the line against major stimu-

lus. Instead, it is instead taking a gritted-teeth approach

accepting short-term pain as the price for structural

reform which will support sustainable growth in long-

term. While aid to vulnerable sectors has been oered,

massive stimulus has been ruled out as the country isstill struggling with the hangover from 4 trillion Yuan

(US$650 billion) rolled out during the 2008-09 crises. As

growth has slowed this year, China has rolled out a se-

ries of targeted scal and monetary stimulus measures,

including stepped-up spending on railways, energy, and

public housing, expanded credit to farmers and private

businesses and more relaxed rules for the housing sec -

tor. The Bank plans to inject 200 billion Yuan (US$32.6

billion) into the banking system, following an earlier

move to pump 500 billion Yuan into the countrys vemajor state-owned banks. The prospects of weaker

growth may raise the chances of more aggressive policy

steps such as cutting interest rates or reserve require-

ments across the board, but the government may not

rush into action as the job market still appears to be

holding up. Steps unveiled since April included reserve

requirement cuts for selected banks and faster invest-

ment in railways and public housing. But much of their

broader impact may have been oset by the cooling

property market and tighter credit as banks grow morecautious about lending as the economy cools. Chinas

leaders have relaxed home-purchase controls and the

Central Bank has pumped liquidity to lenders as they

seek to limit a property-induced slowdown. The govern-

ment has eschewed across-the-board interest rate cuts

and signaled it will tolerate a weaker expansion, leaving

the economy headed for the slowest full-year growth

since 1990.

Even though the colossal strategy of U.S. Federal Re-serve to buy immense piles of bonds in an extraordinary

eort to restart a recession-deadened economy came

to an end in October, after adding more than US$3.5

trillion to the Feds balance sheet an amount roughly

equal to the size of the German economy, it continued

to pump support into the economy the old-fashioned

way, by holding its interest rates near zero. Currencies

and stock markets in emerging markets fell steeply in

mid-January 2014, as investors prepared for U.S. inter-

est rates to rise, but markets rebounded while interestrates stayed low. According to Janet Yellen, the Fed

chair, the benchmark interest rate would remain near

zero for a considerable time, and the Central Bank may


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GLOBAL TRENDS

hang onto the bonds for years, which could give a QE-

like boost even after QE itself has been tapered out. The

near-zero interest rates it plans to leave in place until

While global markets have been buoyant as a conse-

quence, interestingly, Central Banks themselves are less

condent, particularly given the extent to which eco-

nomic growth has repeatedly undershot their expecta-

tions and forecasts. After all, monetary policy makers

dont have the tools to remedy long-term neglect of

growth drivers such as infrastructure investment and

labor-market reforms; unbalanced demand patterns in-

volving a mismatch between the willingness and ability

to spend; and pockets of excessive indebtedness thatsmother economic growth and new investments. That

isnt the only thing worrying Central Banks. If anything,

the labor market has recovered further, is a massive

stimulus in itself, even in the absence of extraordinary

stimulus of massive bond purchases.

unexpected interest-rate cut by Chinas Central Bank

and the European Central Banks decisions implying

that more monetary easing is needed reect weakness,

not strength. This can be seen in the reduced forecasts

for economic growth worldwide and, in the case of the

euro zone, signs that the region is on the verge of price

deation. Not all Central Banks are increasing monetary

stimulus. The U.S. Federal Reserve is likely to continue

diverging from the ECB and others, easing its foot o

the accelerator. This will require adjustments that gobeyond just dollar strengthening and that could cause

volatility.


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DOMESTIC TRENDS

Manufacturing Needs a Quality Boost


A

signicant innovation of the Make in India call

by Prime Minister Narendra Modi, given on Au-

gust 15, was the addition of Zero Defect, ZeroEect. This translates into a manufacturing mission that

is high on quality as also environmentally sustainable.

In fact, the two goals are complementarya nations

development is sustainable only when the producers of

products and services deliver highest levels of quality,

at lowest cost, most eciently, with minimum environ-

mental impact and most responsible use of resources.

Quality is a holistic concept that goes beyond produc-

tion of high-class goods and services to encompass en-

tire processes and systems at the rm level and at the

national level to maximise outcome, eciency and pro-

ductivity at minimal cost. It extends to long-term busi-

ness strategies for organisational excellence and suc-

cess and can be extrapolated to include ecient supply

chains. Inculcating a culture of quality in the country so

as to meet the objectives of Zero Defect, Zero Eect re-

quires a mindset change among the policy-makers and

industry alike in order to enhance national competitive-

ness in the global marketplace and succeed in manufac-

turing transformation.

India today has a large number of winners and recipi-

ents of internationally-acclaimed awards for business

excellence. According to CII data, there are 21 awardees

of the renowned Deming Prize and 238 Total Productiv-

ity Maintenance (TPM) awardees of the Japan Instituteof Plant Maintenance (JIPM). Firms have also worked

towards obtaining international energy and green rat-

ings, certications covering quality, energy and environ-

ment, and other well-known business excellence stand-

ards.

This drive for excellence has enabled gains in produc -

tivity, quality, costs, operational eciencies and con-

servation of critical natural resources. In training pro-

grammes conducted by CII on Quality Management

Systems, we have seen production in participating

rms going up by 50 per cent, quality levels increasing

by 80 per cent, cost of manufacturing coming down by

5-8 per cent, and cost of maintenance being slashed by


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ECONOMY MATTERS 12

30-50 per cent. A huge positive outcome has been zero

accidents, zero breakdowns and zero defects in the

companies which have gone through the TPM process.The high point is raised morale of employees as sta at

all levels is involved in kaizen or continuous improve-

ment and innovation as well as in aligning to enterprise

goals. Such quality interventions have helped enhance

the image of Indian manufacturing and many of our

companies have emerged as top-ve producers of their

product categories in the world. While this is a no mean

achievement, there is still a long way to go for universal

coverage in terms of scale and numbers of manufactur-

ing enterprises.

A comprehensive initiative for expanding quality at-

tainments would aim to transform methodologies, pro-

cesses and systems across the value chain. It would re-

vitalise the use of manufacturing tools and techniques

while building a strong brand for India and its products

and services, focusing both on the customer as well as

on society as a whole. The endeavour of Zero Defect,

with a focus on the customer, would act towards zero

non-conformance and non-compliance. On the other

hand, Zero Waste, Zero Eect, with a societal focus,

would focus on zero air pollution, zero liquid discharge,

zero solid waste and zero wastage of natural resources.

This would converge the Make in India mission with the

Swachh Bharat Abhiyan and stress minimising waste at

the industry level.

Strong and clear standards, identifying specic criteria

for compliance towards Zero Defect and Zero Eect,

need to be developed across diverse elds. Each cri-

terion would be in the form of graded improvements

that would be demonstrable with the highest grade

corresponding to world-class maturity assessment cri-

teria, and should include both enablers and results. This

would help Indian industry to measure itself against

global benchmarks and seek to evolve to its desired lev-

els of quality.

A range of areas need to be addressed to make industry

competitive and quality-compliant. The use and adop-

tion of proven and time-tested quality tools and tech-niques, green technologies, management systems, ex-

cellence models, fundamental concepts and innovative

approaches, and coordinated and time-bound process-

es using a dened roadmap with clear outcomes will be

some of strategies that Indian industry would need to

deploy. Industry would need support in terms of train-

ing, consultancy and advisory services that would assist

rms in adopting these proven methodologies. Multi-

ple modes including awareness dissemination, person-

alised interventions, audits, assessments and clustermode would be required to achieve the twin goals and

build necessary internal capacities and capabilities for

vibrant and sustainable enterprises.

CIIs Institute of Quality is the initiator of Indias rst

maturity assessment criteria ever on Zero Defect, Zero

Eect, termed as the ZED Maturity Assessment Criteria.

Evolved with the collaboration of the Quality Council

of India, this would bring out a ZED framework with

a maturity matrix to guide industry to commence and

advance on quality attainments. Benchmarks would be

established across focus sectors and products, which

would enable Indias 1.1 million MSMEs to reference

themselves. Besides CII Institute of Quality, other CII

Centres of Excellence who will be actively participating

in this ZED movement would include CII-Avantha Centre

for Competitiveness for SMEs, CII-ITC Centre of Excel-

lence for Sustainable Development, CII-Sohrabji Godrej

Green Business Centre, CII-Triveni Water Institute, CII-

Naoroji Godrej Centre of Excellence and CII Andhra

Pradesh Technology Development and Promotion Cen-

tre.

The success of the Make in India mission would depend

heavily on the competitiveness of Indian enterprises,

particularly MSMEs. Zero Defect, Zero Eect should

thus be developed as an additional mission in partner-

ship with industry to support and assist companies.

This article appeared in Financial Express dated 29th November 2014. The online version can be accessed from the follow-

ing link: http://www.nancialexpress.com/article/fe-columnist/manufacturing-needs-a-quality-boost/


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13

DOMESTIC TRENDS


Despite the GDP slowing down to 5.3 per cent in the

second quarter of the current scal (2QFY15) from 5.7

per cent in the previous quarter, the rst-half GDP g -

ure of 5.5 per cent did seem to indicate that growth has

sustainably bottomed out. Deceleration in the second

quarter was on expected lines, and growth could have

slipped further if it was not for surprisingly healthy

performances by agriculture and government spend-

From the supply-side, industrial growth slowed to 2.2

per cent in Q2FY15 compared to 4.2 per cent in Q1FY15.

Weakness was concentrated in the manufacturing sec-

tor where growth fell to 0.1 per cent compared to 3.5

per cent in the rst quarter. Output growth in other seg-

ments within industry - such as electricity and mining

(that were earlier providing support) too slowed. Out-

put growth in electricity, gas and water supply slowed

to 8.7 per cent in Q2FY15 compared to 10.2 per cent

in Q1FY15. Similarly, in the mining sector too, growth

slowed to 1.9 per cent in Q2FY15 compared to 2.1 per

cent in Q1FY15. Contrary to previous expectations, ag-

riculture growth was quite strong at 3.2 per cent inQ2FY15, compared to 3.8 per cent growth in Q1FY15.

ing components. The two key enablers of growth, viz,

industrial output and investment spending, however,

continued to disappoint. The H1 growth at 5.5 per cent

has placed the economy on track to achieve our expec-

tation of full year growth of 5.5-6.0 per cent given that

the second half is likely to be better. However, the mix

in growth needs to change in favour of investments go-

ing ahead in order to move to a sustained path of higher

growth trajectory.

In 2014, south-west monsoons were decient at 12 per

cent below normal with the North-east region being

signicantly aected. Lower impact on rice production

provided a cushion to overall agricultural output. Servic-

es sector growth remained relatively resilient at 7.1 per

cent in Q2FY15 as compared to 6.8 per cent in the quar-

ter before. Community, social and personal services

component of services grew at a higher pace of 9.6 per

cent in Q2FY15 from 9.1 per cent in the previous quarter,

a signicant part of which includes government spend-

ing. However, the trade, hotels, transport component,

which comprises a lions share of GDP at factor cost is

showing gradual, but steady revival which bodes wellfor Indias employment scenario.

Q2 GDP Relatively Resilient Despite Expected

Slowdown


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ECONOMY MATTERS 14

DOMESTIC TRENDS

At market prices, however, GDP grew at 6.0 per cent in

Q2FY15, higher than 5.8 in Q1FY15. Private consumption

growth climbed higher to 5.8 per cent in Q2FY15, but

mainly pushed upwards by a low base of last year (2.8

per cent growth in Q1FY14). Government spending com-

ponent also came in strong at 9.6 per cent, which ex-

plains the April-October scal decit standing at almost

90 per cent of budgeted levels of the entire nancial

year. Consequently, this run rate of spending cannotbe sustained over the second half of the year and will

moderate sharply as the government will start cutting

its spending to rein in the scal decit target for the full

year. From the demand-side, what stood out as a major

concern was the at rate of growth posted by invest-

ment spending in Q2FY15 from 7.0 per cent growth in

Q1FY15. The capital goods sector has continued to face

the wrath of sluggish investment. This builds a strong

case for cutting of interest rates by the RBI as pick-up

in investment is crucial for having a sustained improve-

ment of growth in the medium-term. Additionally, sup-

port from external sector is waning and export growth

turned negative after four quarters of positive double-digit growth presumably on account of muted global

growth. However, the sharp fall in crude prices will help

to somewhat oset the drag.

Outlook

Despite the slowing down of GDP in the 2QFY15 owing to a steep decline in manufacturing output, the economy

does remain rm on the road to recovery as compared to the previous year. In order to boost the output in theremaining quarters of the scal, the Centre should roll out proactive policies which would help revive investments

and address the bottlenecks plaguing the agriculture and industrial sectors, a stable and predictable taxation sys-

tem, faster regulatory clearances and industry-friendly land acquisition and labour laws.


17/54

15

DOMESTIC TRENDS


After remaining subdued for the last two months, in-

dustrial output growth accelerated to 2.5 per cent in

September 2014 from 0.4 and 0.5 per cent in July and

August 2014 respectively. After contracting for two

consecutive months, manufacturing output improved

to 2.5 per cent in September 2014. Capital goods output

too moved to the positive territory after languishing in

the red for the last two months. On a cumulative basis,

In contrast to overall industrial output, the core sector

output moderated to 8-month low in September 2014

on the back of dwindling production of crude oil, ferti-

lizer and natural gas. The eight core industries comprise

nearly 38 per cent of the weight of items included in the

Index of Industrial Production (IIP). In October 2014,

however, core sector output accelerated to 6.3 per

cent. This is the highest growth recorded by the index

in the last four months. The growth came on a at base.

The growth in October 2014 was driven by the coal and

the electricity industries. Both the industries recorded

a double-digit growth in output during the month. Coal

production rose by 16.2 per cent and electricity genera-

industrial output grew by 2.8 per cent in the rst half

of the current scal as compared to 0.5 per cent in the

same period last year. The sequential momentum as

indicated by the movement in the seasonally-adjusted

month-on-month series too showed that industrial out-

put growth improved in September 2014 (from -1.0 per

cent in August 2014 to 2.0 per cent in September 2014).

tion increased by 13.2 per cent. Renery products out -

put grew by a modest 4.2 per cent, after falling for three

months. The crude oil industry also returned to growth

after a gap of three months. Its output grew by 1 per

cent in October 2014. The natural gas industry, howev-

er, continued to register a fall in production for the 47th

consecutive month. Its output dropped by 4.2 per cent

in October 2014. Production of cement and fertilisers

declined too. Cement production declined by 1 per cent

and fertiliser production declined by an even steeper

pace of 7 per cent. Fertilisers production has been fall-

ing for the last ve months.

Industrial Output Grows at a Higher Pace in September

2014


18/54

ECONOMY MATTERS 16

DOMESTIC TRENDS

On the sectoral front, output of the manufacturing sec-

tor, which constitutes over 75 per cent of the index,

grew by 2.5 per cent in September 2014 as compared

to contraction to the tune of -1.3 per cent in the pre-

vious month. In terms of industries, fteen (15) out of

the twenty two (22) industry groups (as per 2-digit NIC-

2004) in the manufacturing sector have shown positive

growth during the month of September 2014 as com-

pared to the corresponding month of the previous year.

The industry group Electrical machinery & apparatus

n.e.c. showed the highest positive growth of 29.9 per

cent, followed by 19.1 per cent in Other transport equip-

ment and 12.3 per cent in Basic Metals. On the other

hand, the industry group Radio, TV and communication

equipment & apparatus recorded the highest negative

growth of (-) 43.8 per cent, followed by (-) 34.2 per cent

in Oce, accounting & computing machinery and (-)

4.4 per cent in Chemicals and chemical products.

The Supreme Court ruling on coal block allocations is -

nally showing its adverse impact on electricity output.

Electricity output decelerated sharply to 3.9 per cent in

September 2014 as compared to a healthy 12.9 per cent

growth in the previous month. Mining output too slid to

0.7 per cent from 2.0 per cent in August 2014. Going for-

ward, we expect the electricity production growth to

slow down further due to shortfall in coal supply. In ad-

dition, the Supreme Court ruling on cancellation of coal

blocks allocations to 214 mines could see mining sector

growth decelerating further in the months to come.

From the use-based perspective, consumer goods pro-

duction continued to remain in negative territory. The

major part of the contraction in consumer goods was

primarily on account of sharp drop in consumer dura-

bles by 11.3 per cent. Acute rainfall deciency during

the initial phase of the monsoon season (about 30 per

cent average during June to August) has likely to have

dented farm incomes and hence demand for consumer

durables. The negative print for non-durables during

the month was also worrying. Moreover, the volatility incapital goods continued, with the sectors output grow-

ing by 11.6 per cent in September 2014 after remaining in

the negative territory for the previous two consecutive

months. Meanwhile, basic goods production slowed

down to 5.1 per cent after remaining healthy at 9.2 per

cent in August 2014.


19/54

17

DOMESTIC TRENDS


WPI based ination moderated sharply to 5 year low of

1.8 per cent in October 2014 from 2.4 per cent in the pre-

vious month. The fall in WPI ination was attributable to

all round moderation in all its sub sectors. CPI ination

too fell to 5.5 per cent in October 2014 from 6.5 per cent

last month driven by a fall in food ination (fell to 5.6

per cent from 7.7 per cent in September 2014). Core CPI

ination remained broadly unchanged falling slightly

from 6.0 per cent last month to 5.9 per cent in October

2014. This is the lowest core ination recorded since the

beginning of the new CPI series. A signicant decline in

crude oil prices globally contributed to the downward

price pressures in transport and communication and

fuel CPI ination. We expect the moderation in both

WPI and CPI ination to give RBI the necessary legroom

to cut interest rates in its forthcoming monetary policy

in order to spur demand conditions in the economy.

OutlookThe upturn in industrial production in September 2014 underpins the perception that the growth momentum is

positive for industry and the economy is showing early signs of revival based on the feel good factor and positive

investor sentiment. We hope that going forward, the tentative signs of revival would transform into a rm recov-

ery as overall business condence is looking up and there is optimism about the change in governance conditions

pertaining to the ease of doing business. A disaggregated analysis showed a robust growth in capital goods sector

indicating some pick up in investment as companies are contemplating expansion as business environment has

turned positive. However, consumer durables are still in the red as high interest rates have stymied demand.

Another Positive Print for Ination in October 2014


20/54

ECONOMY MATTERS 18

DOMESTIC TRENDS

Primary ination moderated further to 1.4 per cent in

October 2014 from 2.2 per cent in September 2014. Part

of the moderation was driven by a high base of last

year. Primary food ination too eased to 2.7 per cent

from 3.5 per cent in the previous month. Notably, food

ination has come down sharply in the last couple ofmonths, thanks to proactive steps taken by the govern-

ment such as release of food grain stocks, low increase

in minimum support prices etc. Amongst primary food

prices, the data showed that vegetable prices have

come down sharply to -19.6 per cent in October 2014

from -14.9 per cent in September 2014. In contrast, in-

ation in fruits has remained relatively rm at 19.3 per

cent in the reporting month as compared to 20.9 per

cent in September 2014. Primary non-food ination de-

celerated sharply to -1.4 per cent in October 2014 from0.5 per cent in the previous month. Amongst non-food

articles, ination in bres and minerals was the main

driving force behind the moderation.

Fuel ination too decelerated sharply to 0.4 per cent in

October 2014 as compared to 1.3 per cent in the previ -

ous month, benetting from a favourable base eect.

Fuel prices came o sharply tracking a fall in global

Brent crude prices, which is now trading at a two-year

low. Ination in petrol declined further to 7.0 per cent

from -9.4 per cent in September 2014. In an interesting

development, in October 2014, government de-regulat-

ed the price of diesel and announced a new price for do-

mestically-produced natural gas. The price of diesel, likepetrol, would now stand linked to the market without

any government intervention, with retail rates reect-

ing price changes in the global market. The immediate

impact on diesel will be a reduction in prices by Rs 3.37

a litre.

Manufacturing ination eased further to 2.4 per cent in

October 2014 as compared to 2.8 per cent in the pre-

vious month. Encouragingly, non-food manufacturing

or core ination, which is widely regarded as the proxy

for demand-side pressures in the economy, continued

its downward trajectory as it moderated to 2.5 per cent

during the month as compared to 2.8 per cent in Sep-

tember 2014. In the coming months, we expect core

WPI to hover around 3.0-3.5 per cent, RBIs comfort

level for this ination measure. Manufacturing food in-

ation too decelerated during the month.


21/54

19

DOMESTIC TRENDS


In its fth bi-monthly monetary policy review held on

2nd December, 2014, RBI maintained status quo on all

key rates citing uncertainty regarding strength of the

on-going disinationary impulses, the pace of change

of the publics inationary expectations, as well as the

success of the governments eorts to hit decit tar-

gets. Moreover, the favourable base eect that is driv-

ing down headline ination currently will likely dissipate

and ination for December (data release in mid-Janu-

ary) may well rise above current levels. As per RBI, some

easing of monetary conditions has already taken place.

The weighted average call rates as well as long term

yields for government and high-quality corporate issu-

ances have moderated substantially since end-August.

However, these interest rate impulses have yet to be

transmitted by banks into lower lending rates.

With this the repo rate stands at 8.0 per cent, the re -verse repo rate at 7.0 per cent, the marginal standing

facility (MSF) rate and the Bank Rate at 9.0 per cent.

Additionally, the RBI will continue to provide liquidity

under overnight repos at 0.25 per cent of bank-wise

NDTL at the LAF repo rate and liquidity under 7-day and

14-day term repos of up to 0.75 per cent of NDTL of the

banking system through auctions while continuing with

daily one-day term repos and reverse repos to smooth

liquidity.

OutlookCII welcomes the drop in ination based on both consumer and wholesale price. Over the next 1-2 months, head -

line CPI ination could ease further due to a base eect from last scal, lower crude oil prices, revival of monsoon,

proactive measures taken by the government to keep food prices under control, and a stable currency. However,

factors such as improvement in demand conditions and rising geopolitical tensions reversing the current decline in

oil prices could derail this moderation in the coming months.

RBI Stays Put on Interest Rates


22/54

ECONOMY MATTERS 20

DOMESTIC TRENDS

As per the RBI, economic activity appeared to have lost

some momentum in Q2, probably extending into Q3,

conditions congenial for a turnaround the softening

of ination; easing of commodity prices and input costs;

comfortable liquidity conditions; and rising business

condence as well as purchasing activity are gather-

ing. These conditions could enable a pick-up in Q4 if

coordinated policy eorts fructify in dispelling the drag

on the economy emanating from structural constraints.

A durable revival of investment demand continued to

be held back by infrastructural constraints and lack of

assured supply of key inputs, in particular coal, power,

land and minerals. The success of ongoing government

actions in these areas will be key to reviving growth

and osetting downside risks emanating from agricul-

ture in view of weaker-than-expected rabi sowing

and exports given the sluggishness in external de-

mand. Anticipating such success, the central estimate

of projected growth for 2014-15 has been retained at 5.5

per cent by RBI, with a gradual pick-up in momentum

through 2015-16.

RBI noted that liquidity conditions eased considerably

in Q3 of 2014-15 due to structural and frictional factors,

as well as the ne tuning of the liquidity adjustment

framework. With deposit mobilisation outpacing credit

growth and currency demand remaining subdued in re-

lation to past trends, banks were ush with funds, lead-

ing a number of banks to reduce deposit rates. The main

frictional source of liquidity has been the large release

of expenditure/transfers by the government. In view of

abundant liquidity, banks recourse to the Reserve Bank

for liquidity through net xed and variable rate term

and overnight repos and MSF declined from Rs 803 bil-

lion, on average, in Q1 to Rs 706 billion in Q2 and further

to Rs 476 billion in October-November 2014.

In its review statement, RBI amply indicated that if the

current ination momentum and changes in ination-

ary expectations continue, and scal developments areencouraging, a change in the monetary policy stance

is likely early next year, including outside the policy re -

view cycle.

The scal decit in the rst seven months of the currentscal (April-October) stood at Rs 4.75 lakh crore which

translates into 89.6 per cent of the budgeted gure for

the entire nancial year. The jump in scal decit was

underpinned by rise in expenditure growth and contrac-tion in revenue growth. However on a monthly basis,

scal decit declined by 19.4 per cent to Rs.369.25 bil-

lion in October 2014 as compared to the same month a

Fiscal Decit Rises to 89.6% of Budgeted in

April-October 2014


23/54

21

DOMESTIC TRENDS


year ago. This was the lowest level of the decit in the

last three months. Both, expenditure and non-debt re-

ceipts declined on a y-o-y basis in October 2014. How-

ever, a sharper fall in expenditure vis-a-vis non-debt re-

ceipts led to the contraction in the scal decit.

To be sure, while presenting the rst budget of the

newly elected NDA government in July 2014, Finance

Minster (FM), Mr Arun Jaitley had laid stress on scal

prudence, lowering the scal decit target of 4.1 per

cent of GDP for 2014-15 as compared to 4.6 per cent in

2013-14. Notwithstanding, the current precarious state

of aair of government nances, the scal outlook

should brighten because of the fall in crude prices, but

weak tax revenue growth and the slow pace of disin -

vestment suggest some uncertainty about the likely

achievement of scal targets, and the quality of even-

tual scal adjustment. The government, however, ap-

pears determined to stay on course.

The decit touched almost 90 per cent of its annual tar-

get in the rst seven months of the year itself mainly

because of weakness in revenues. Total receipts stood

at Rs 4.86 lakh crore during April-October 2014, whichtranslates into only 38.5 per cent of the budgeted esti-

mates for the full year. Mirroring the sluggish economic

scenario, gross tax revenues growth too remained

weak. On a monthly basis, non-debt receipts declined

by 6 per cent to Rs.631.1 billion in October 2014 on a y-

o-y basis. While tax revenue declined by 6.7 per cent to

Rs.456.81 billion, non-tax revenue collection fell by 4.1

per cent to Rs.164.96 billion.

Total expenditure stood at Rs 9.6 lakh crore during

April-October 2014. This translates into 53.6 per cent of

the budgeted targets for the current year. While non-

plan expenditure increased by 8.4 per cent to Rs.6.95

lakh crore, plan expenditure declined by 0.4 per cent to

Rs.2.67 lakh crore. On a monthly basis, total expendi-

ture declined by 11.4 per cent to Rs.1 lakh crore in Octo -

ber 2014. This decline was entirely on account of a sharp

compression in plan expenditure, which tanked by 35.2

per cent to Rs.207 billion during the month. Non-plan

expenditure declined slightly by 2.1 per cent to Rs.793.3

billion.

The performance of the government nances has not

been up to the mark in the scal so far. It would need

to tighten its purse strings and boost revenue growth in

order to meet the scal decit target for 2014-15. To be

sure, in order to lower the scal decit to 4.1 per cent

of GDP in 2014-15, the government is betting on both

revenue and expenditure growth of 12.9 per cent as

compared to the revised estimates for 2013-14. In order

to achieve the revenue growth target, tax revenues,

which form around 80 per cent of total revenues, need

to prop up. Moreover the nature of expenditure com -

pression needs to be kept in mind as trimming of capital

expenditure will further slow down the economic re-

covery process.


24/54

ECONOMY MATTERS 22

TAXATION

Transfer Pricing in Income Tax and Customs Valuation ofRelated Party Transactions Need for Harmonization

Transfer Pricing, a term used in the income tax

parlance, is a mechanism adopted by Multina-

tional Enterprises (MNEs) for valuing the goods

and services traded with their subsidiaries or associate

companies situated in dierent tax jurisdictions. The

income tax authorities use arms length principle in

terms of the international standard for transfer pricing,

as set out in the Organization for Economic Coopera-

tion and Development (OECD) Transfer Pricing Guide-

lines, and the Model Tax Convention. Customs address-

es the related party transactions through provisions

as mandated by the World Trade Organization (WTO)

agreement on customs valuation. The customs valua-

tion treatment of related party transactions has been

dealt with elaborately in articles 1.1 (d), 1.2 (a) & (b) and

15 of the WTO valuation code. When goods, intangibles

and services are transferred across borders within the

MNEs, transfer pricing becomes an important issue for

both the MNEs as well as for the income tax and cus-

toms authorities. Revenue administrations are naturally

concerned about transfer pricing as it inuences both

the direct and indirect taxes. Price of goods in a cross-

border transaction is the starting point for assessing

customs duties and for determining prots that arise

to each party for computing the income tax. The trans -

actions between related parties, as used in customs or

associate enterprises, as used in income tax are not al -

ways subject to the same market forces as transactions

between independent parties. As a result, the revenue

administrations are apprehensive that there is a poten-

tial for under or overpricing of the goods, thus inuenc-

ing the determination of customs duty and income tax.

There is another angle. A high transfer price reduces

the income tax liability, while low transfer price lowers

the customs duty. Thus there lies an inherent conict

of interest between the customs and the income tax

authorities. While the income tax authority may seek

to stop diversion of prots to the exporting country by

assessing lower transaction price on imports, the cus-

toms authority may prefer to determine a higher trans-

fer price on the same imports so as to enhance the cus-


25/54

23

TAXATION


toms duty. There could also be a case where the same

assesses declares a lower import value to customs to

pay less customs duty, while indicating a high transferprice for the same goods so as to minimize prot and

pay less income tax.

The global business models of the MNEs are chang-

ing continuously according to the business demands.

A globalised supply chain always aims to reduce costs

and increase eciency with centralization of certain

functions, assets and risks in principal entities. In terms

of UNCTAD report, eighty percent of global trade is

estimated to be linked to the international production

networks of MNEs. Further, a substantial portion of in-

ternational trade going up to 60 per cent takes place

within the MNE Groups. The OECD BEPS (Base Erosion

Prot Shifting) report for G20 includes transfer pricing

as one of the six Key Pressure Areas.

Thus, transfer pricing is no longer an issue for devel -

oped countries only. It is becoming important for the

developing and emerging economies as well to man-

age transfer pricing well so that the revenue adminis-

trations may protect their tax base eectively, while at

the same time avoiding double taxes. While both cus-

toms valuation and transfer pricing rules set standards

for determining arms length or fair value of these

transactions, the international rules and guidelines are

dierent in the customs and income tax domains, as ex-

plained before.

The trade and industry have voiced their concern about

the diculty they face in satisfying the dierent regu-

latory requirements of both income tax and customs.

Their basic concern is that dierent rules and standards

are applied by the two departments, and the absence

of coordinated eorts could also lead to double taxa-

tion that might create barriers to trade and investment.

In this background, the international trading commu-

nity has been raising certain critical questions, some

of which are as follows: To what extent is it acceptable

to have dierent rules, merely because the policy ob -

jectives of customs and income tax departments are

dierent? How can one accept dierent answers from

two dierent authorities to the same question i.e. what

is the arms length price? Should both sets of rules

converge? And to what extent should they converge,

and towards what standard? These are the challenging

questions on the issue of transfer pricing for the incometax and customs authorities as well as the trading com-

munities all over the world.

In response to these challenging questions, the World

Customs Organization (WCO) and the OECD jointly

hosted two international conferences on transfer pric-

ing and customs valuation, at the WCO headquarters in

Brussels in 2006, and 2007, at the initiative of Mr. Kunio

Mikuriya, then Deputy Secretary General, WCO. This au-

thor had the privilege to participate in both the confer-

ences on invitation from the WCO.

In the rst joint conference, the dierences and simi -

larities between two sets of rules applied by the two de-

partments were demonstrated on the basis of compari-

son between how income tax and customs authorities

treat transfer pricing in accordance with their specic

international standards. The conference also discussed

pros and cons of the desirability and feasibility of having

converging standards for the two systems.

Two schools of thought emerged. Those who were in

favour of convergence pointed out that a credibility

question did arise if two sets of rules on value deter-

mination led to dierent answers to virtually the same

question - what is the arms length / fair value for a

transaction. They further argued that convergence

would result in less compliance cost for the trade and

less enforcement costs for the administrations. Those

from the other school of thought called for caution

against convergence. They pointed out that the two

systems are based on dierent principles while viewing

the valuation of imported goods. The transfer pricing

principles in terms of the OECD guidelines are in many

ways dierent from the principles of customs valuation

treatment outlined by the WTO valuation agreement.

Therefore, their advice was to focus more on dispute

resolution mechanisms to solve the questions that

might arise from the divergence in the two systems.

In the second joint conference held in May, 2007 theconference went more into the nitty-gritty of exploring

possible convergence. The conference recommended,

inter alia, for setting up of a focus group to suggest so-


26/54

ECONOMY MATTERS 24

TAXATION

lutions for harmonization of the two streams of valu-

ation. At the conclusion of the conference, one found

the message to be loud and clear - convergence is de-nitely desirable, and ways and means would have to be

found to reach that goal.

As a follow-up to the second joint conference of May

2007, the focus group recommended, inter alia, that

the technical committee on customs valuation (TCCV)

at the WCO, which assists the members on various tech-

nical issues related to customs valuation may examine

the phrase circumstances of sale in Article 1.2 (a) of the

WTO valuation agreement in respect of its applicationto transfer pricing situation. This was the rst attempt

to build the bridge between OECD guidelines and WTO

valuation agreement.

The TCCV at the WCO came out with a WCO instrument

commentary 23.1 titled examination of the expression

circumstances surrounding the sale under Article 1.2

(a) in relation to the use of transfer pricing studies.

The said commentary sought to provide guidance on

the use of a transfer pricing study in determining the

customs value under Article 1.2 (a) of the agreement.

To elaborate, the said commentary provided guidance

in situations where TP Studies, prepared in accordance

with the OECD transfer pricing guidelines are produced

by importers as a basis for examining the circum-

stances surrounding the sale under Article 1.2 (a) of

the agreement. The question that arose was whether

a TP Study prepared for tax purpose, and provided by

the importer could be utilized by the customs admin-

istration as a basis for examining the circumstances

surrounding the sale. The commentary observed that

on one hand, a TP Study submitted by an importer may

be a good source of information, if it contains relevant

information about the circumstances surrounding the

sale. On the other hand, TP Study might not be relevant

or adequate in examining the circumstances surround-

ing the sale because of the substantial and signicant

dierences which existed between the methods in the

agreement to determine the value of the imported

goods and those of the OECD transfer pricing guide-

lines. The commentary nally concluded that the use of

a transfer pricing study as a possible basis for examiningthe circumstances of the sale should be considered on

a case by case basis, and that any relevant information

and documents provided by an importer may be utilized

for examining the circumstances of the sale. A transfer

pricing study could be one source of such information.

Obviously the said WCO document displayed cautions

approach with respect to harmonization of the princi-

ples laid down in the agreement and the guidelines.

Nevertheless, it is a positive move, and a good be-ginning has been made. It is now hoped that further

analytical studies would show that the customs valua-

tion treatment of related party transactions and trans-

fer pricing laws for associated enterprises do share

common principles in many areas. Common meeting

grounds can be found in the OECD arms length meth -

ods of Comparable Uncontrolled Price (CUP) method,

Resale Price Method, Cost Plus Method, Transaction

Prot Methods etc. and the methods laid down in the

articles 2,3,5, and 6 of the WTO valuation code. It hasalso to be realised that the OECD transfer pricing guide-

lines constitute a body of rules that is appropriate to

supplement the related party provisions of the WTO val-

uation code. It is however unfortunate that after show-

ing the much required urgency in two consecutive years

of 2006 and 2007, both the OECD and the WCO seem

to have slowed down in nding the path for conver-

gence. There has not been any other joint OECD- WCO

conference on the subject to take this matter forward.

There is no denying the fact that in the long-run, major-ity of the stakeholders would nd convergence to be

denitely desirable. But there is a long and bumpy road

ahead to make it feasible and there are many issues

which would need to be settled before moving towards

convergence. The organizations like WTO, WCO, OECD

and APTF (Asia Pacic Tax Forum) must pursue the dia-

logue in a proactive manner at least for harmonisation

of the two valuation treatments, if not for reaching the

ultimate goal of convergence.

Mr. Sumit Dutt Majumdar is also the author of a book titled Customs Valuation - Law and Practice (2005), published

by Centax Publications


27/54

25

SECTOR IN FOCUS

Make in India : Turning Vision into Reality


The Indian manufacturing sector is a classic exam-

ple of an industry that has had great potential,

but one that has been systematically done in

by political ineectiveness, entrepreneurial myopia

and sheer ignorance of what it takes to succeed. Over

the last 20 years, Indian manufacturing has by and

large grown at the same pace as our overall economy.

Our share of global manufacturing has grown from0.9 to 2.0 per cent during this period while our GDP

share has grown from 1.2 to 2.5 per cent. Despite this

encouraging growth, however, the relative share of

manufacturing in the Indian economy has remained

unchanged, dashing hopes of an economy based on

manufacturing-led growth. The sector accounted for 15

per cent of GDP in 1993, a rate that remains about the

same today. Meanwhile, several Rapidly Developing

Economies (RDEs) have increased their share of manu-

facturing to above 20 per cent of their GDP, in particu -

lar Thailand (34 per cent in 2012), China (32 per cent),Malaysia (24 per cent), Indonesia (24 per cent) and the

Philip-pines (31 per cent).

In India, the number of jobs in the sector has also re-

mained low over the last twenty years, increasing only

by 1.8 per cent per year from 37 and 53 million. This con-trasts with the services sector, which has increased by

6.5 per cent per year during the same period, growing

its share of Indias labour force from 22 to 31 per cent

and now accounting for 150 million jobs (compared to

approximately 80 million in 1993).

In this context, the recently announced Make in India

policy by the new government aims to push manufac-

turing growth to the next level. In the recently conclud-

ed CII 13thManufacturing Summit 2014, a report titled

Make in India: Turning Vision into Reality prepared

by CII and BCG was released. We cover the crucial in-

gredients required to make this vision into reality as

discussed by the report in this months Sector in Focus.

Current State of Manufacturing

Over the last ve years, there has been a reversal of

sorts to this manufacturing trend, with Indian manu-

facturings share of GDP falling from 2.2 to 2.0 per cent

between 2009 and 2013, even as the countrys share of

global GDP grew from 2.2 to 2.5 per cent over the sameperiod. At the current rates of underperformance, the

sector will fall well short of the target set by the Nation-


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SECTOR IN FOCUS

al Manufacturing Policy (NMP) of 2012. While the policy

set out plans for the sector to reach 25 per cent of GDP

and create 100 million additional jobs by 2022, the sec-

While the historic performance of the manufacturing

sector has been below par, with es-pecially poor results

over the past ve years, the mood in India across the

broader industrial sector has started to shift over the

past six months, thanks to election of a stable govern-

ment at the centre along with set of specic actions de-

signed to rejuvenate manufacturing announced by the

new government. At the forefront has been the Make

in India campaign, which is aimed at creating 100 mil-lion jobs over the next decade and bringing manufactur-

ing up to 25 per cent of Indian GDP. Specically, these

include:

- Investment to foster innovation and new technolo-

gy development, including a USD 1.2 billion invest-

ment to develop smart cities and the creation of a

USD 16 million development fund;

- Actions to facilitate Foreign Direct Investment, in-

cluding an increase of the FDI cap to 100 per cent

in railways and to 49 per cent in defence and insur-

ance;

- Actions to foster project execution, including the

reforms of approval and clearance requirements

and processes, including the rolling out of an online

system designed to speed up approvals for devel-

opment projects that might have environmental

impacts;

- New policies to facilitate the expansion of Mi-

cro Small and Medium Enterprises (MSME) and

tors contribution to GDP has fallen from 16 to 15 per

cent, with fewer than ve million incremental jobs hav-

ing been added to the economy over the past ve years.

increase the focus on innovation, including the

launch of a INR 10,000 crores venture capital fund

dedicated to MSMEs; and

- Actions to enhance skills and job creation in lead-

ing manufacturing sectors, including automobiles,

chemicals and textiles.

Making Make in India A Reality

at a more opportune time. The global economy is on the

path to gradual, yet denitive recovery. The country has

had a change of guard with a clear majority and whole-

hearted support. The overall mood is one of develop-

ment and progress. No wonder then, that the PMs call

to action has received an overwhelming response from

both Indian and global industrialists and investors. To

achieve a manufacturing led transformation, India

would need to undertake a well- planned and struc-

tured approach. Even as we go about xing the basic

factors around infrastructure, the ease of doing busi-

ness in this country and related government policies,

there is a need to actively plan for and pursue long

term goals of fostering technology and innovation.

The road to global leadership requires a structured ap-

proach across three levels:

1. Revive manufacturing;

2. Gain global competitiveness;

3. Claim global leadership.


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SECTOR IN FOCUS


Revive Manufacturing

GETTING INFRASTRUCTURE EXECUTIONRIGHT

Infrastructure is the backbone of any economy, and is

arguably the single most important factor that sepa -

rates the leaders from the laggards. The right infra -

structure not only ensures an eective supply chain and

key inputs feeding into the manufacturing process,

but also creates a seamless link across production hubs

and end marketsboth domestic and global.

Unfortunately, India lags behind in this key area. Over

the past few decades, while momen-tous growth rates

have fuelled Indias emerging economic prowess, the

country has lacked the corresponding investment in

DRIVING LABOUR REFORMS

Employment growth during 2004-05 to 2011-12 clockedonly 0.5 per cent, compared to 2.8 per cent during the

period of 1999 to 2005. This situation will not change,

unless manu-facturing leaders feel more condent of

hiring and increasing the size of their rms. Today,

the average manufacturing leader is wary of increasing

the size of his permanent workforce, because of inabil-

ity / diculty in downsizing if required, and the signi-

cant managerial eort that goes into managing govern-

ment authorities or unions. As a result, the proportion

of temporary and contract sta in the workforce is

very high. Also, man-ufacturers are open to outsourc-ing labour-intensive operations to SME suppliers who

would then suer from lack of scalewhich would hurt

in the longer term.

infrastructure development. Today, we are left with

a sorry state of transit systems and almost all pillars of

infrastructure in India have been marred by under-capacity and poor execution. The power sector is in an

abysmal state, with widespread capacity constraints

since long and overdependence on non-renewable

sources of energy. The transportation sector has been

crippled by poor quality of public transport, roads and

rolling stock in railways. The average operating speed

of freight trains in India is around 25 km/hr, which is less

than half of that in the US and Germany. Indian ports

have a turnaround time which is more than twice that of

China. The Indian road network is severely inadequatefor supporting a burgeoning economy. The real estate

sector has suered from large delays in projects and un -

der-investments.

Unless this central issue of managerial condence in

increasing workforce size is addressed, all plans for

manufacturing growth will be dicult to implement.The government has started addressing this issue.

For example a unied Labour Identication Number

(LIN) for simplifying business regulations and securing

transparency and accountability in labour inspections

has been announced. The wage ceiling for Employees

Provident Fund (EPF) has been increased from INR

6,500 to INR 15,000. While these are indeed welcome

and much needed initiatives, still more reforms are re-

quired to truly unlock the potential of Indias vast hu -

man resources.

EASING DOING BUSINESS

Even after two decades of economic reforms, India has

been struggling to provide the right environment and fa-


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ECONOMY MATTERS 28

SECTOR IN FOCUS

Gain Global Competitiveness

BUILDING AN EXPORT ECO-SYSTEM

Reviving the domestic manufacturing sector to better

cater to domestic demand is a critical but incomplete

solution. Countries successful in manufacturing have

also correspondingly boosted their share in global

trade. If India wants to become a preferred manufac -

turing hub, the government would need to create an

ecosystem for exports powered by policy reforms, in -

vestments and infrastructure.

DEVELOPING AN INFRASTRUCTURE WHICHSUPPORTS EXPORT GROWTH

There is an urgent need to develop export focused in -frastructure in India. Under-capacity and mismanage-

ment in Indias transit and power systems needs to be

addressed. To encourage global trade, ports would

require higher capacity and streamlined processes.

Their linkage to inland transportation for the seam-

less movement of goods also calls for an upgrade. The

development of industrial corridors and smart cit-

ies would provide a stimulus to the growth of a glob -

ally competitive manufacturing sector. Policy reforms

for simplica-tion of tax regime and promotion of ex -

ports would further help boost Indias share in global

merchandise trade. Brand India would also need to be

strengthened across the globe for an increased accept-

ance and preference for Made in India products.

ATTRACTING INVESTMENT

Industrial Production growth has high correlation with

FDI inows. The eect of FDI on economic development

ranges from productivity increase to enabling greater

technology transfer. Higher FDI inows are central for

India to transcend from 5-7 per cent growth to 10-12 per

cent growth. India currently fares poorly on FDI when

compared its global peers. On a per-capita basis, cumu-

lative FDI equity inows from April 2000 to April 2014

for India is just USD 183 compared to USD 2,017 and USD

1,531 for Mexico and China respectively.

The Indian government has already started taking

steps in this direction to revive manufac-turing sector

growth. The recent move of the government to relax

the cap on FDI in the de-fence and construction sector

is a welcome step in this regard. Already we are witness-

ing early rewards. More changes like an increase in FDI

cap, and the elevated investor condence due to the

new government are expected to cause FDI inow to

cross USD 30 billion in 2013-14 as against USD 24 billion

in 2013-14.

BETTING ON TECHNOLOGY ANDINNOVATION

Indias current standing on innovation and research isnot a desirable one. India has one-fth the number of

researchers per million as compared to China and even

lesser proportion as compared to developed coun-

cilities for its businesses. The eort and time consumed

in India for starting a business, dealing with construc-

tion permits, gaining access to electricity, register-ing

property, paying taxes, enforcing contracts or resolving

insolvency is higher than most other countries.

A study undertaken by the World Bank on Ease of do-

ing Business reects a similar story, where India sits at

the bottom of the pile at Rank 142. In addition to issues

related to domestic business infrastructure, the pro-

cess of getting approvals for exports in India is quite

outdated and highly time consuming. The cost involved

in the process is higher than even in some developed

countries.


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SECTOR IN FOCUS


The US has always led other countries in embracing

new technologies. To make shale gas revolution a huge

success, federal programs played an active role along

every phase of the innovation pipeline. China has also

realised the need for innovation for sustaining its manu-

facturing sector growth. Chinese industries saw sys-

tematic transfer of technology after indigenisation was

promoted in the country. China now accounts for 24

per cent share in the worlds high technology manufac-

turing compared to the US share of 27 per cent.

Claim Global Leadership

Once the foundation is built to revive manufacturingand competitiveness driven across key sectors, achiev-

ing global leadership will be a function of two aspects:

Global competitiveness once achieved needs to be ex-

panded to more sectors to build the ecosystem in gen-

eral and also be defended aggressively. China is a per-

fect example of a nation that rst established its mark

as a cheap source for labour intensive, low technology

goods (for example, cotton-based base oerings in ap-

parel), but has slowly made a mark for technology in -

tensive, complex products as well (for example, aero-

space, electronics, power equipment, etc.). This would

involve continuous investment in infrastructure and

technology.

India will not be able to realise her true potential in

manufacturing unless there is tangible change in two

specic mindsets:

Changing the Consumers Mindset About Made in In-

dia Products.Made-in-India products are not ranked

as high as products made in international locations. The

so-called Made in China discount that the country suf-

fered with has also been systematically been done away

with. Addressing mindsets of Indian consumers rst,

and then international markets is critical to driving ac -

ceptance of Made-in-India goods.

Moving the Entrepreneurs Mindset from Medium-termValue Creation to Long-term Visionary Transforma-

tion. According to a global study conducted by Egon

Zehnder, Indian businesses tend to think more short-

term compared to their global counterparts. In such a

scenario, building structures and putting processes in

place take a backseat. Such a near sighted approach

inevitably takes a toll on their ability to invest in R&D,

innovation, capability building and other such invest-

ments with long term payos. Addressing this mindset

and driving investments in capabilities that will have alonger-term payo is critical to upgrading Indias per-

formance capabilities.

tries (see below graph). High-technology exports from

India form less than seven per cent of the total ex-

ports, while for most other countries the number is in

mid-twenties. Indias number of patent applications and

R&D expenditure also stands nowhere close to that of

the developed countries.


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ECONOMY MATTERS 30

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ConclusionThis is truly a time of great expectations for India, and this is probably the only time in recent past where our

odds of driving breakout growth in manufacturing are very high. We have a strong, pro-industry government,

global economy is picking up, and our core advantages are still strong and relatively unaected from the global

slowdown. Having said that, there is a long journey ahead of us, one that starts with reviving the industry, and

then achieving global competitiveness followed by claiming global leadership. A good start has been made with

the government announcing its intent and making a few small yet important changes to improve manufacturing

sector. The next year is crucial to implementing the announcements well, and seizing the opportunity to make the

right investments at a company level.


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31

FOCUS OF THE MONTH

Trade: Policy & Performance


India saw its foreign trade expand remarkably in the

past decade. Although, the pace of exports growth

was punctuated twice by sharp slowdown in world

economy during 2008-09 and during the last two s -

cal years, Indias trade prospects have continued to

grow over time. In scal year 2003-04, Indias exports

were worth US$64.0 billion. By 2013-14, they more

than quadrupled to US$312.6 billion. In the current s-

cal, cumulative exports have reached US$189.8 billionin the rst seven months of the scal (April-October

2014) as compared to US$181.2 billion in the same pe -

riod last year, thus registering a growth of 4.7 per cent.

On a monthly basis, exports shrank for the rst time in

seven months in October 2014, tempering hopes for an

export-led recovery. Exports contracted by 5 per cent

on y-o-y basis to US$26.1 billion in October as against

2.7 per cent growth recorded in the previous month.

With the Japanese economy now in recession and the

Euro Zone irting with one, overseas demand for Indianexports has become a little uncertain. A high base ef-

fect of last year was also partly responsible for the con-

traction in exports in October 2014. For the rest of this

scal year, the base eect is likely to turn favourable

as export growth fell sharply in the period November

2013-April 2014. Given that the Indian currency has re-mained broadly stable for the past few months, global

growth prospects have become an important variable

for exports. At a disaggregate level, engineering, pe-

troleum and gems & jewellery which accounted for

58 per cent of total exports, contracted by (-) 9.2 per

cent, (-) 0.16 per cent and (-) 2.25 per cent respectively.

Imports grew by 3.6 per cent in October 2014, a sharp

slowdown from 26 per cent growth registered during

September 2014. On a cumulative basis, imports grew

by 1.9 per cent during April-October 2014. In terms of

key imports, gold imports jumped to 106.3 tonnes (US$

4.2 billion) in October the highest monthly imports this

scal year, from 26 tonnes (US$1.1 billion) a year ago.

Higher demand spurred by the festive season and low

prices (Rs 1222.5/troy ounce vis-avis Rs 1316.2/troy ounce

a year ago) is likely to have led to the rise

Documents

Economy Matters Oct Nov 14