In his Independence Day address, Prime Minister Narendra Modi articulated his government’s plan to make India a global hub for industrial manufacturing. However, despite significant efforts by policymakers to bolster the manufacturing sector, it still accounts for only 17% of India’s GDP and a mere 2.8% of global manufacturing, a figure that pales in comparison with China and advanced economies. As India seeks to rise in the global manufacturing hierarchy, its strategy must focus on a critical component: the capital goods industry. This industry comprises key segments such as electrical equipment, process plant equipment, earth moving, construction & mining machinery, machine tools, and textile machinery.
The capital goods industry accounts for nearly 12% of India’s manufacturing output, 2% of its GDP, and provides direct and indirect employment to over 8 million people. Building a robust indigenous capital goods sector is essential for driving the competitiveness of the manufacturing sector, and has been central to the industrialisation strategies of countries like China, South Korea, Germany, and Japan.
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India’s capital goods sector
In the last decade, India’s capital goods sector experienced sluggish growth, with a mere 1.1% year-on-year increase. This stagnation has led to a significant rise in imports, which have nearly doubled during the same period. India remains a net importer of capital goods across all subsectors, with imports nearly three times higher than exports. However, the sector has emerged from this slump post-COVID, experiencing healthy double-digit growth at 12% year-on-year, driven by substantial government capital expenditure, infrastructure development, and digitalisation.
The Modi government has already initiated discussions on formulating a new Capital Goods Policy, led by the Department of Heavy Industries. A new policy for Amrit Kaal and Viksit Bharat would require innovative thinking and a highly focused approach. To begin with, the government needs to conduct a thorough gap analysis of the 10 critical sub-sectors outlined in the National Capital Goods Policy 2016, focusing on identifying gaps in technology, innovation, capacity, and skill development needed to meet current and future production demands.
Additionally, it should address demand and supply gaps in emerging industries, such as high-tech precision manufacturing, EV manufacturing, and machinery required for India’s energy transition. This foundational work will be crucial for developing targeted incentives and strategies for various sub-sectors, both established and new.
Second, import substitution becomes critical as the government focuses on reducing India’s reliance on foreign goods. The private sector could collaborate with government ministries to develop a three-tiered import substitution plan. The first tier would target low-hanging opportunities, where minimal innovation and investment could lead to complete import substitution, enabling SMEs and MSMEs to meet domestic demand. The second tier would address medium-level opportunities, requiring more significant investments and innovations, allowing larger Indian companies to expand and innovate.
The third tier would focus on high-tech and emerging industries, which demand advanced innovation, AI, and machine learning, where strategic joint ventures or acquisitions with global partnerships are essential. To support these initiatives, the government could offer incentives such as interest subvention schemes, technology upgradation funds for SMEs/MSMEs, R&D funds for large-scale investments, and Production Linked Incentive (PLI) schemes for high-tech industries. These incentives would also encourage foreign companies to invest in India.
Third, the low technology orientation of Indian SMEs is partly due to the current capital investment ceiling. Given the capital-intensive nature of the industry, the government could consider raising this ceiling, using benchmarks from China, South Korea, and Germany. This move would further encourage more significant investment, fostering innovation and growth.
Fourth, globally, public procurement policies play a pivotal role in driving demand for indigenised machinery. By streamlining Public-Private Partnerships (PPPs) across states and prioritising domestically produced capital goods, the sector could witness significant growth. The government’s preference for indigenous producers, similar to the approach taken by China, would stimulate demand for locally manufactured machinery, thereby reducing dependency on imports.
Additionally, addressing the inverted duty structure—where higher import prices for production inputs disadvantage domestic manufacturers—is crucial. The government’s ongoing efforts in this area will help facilitate smoother and more cost-effective production processes, further boosting sector growth.
Fifth, India could establish high-tech capital goods manufacturing zones to attract investments, particularly in high-tech manufacturing. Inspired by successful models like Chengdu in China and Colorado in the USA, these zones would encourage foreign investment and joint ventures, facilitating technology transfer to India. The government could promote high-tech products with high-value addition and low volumes, especially in quality-conscious sectors, through joint ventures or strategic acquisitions.
Supporting these initiatives with incentives such as PLI schemes, tax breaks, and tax-free zones for the first five years would be crucial. Government-to-government collaborations with countries like Norway in Carbon Capture, Green Hydrogen, Solar and Wind Projects, and Green Shipping could mutually benefit emerging industries like green energy.
Sixth, investing in Research and Development (R&D) is crucial for driving innovation and competitiveness. The impact of private-sector R&D investment is evident in China’s growth, with its share of global R&D investment by companies rising from 2% in the mid-1990s to 27% in 2017. In contrast, India’s share in global R&D expenditures has only modestly increased from 1.8% to 2.9% over the past 25 years.
In 2016, the Government of India’s Department of Heavy Industries (DHI) established a Center of Excellence in Machine Tools and Production Technology in collaboration with IIT Madras and the Indian Machine Tool Manufacturers’ Association (IMTMA), which has been delivering promising results. More such centers are needed to drive innovation and competitiveness, necessitating increased government budget allocation and large-scale industry-academia partnerships with international companies. Continuous investment in R&D will be crucial for the sustained growth of the capital goods sector.
India has the potential to significantly enhance the ease of doing business in the capital goods sector and attract the necessary investments to propel this industry forward. Building a robust, globally competitive capital goods sector is critical to India’s dream of Viksit Bharat. This transformation will reduce India’s dependence on imports and position the country as a world-class manufacturing and export hub, driving economic growth and creating high-quality jobs for the future.
(Prachi Priya is a Mumbai-based economist and Aniruddha is a US-based economist.)