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Services growth is poised to drive manufacturing in India

KV Kamath     December 19, 2014

KV Kamath
KV Kamath
ABOUT: One of Corporate India's top citizens, banker K.V. Kamath has a bird's eye view of the national economy. He strongly believes in the power of brands and the use of technology for deep impact in a business. Sitting on boards such as those of ICICI Bank and Infosys, Kamath has argued in the past that the high contribution of services to India's GDP should not be considered a disadvantage.

In recent years, concerns have been expressed about the Indian economy's reliance on the services sector. It is felt that there is a need to build a larger manufacturing sector. We have the resources to create a global manufacturing base in our country which will have multiple advantages in the form of augmenting the supply side, employment generation, driving growth and improving the trade balance.

While manufacturing will add another dimension to our growth, the services sector will continue to be strong, given its robust contribution in the last 15 years and enormous potential to drive growth by meeting the aspirations of a growing consuming class.

The liberalisation and reforms process of the 1990s triggered unprecedented changes in the economy. A significant structural shift was seen in the economy with the emergence of the services sector as its contribution to India's GDP rose from 42.55 per cent in 1990/91 to 60 per cent in 2013/14. During this period, the services sector grew at a compound annual growth rate (CAGR) of 8.1 per cent compared to 6.5 per cent overall economic growth.

Growth model
Growth model
The rapid growth in services was driven by two major factors - the exponential advances in technology and the rise in per capita income, which had a significant effect on the demand for better services in the country. There has been a significant uptick in demand, both in terms of quality and quantity, and the entry of new players in sectors like financial services has expanded markets and driven growth.

India's progress has been unique in many ways as it developed a distinct growth model. The economy transitioned to a knowledge economy driven by the services sector, leapfrogging the intermediate manufacturing driven stage seen in developed economies. In the 1990s, a sequence of drivers emerged which pushed the services engine at a remarkable speed.

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The acceleration started in the technology industry and as Moore's law came into effect, technology grew at exponential speed and growth in services kept pace. This was followed by an acceleration in financial services, telecom, retail and the rise of the retail customer. The change continued with transportation, travel, tourism, media, health services and the list goes on. Growth in these sectors was accelerated further by the rapid increase in the per capita income witnessed in this period.

The services story began with knowledge intensive companies leveraging the rapid technological changes post the information technology revolution. These developments happened under the radar, with very few people realising that a big paradigm shift was underway. Technology facilitated new ways of doing business via increasing computing power, data storage capacity and data transmission capacity. In fact, each new wave of change in technology is faster than the previous ones. This has resulted in technology becoming ubiquitous and almost universally accessible.

Telecom connectivity has grown at a dramatic pace and today we have the second-largest mobile subscriber base in the world with over two-thirds of the Indian population having access. Farmers who were earlier dependent on middlemen, now have better information on pricing. It has democratised access to information and increased access to markets.

The banking industry has been at the forefront of leveraging these trends and ICICI Bank was one of the early adopters of technology and innovation in banking leading to expansion of services and credit to the retail consumer. Technology adoption in financial services continues with the Jan Dhan Yojana announced by the Prime Minister.

The programme is being rolled out at a record speed and will give access to the banking system to a large number of consumers and small businesses. The account itself will become a channel for delivery of government benefits and reach a massive scale of 100 million households or about 400 million persons opening up tremendous opportunities for further rollout of services. The next wave will be to make credit available to individual entrepreneurs and the tiniest of enterprises. Innovative models will need to be adopted to reach over 45 million small and tiny businesses which will again need an organised push from the services sector.

India's per capita income
The organised retail sector has made the Indian consumer more brand conscious by offering multiple choices across products and has also brought in efficiency in the supply chain. At the same time, it has also been able to pass on the benefits of efficiency in the form of savings to the end customer. We are now seeing the rapid growth of e-commerce and online retail stores.

In a very short time e-commerce companies have built scale, leveraging the trends of a growing consumer market, technological advancements and connectivity. More than half of the sales are to people in smaller cities and towns where either brands are not available or product variety in local markets is inadequate. E-commerce has spawned investments and growth in extensive delivery networks. In recent years, there has also been a transition in rural consumption patterns with reducing dependence on agriculture as a means of livelihood and rising wealth creation among the middle class in rural areas, in turn increasing the demand for products and services.

The automobile industry is also a key contributor as the rise in sales of personal vehicles has created a multiplier effect on support services required after sales and also the car accessories market. Transportation and logistics services grew rapidly as demand for goods grew across the country. In much the same way, the impact of service industries is not limited to just the direct output or direct employment, but also the creation of ancillary services and employment generation. According to a study by NASSCOM and CRISIL, in 2007, for every job created in the IT and IT enabled services sector, four jobs are created elsewhere.

The services story is still unfolding. A GDP per capita of $1,000 is the first important threshold beyond which an economy sees increased affordability and aspirations for a better lifestyle. India's per capita GDP doubled from around $260 in 1980 to $550 in 2003, and it doubled again in just five years to cross $1,000 and then cross $1,500. This has tremendous implications for savings growth, consumption demand and the ability to finance investment in the country.

As affordability increased, the retail consumer became a large driver for the demand in services. Travel sector saw a significant expansion as air and road travel grew, in turn leading to a growth in demand for tourism and hotels. Similarly other sectors like media, entertainment, health care and education all benefited with increased aspirations of the retail consumer. As the GDP per capita pushes towards the $2,000 mark it will further push the services already in place and open newer areas to move to a higher trajectory.

In summary, the growth in services over the last two decades has driven income growth and expanded domestic demand. This now presents a strong platform of a large domestic market to drive manufacturing sector growth. At the same time, the services sector itself will continue to see robust growth drivers which will further propel its expansion. Technology continues to drive innovation and creation of new smart business models which are based on leveraging digitisation, mobility and social media.

Given these factors, coupled with our demographic dividend and the expected jump to a higher trajectory for both growth and per capita GDP, we have the right conditions for a virtuous cycle to sustain for many years. I believe that manufacturing and services both, ticking together, will drive growth, provide employment to youth in our country and ensure that we reach the potential that our country is capable of achieving.


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