This Labour Law Reform Can Help Create Low-Skilled Jobs That India Needs



One of the fundamental points that Indian policymakers and politicians haven’t understood since independence is that India needs to encourage manufacturing that employs low skilled and unskilled workers.

The public sector enterprises that were launched after independence concentrated on skilled manufacturing, and in the process did not create much employment. The Make in India programme launched by Narendra Modi, made the same mistake initially.

As Ruchir Sharma writes in The Rise and Fall of Nations—Ten Rules of Change in the Post Crisis World: “After Narendra Modi became prime minister in 2014, he launched a “Make in India” campaign. But there was still a basic problem: His aides, at least initially, were not talking about building simple factories first, in industries like toys or textiles, of the kind that can employ many millions of people and jump-start an industrial middle class. They were talking about advanced factories in industries like solar-powered appliances and military weapons, which require the highly skilled workers not yet found in abundance among India’s vast population of rural underemployed. India was trying to skip over a step in the development process, not for the first time.”

On June 22, 2016, the Modi government made a small but very important change in the labour laws that govern the textile sector in India. As the press release put out by the Ministry of Textiles pointed out: “Looking to the seasonal nature of the industry, fixed term employment shall be introduced for the garment sector. A fixed term workman will be considered at par with permanent workman in terms of working hours, wages, allowanced and other statutory dues.

The fact that the move has come nearly two years after Modi became the prime minister tells us that the Indian establishment still remains enamored by the idea of skilled manufacturing.

Nevertheless, this a very important move. As Amrit Amirapu and Arvind Subramanian write in a research paper titled Manufacturing or Services? An Indian Illustration of a Development Dilemma: “Historically, there have been three modes of escape from under-development: geology, geography, and “jeans” (code for low-skilled manufacturing).”

In fact, the East Asian countries that escaped poverty did so by jumping on to the jeans or the low-skilled manufacturing bandwagon. As Amirapu and Subramanian write: “In the early stages of their success, East Asian countries relied on relatively low-skilled manufacturing, typically textiles and clothing (China, Thailand, Indonesia, Malaysia etc), to motor economic growth. Later on they diversified into more sophisticated manufacturing but “jeans” offered the vehicle for prosperity early on. No country has escaped from underdevelopment using relatively skill-intensive activities as the launching pad for sustained growth as India seems to be attempting.”

There is no reason that India should have been attempting anything else. But such was the marketing spin, first around public sector enterprises and then around information technology, that manufacturing that employs low-skilled workers was sort of looked down upon. But at the end of the day public sector enterprises and information technology needed skilled workers and given that they could create only so many jobs. And this was nowhere near the number of jobs that India needs.

Most estimates now suggest that India needs to create around one million jobs every month, for fresh individuals who are entering the workforce.

The textiles sector has the ability to create many low-skilled jobs and that gives it a tremendous fit with India’s natural competitive advantage i.e. low-skilled labour. In fact, as Arvind Subramanian and Rashmi Verma point out in a recent column in The Indian Express: “Every unit of investment in clothing generates 12 times as many jobs as that in autos and nearly 30 times that in steel.”

But the irony is that when comes to textiles, even Bangladesh is doing better than India. As Mihir S. Sharma writes in Restart—The Last Chance for the Indian Economy: “Before the expansion of trade thanks to new international rules in the twenty-first century, India made $10 billion from textile exports, and Bangladesh $8 billion. Today India makes $12 billion—and Bangladesh $21 billion.”

So what happened here? The textile industry, explains Sharma, needs to turnaround big orders quickly and efficiently. This means that really long assembly lines are needed. As he writes: “100 people can sequentially work to make a pair of trousers in least time. In Bangladesh, the average number of people in a factory is between 300 and 400; in the South Indian textiles hub of Tirupur, it’s around 50.”

India has very few factories that actually employ more than 500 people.[1] Now compare that with China. The largest garment manufacturing factories in China have a workforce of 30,000. In fact, even Bangladesh has garment manufacturing units with 10,000 workers. In India, the numbers rarely go beyond 1,000 workers. In fact, in India, the garment manufacturers prefer to split their workforce into many units, instead of employing a lot of workers at one unit. This basically comes from the fear of not being able to retrench workers.[2]

In fact, Subramanian and Verma make a similar point in their column in The Indian Express where they say that “an estimated 78 per cent of firms in India employ less than 50 workers with 10 per cent employing more than 500 workers.” “In China, the comparable numbers are about 15 and 28, per cent respectively.”

This leads to a situation where the Indian companies operating in the textiles sector do not have the economies of scale required to compete globally. One of the reasons the Indian companies cannot compete globally is because they can’t hire and fire workers according to the demand for their products.

The government has now introduced the concept of the fixed term contract which allows textile companies to hire workers for a fixed period, instead of offering permanent employment. Up until now companies had been hiring contract workers, who in many cases are not paid as much as permanent workers even though the work being done is exactly the same. The fixed term contracts will also allow companies the flexibility to hire according to their demand. And they won’t have to keep workers on the rolls even when they don’t actually need them.

In fact, this is one factor which has led to many textile companies not taking on more business in the past because once they had hired workers, they wouldn’t have been able to let them go.

As the Eleventh Five Year Plan (2007-2012) pointed out in this context: “Chapter V-B of the Industrial Disputes Act 1947 does create a psychological block in entrepreneurs against establishing new enterprises with a large workforce and impede attainment of economies of scale. As a result, firms prefer to set up enterprises with a smaller permanent workforce, and these enterprises are unable to cope with large size orders from retail market chains in garments and footwear for instance.”

Chapter V-B of the Industrial Disputes Act essentially makes it compulsory for a firm with more than 100 workers, to take the permission of the local government before retrenching workers. This complicates the entire scenario. In the recent past, this limit has been increased to 300 workers in the states of Rajasthan and Madhya Pradesh.

In case of garment manufacturing, a lot of demand is basically export demand. This means that the demand tends to pick sometime before Christmas and New Year, and then it falls. In an ideal scenario this would mean hiring workers just a few months before Christmas and then letting them go, after the garments have been made and shipped. The fixed term contracts will allow companies to do just that, by hiring workers through the formal job market, instead of working through contractors, and short-changing the workers.

The fixed term contracts will encourage textile companies to hire more workers. Nevertheless, they will still think going beyond 100 workers (or 300 workers in some cases) because then the Chapter V-B of the Industrial Disputes Act, 1947, is likely to kick-in.

[1] Annual Survey of Industries 2013-2014

[2] A.Hoda and D.K.Rai, Labour Regulations and Growth of Manufacturing and Employment in India: Balancing Protection and Flexibility, Written for the World Bank, ICRIER, 2015

The column originally appeared in Vivek Kaul’s Diary on July 5, 2016

The Recovery of Bad Loans from Large Borrowers Will Be a Big Challenge for Modi Govt


Earlier this week the Reserve Bank of India released the Financial Stability Report.

Among other things, this report talks about the inability of large borrowers to repay the loans that they have taken on from banks, in particular the public sector banks. The Reserve Bank of India defines a large borrower as a borrower who has taken on a loan of Rs 5 crore or more.

The Indian banking system has been trouble primarily because of the large borrowers and not the retail borrowers. As the Financial Stability Report points out: “Retail loans continued to witness the least stress.

This can be seen from the following chart.

Asset quality in major sectorsChartThe chart makes for a very interesting reading. The retail loans remain the safest form of lending. The gross non-performing assets ratio (or the bad loans ratio) of lending to retail is at 1.8% of the loans given to the sector. Retail loans essentially include home loans, vehicle loans, credit card outstanding, loan against shares, bonds and fixed deposits, and personal loans.

As can be seen from the above chart, the bad loan ratio of retail lending is the least. This explains why 46% of lending carried out by banks between April 2015 and April 2016, has been retail lending. Between April 2014 and April 2015, 32.4% of all lending was retail lending.

Lending to industry is the most risky form of lending. As on March 31, 2016, the bad loans ratio had stood at 11.9%. Over and above this, the stressed advances ratio was at 19.4%. The stressed advances figure is obtained by adding the bad loans to the restructured assets. A restructured asset is essentially a loan where the borrower has been given a moratorium during which he does not have to repay the principal amount. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased.

Hence, nearly one fifth of the loans given to industry are in trouble. Given this, it is hardly surprising that banks (in particular public sector banks) do not want to lend to industry. Bank lending to industry between April 2015 and April 2016, remained more or less flat.

Industries which have taken on loans from banks can largely be categorised as large borrowers or borrowers who have taken on a loan of Rs 5 crore or more. And this is where the basic troubles of Indian banks lie.

As the Financial Stability Report points out: “Share of large borrowers’ in total loans increased from 56.8 per cent to 58.0 per cent between September 2015 and March 2016. Their share in GNPA s[gross non-performing assets or bad loans] also increased from 83.4 per cent to 86.4 per cent during the same period.”

What does this mean? This basically means that large borrowers have been given 58% of all loans but they are responsible for 86.4% of the bad loans. In fact, the bad loans ratio of large borrowers stood at 10.6% as on March 31, 2016. As on September 30, 2015, it had stood at 7%. When it comes to public sector banks this ratio had stood at 12.9% as on March 31,2016, for large borrowers.

Hence, the bad loans to big borrowers have been going up. One reason, as I had explained in yesterday’s column is that the Reserve Bank of India(RBI) has been forcing public sector banks to recognise bad loans as bad loans. Up until now, banks had been passing off many bad loans as restructured loans.

Of course, even within the large borrowers there are many categories.

While banks are able to go after the small enterprises which have taken on loans and not in a position to repay them, the same cannot be said about the very large borrowers. As the RBI governor Raghuram Rajan had said in a November 2014 speech, the full force of bank recovery is “felt by the small entrepreneur who does not have the wherewithal to hire expensive lawyers or move the courts, even while the influential promoter once again escapes its rigour.” “The small entrepreneur’s assets are repossessed quickly and sold, extinguishing many a promising business that could do with a little support from bankers,” Rajan had further said on that occasion.

The Financial Stability Report does not give a detailed breakdown of large borrowers, but it does give us a very interesting data point about the top 100 borrowers among the large borrowers.

As the Report points out: “Top 100 large borrowers (in terms of outstanding funded amounts) accounted for 27.9 per cent of credit to all large borrowers…There was a sharp increase in the share of GNPAs [Gross Non-Performing Assets] of top 100 large borrowers in GNPAs of all large borrowers from 3.4 per cent in September 2015 to 22.3 per cent in March 2016.”

What does this mean? The loans given to the top 100 borrowers among the large borrowers constitute for 27.9% of all loans given to large borrowers. As on September 30, 2015, the bad loans of the top 100 borrowers among large borrowers amounted to around 3.4% of bad loans of all large borrowers. By March 31, 2016, this had jumped to 22.3% of bad loans of all large borrowers.

What does this tell us? It tells us very clearly that banks were treating its largest borrowers with kids gloves and not recognising their bad loans as bad loans. This could have possibly been done by restructuring their loans.

Thankfully, this game is now over. And for that both the RBI and the Modi government deserve credit. The bigger challenge now lies ahead. The government as the major owner of public sector banks needs to make sure that these largest of defaulters are made to repay the loans of public sector banks that they have taken on.

Given that, such a thing has rarely happened in the past, it will be interesting to see how the Modi government will go about this. If it can clean this mess up, then the phrase that telephones from the government to the public sector banks have stopped, will acquire a real meaning. Let’s hope for the best.

Watch this space!

The column originally appeared in Vivek Kaul’s Diary on July 1, 2016