Manufacturing still lags services

Manufacturing still lags services

Indian manufacturing, so goes the story, is enjoying a big revival. A look at the sales and profit growth of manufacturing companies bears out this fact, as do the numerous overseas acquisitions by Indian manufacturers. The macro numbers, however, show no such thing. In spite of the huge growth in the sector during the last few years, manufacturing’s share in gross domestic product (GDP) has gone up very marginally. In 1999-2000, the share of manufacturing in GDP was 14.8% and, by 2006-07, this share had gone up by 70 basis points to 15.5%. In fact, the share of manufacturing was 15.3% in 2000-01, so if that year is taken as the base, the improvement in the next six years has been just 20 basis points.

In contrast, the category “trade, hotels, transport and communication", which is part of the services sector, had a share of 27% of GDP in 2006-07, against 21.7% at the turn of the century. This category now occupies the biggest share of the economic pie, especially since the share of “agriculture, forestry and fishing" has fallen from 25% in 1999-2000 to 18.5% in 2006-07. The rapid growth of the telecommunications industry could be one reason for the rise in the share of this segment.

The other sector that has increased its share of the total pie is construction. Construction accounted for just 5.7% of GDP in 1999-2000, increasing to 6.9% in 2006-07. That’s probably fuelled by the real estate boom of the last few years. While, the share of “electricity, gas and water supply" has shrunk from 2.5% of GDP to 2% over the period. That’s an indication of the worsening power situation in the country. The data show that while the manufacturing sector may be growing rapidly, services have been growing even faster, resulting in a higher share of GDP.

Industry as a whole (including manufacturing, construction, mining and electricity, gas and water supply) added up to 26.6% of GDP in 2006-07, compared with 25.3% in 1999-2000. Over the same period, the share of services has grown from 49.7% to 54.9%. However, in China, the share of “secondary industry" in the first three quarters was 50.3%.

When the New York Stock Exchange (NYSE) purchased a 5% stake in India’s National Stock Exchange (NSE) for $115 million (Rs453 crore) earlier this year, it seemed like a good deal for selling shareholders such as IFCI Ltd, Infrastructure Leasing & Financial Services Ltd and ICICI Bank. After all, they’d made a killing on their tiny initial investment, besides which NSE was valued at a handsome 36.6 times trailing earnings.

But thanks to a near 40% jump in NSE’s consolidated profit in the year till March 2007, valuations look much less expensive at 26.5 times in the fiscal year 2007 earnings. This includes the profit of 100% subsidiary, National Securities Clearing Corp. Ltd, and excludes a one-time capital gain. Considering that the acquisition was done in January, the fiscal 2007 multiple is as good as trailing the price-earnings multiple. Also, with traded volume growing by more than 75% so far this fiscal on the exchange, the valuation at which NYSE got a toehold in India’s leading exchange seems cheap.

NSE enjoys a near monopoly in the fast growing derivatives segment. This segment now contributes to 80% of its turnover, and continues to grow at a faster pace. The curb on participatory note issuances with derivatives as underlying has slowed down activity in the segment, but year-on-year growth continues to be robust.

Besides, the market regulator’s plan to introduce new products in the derivatives space is expected to enhance liquidity further.

In the previous fiscal year, i.e. fiscal year 2006-07, turnover on the exchange had increased 45% to Rs93 trillion. Although NSE’s revenues through fees such as transaction charges grew at a lower rate of 32%, pre-tax earnings rose as much as 54% thanks to savings on clearing and settlement charges. The drop in clearing and settlement charges led to a fall in revenues of the exchange’s subsidiary, the National Securities Clearing Corp. Ltd (NSCCL), but it almost it made up through higher interest income. Although the drop in revenues squeezed margins, NSCCL continues to be an extremely profitable business, with pre-tax margins of more than 77%.

As far as the core stock exchange business goes, NSE’s near monopoly of the derivatives market and its rub-off effect on cash market turnover means that its position as the leading exchange continues to strengthen. With this backdrop, it’s easy to understand why financial investors continue to evince interest in the exchange—the most recent instance being that of Kotak Private Equity buying a 1% stake for an undisclosed sum. With the business doing well, and the supply of shares being limited, it would be fair to assume that the current valuation would be higher than what NYSE and a clutch of financial investors paid this January.

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