By Matthias Williams and Lyndee Prickitt
GREATER NOIDA, India, April 18 (Reuters) - India's rise as an emerging market star with seemingly insatiable demand means firms such as South Korea's LG Electronics are doing a booming business, but the country must rev up its manufacturing sector further or risk an unmanageable trade gap and a slowdown in its blistering growth.
The sector has started to catch up with India's world-famous IT and services industry to sate demand for anything from cars to air-conditioners to flat-screen TVs in the homes of hundreds of millions of newly affluent Indians who are ready to splurge.
The potential is vast for the likes of LG , which plans to double its India revenue in just four years pumping out appliances every few seconds at its factory outside New Delhi, products that were seen as rare luxuries before economic liberalisation.
But creaky infrastructure, erratic policies and a shortage of skilled labour mean factory growth has yet to emerge from the shadows of neighbouring China's prowess.
Manufacturing makes up about a third of China's gross domestic product (GDP) compared to a 16 percent share in India, the same as it was 20 years ago. New Delhi has set an ambitious target to raise that figure to 25 percent in a decade.
"Manufacturers are becoming optimistic, but my feeling is that a huge level of manufacturing coming to India has still too many challenges," said LG's Chief Operating Officer Yasho Verma.
"This type of factory is OK. But if suppose LG decides tomorrow it should have 20 factories in India, then it's a major problem," he said in an interview at LG's plant.
The trade ministry has raised "serious concern" that the current account deficit may become unsustainable as India's trade deficit is set to balloon to $278.5 billion by 2014, a twenty-fold increase over a decade from the $14.3 billion in 2004.
"A large widening of the trade deficit can potentially result in payments difficulties," it said in a recent strategy document. "Such a situation is simply unacceptable because it may jeopardize the entire growth process."
India can no longer rely on a mix of its IT and service sector heft, remittances from its citizens working overseas and capital flows to finance a huge import bill of one of the world's fastest growing economies.
Manufacturing may need to plug the gap and provide jobs for the tens of millions expected to enter the workforce in the next decade who cannot be absorbed in farming or IT and services.
"If India is to achieve its stated goals on GDP growth and more importantly, to generate higher levels of employment for the growing young population, India's manufacturing sector has to enter into a new orbit of even higher growth," said a report by the Boston Consulting Group, which suggested India's manufacturing sector should aim to grow an annual 11 percent.
"If India has to target a high growth of 11 percent for its manufacturing sector over next 15 years, it needs to necessarily focus on growing its exports much faster," it said.
The government in February estimated manufacturing growth in the 2010/2011 fiscal year at 8.8 percent.
NOT PERFECT, BUT GETTING BETTER
Reuters spoke to four executives from manufacturing firms who have set up shop in India. The consensus was that, while things aren't perfect, they're improving rapidly and India is starting to shed its tag as a manufacturing laggard.
A maturing supplier base, the influx of seasoned global firms and an explosion in demand have brought transformation even in the last couple of years to a sector infamous for its red tape, countless licence requirements and pitiful output before liberalisation began in 1991.
"I've been here living in the country for 18 months, I've been coming here for 10 years, and I can tell you in the 18 months I've seen a huge difference," said John Flannery, the India chief executive of General Electric Co .
"The things that we would ask or expect of our supply chain today are quite different than what we could even think about two years ago. So it's changing very quickly," he said.
"You look at the best companies today, the best manufacturing companies today, they're very very sophisticated. And you wouldn't have seen that 5-10 years ago."
Indian suppliers no longer work on the principle of "jugaad" -- a Hindi word for muddling through problems with quick fixes that flourished during the days of the so-called "Licence Raj" -- which had created a culture of short-termism and inefficiency, LG's Verma said.
A more sophisticated supplier base makes it simpler and cheaper for foreign firms to set up factories on Indian soil and even look to India as a major exporter further down the line.
Cars leaving the assembly line of General Motors in India are now up to 98 percent locally produced, designed with the help of 2,000 engineers in the company's Bangalore offices.
Hyundai Motor Co has made India an export hub for its vehicles. From 20 Santros sold to Nepal in 1999, the firm exported 247,102 "Made in India" cars globally last year, the highest number in any country outside the company's native South Korea.
POLICY, INFRASTRUCTURE HURDLES
But India's infrastructure development has not kept pace with the demands of its manufacturing. Power is in short supply, highways are clogged with traffic and ports are too crowded.
The average cost to move a container within India is $945, more than double the $460 it costs in China. Due to restrictions on goods traffic, Hyundai can only ship cars from its Chennai plant to the coast for seven hours at night, said Arvind Saxena, a director of Hyundai Motor India.
"Infrastructure has improved ... but yes, a lot still needs to be done," he said.
LG's Verma would like to see the government adopt China-style policies to foster growth of Indian suppliers.
"The Chinese government has spent a huge lot of money, creating cities where the vendors will be placed, creating infrastructure there," he said. "Those things are not in focus in India."
Companies have also grappled with slow or inconsistent policy decisions from the Indian government. For example, five years ago New Delhi rolled out a policy for so-called Special Economic Zones (SEZs), hubs with long tax holidays that were set up in Beijing's footsteps to spur manufacturing growth.
But the finance ministry slapped a 18.5 percent duty on book profits in the zones in February's budget, sparking criticism from the trade ministry that the tax would send the wrong signal about India's credibility with investors. [ID:nSGE72908B]
Karl Slym, the head of GM India, cheers what he sees as largely business-friendly policies from the government for auto makers. But some decisions from New Delhi come out of the blue and catch investors unawares, he said.
"Nobody has the chance to be able to respond correctly or be able to manage the situation," Slym told Reuters.
"If you know what the outlook is, what the playing field is, then you can plan accordingly for that. But if you start out playing football on a football field and then all of a sudden you're trying to play on a cricket field then you've got the wrong equipment to be able to perform the best," he added.
Whatever its problems, the four companies interviewed by Reuters remain largely optimistic on India's manufacturing rise. And as global firms look to ride India's 9 percent growth story, Asia's third-largest economy has also flexed its export muscle with the growth of domestic brands.
The trade ministry has set India a target to double its exports by 2014 to help keep the deficit in check. No longer known just for its iconic exports such as textiles and gems, India's manufacturers are becoming household names in sectors such as cars, generic medicines and oil products.
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