India Labor Reforms - Axis

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com 01

24 JUN 2014
LABOR REFORMS | Thematic Report

Sachchidanand Shukla Sr VP & Economist
sachchidanand.shukla@axiscap.in
Tel.: + 91 22 4325 1108
Swaminathan B VP Banking & Economy
swaminathan.balasubramaniam@axiscap.in
Tel.: + 91 22 4325 1126

Axis Capital is available on Bloomberg (AXCP<Go>), Reuters.com, Firstcall.com and Factset.com 1

25 JUN 2014 Thematic Report
LABOR REFORMS

Bold steps initiated, a potential US$ 500 bn gain for the economy
With emerging markets vying for the global manufacturing pie of ~ US$ 8.5 trn, the new government has initiated bold
steps to overhaul archaic labor laws stifling the Indian manufacturing sector (~US$ 263 bn). It has envisaged a National
Employment policy that is responsive to the aspiration of the youth and in synergy with the economic growth.
This comes close on the heels of Rajasthan cabinets bold move of clearing amendments to The Industrial Disputes Act,
The Factories Act and The Contract Labor Act3 of the key laws among 47 central and 200 state laws regulating labor
in India (that apply mainly to the manufacturing sector).
Not even the most optimistic would have thought that the ball would start rolling so quickly on labor reforms. So why is
the BJP ready to bite the bullet on the politically contentious policy of labor market reforms? We believe there is a huge
demographic and political underpinning to these reforms. First, Prime Minister Modi has tacitly endorsed labor reforms
for several years as CM of Gujarata subject known to be particularly close to his heart (Refer page 10 for Gujarats
experience in labor reforms). Rajasthan CM has also reportedly promised creation of ~1.5 mn jobs over the next five
years in the backdrop of scaled manufacturing investment under the Delhi Mumbai Industrial Corridor.
Secondly, and, more importantly, job creation will be paramount for BJPs electoral success hereafter, given that:
India has seen jobless growth over the past decade with jobs growing at 1% even as economic growth was 8%
NDA has done exceedingly well in the so-called BIMARU states (154/172 seats from these four states out of its
total tally of 343 seats). BIMARU states are likely to contribute > 200 mn people to working-age population by
2021 (over half of the nations addition)
Region-wise working age (15-59) population addition up to 2021 Exhibit 1:
2011-21 Net additions (mn) % of net additions
BIMARU states 541 49
Other northern states 114 10
Eastern India 185 17
Western India 163 15
Southern India 111 10
Total 1,114 100

Source: Company, Axis Capital Note: BIMARU (meaning sick in Hindi) comprise the states of Bihar (B), Madhya Pradesh (MA), Rajasthan (R) and Uttar Pradesh (U)

Odds stacked in favor of labor reforms: We believe that for the first time in recent history, the odds are stacked in favor
of labor reforms. First, the new governments electoral prospects are critically aligned with job creation. Secondly, the
ruling party has a majority in the Lok Sabha - something not seen for nearly two decades. Thirdly, companies will step
up hiring when growth is healthy and there is a cyclical turnaround in the economy.
Genesis: India's much vaunted demographic dividend has remained confined to only power point presentations thus far,
as the country added just ~3 mn jobs per annum between FY05 and FY12 against the requirement of 10 mn.
Importantly, more people are dropping off the workforce as is evident from the 3% fall in the labor force participation
rate to 39.5% during the same period. Worse still, the manufacturing sector lost 5 mn jobs between FY05 and FY10,
when growth was at its peak. Labor intensive sectors like textiles, electronics and apparel lost the most workers.
Despite having abundant unskilled labor, Indian firms have specialized in capital-intensive sectors (engineering goods,
pharmaceuticals, etc). India is the only country in emerging markets which requires the firm to take permission from
both the government and the unions in retrenching workers. Stringent laws have forced entrepreneurs to keep the scale
of operations small. In the labor intensive textile segment, >90% of the workers are employed in firms employing
<49 workers (as compared to more than half of Chinas textile workers who work in firms with > 200 employees).
Moreover, Indian manufacturing companies largely employ contractual workers. The jobs are thus confined to the
informal sector, which employs ~85% of the total workforce.
BIMARU states were crucial to
NDAs thumping Lok Sabha victory
NDA garnered 154/172 seats in
these states


LABOR REFORMS

The road ahead
Political challenges: Rajasthan governments moves on labor reforms have
drawn flak from central trade unions who believe that the amendments would
lead corporate houses to disregard wage, safety and job security norms.
Moreover, India is a unique country in that all major political parties have a
trade union wing. This means political parties are reluctant to legislate on labor
flexibility, since this would antagonize their own trade union wings.
Legal challenges: Labor laws fall under the Concurrent List which means both
Centre and States have purview over the regulations. Article 254 (2) suggests
that laws made by a state, even if it is "repugnant to" an earlier law from
Parliament, can prevail in that state if it receives the President's assent.
However, experts have pointed out that some readings of recent Supreme Court
judgments suggest that the states' ability to amend existing central legislation
can be limited. Rajasthan, therefore, may have to endure a complicated legal
battle over the constitutionality of its labor law amendments.

Labor reforms can fuel a virtuous cycle in Indian manufacturing Exhibit 2:

Source: Company, Axis Capital

Implications: We believe that labor reforms lie at the heart of helping realize the aim of taking manufacturing share of
GDP to 25% by 2022. A let-up could potentially cost India ~US$ 470 bn
1
besides million heartaches from the ~10 mn
people getting added to the workforce every year.
Manufacturing sector set to take center stage Exhibit 3:
Mfg,
US$ 263bn
15% share
2014: Total GDP of US$ 1.8 trn

Source: Axis Capital, CSO

Mfg,
US$
1,168bn
25% share

Source: Axis Capital, National Manufacturing Policy
Note 1: The cost (US$ 470 bn) to the economy in 2022 is calculated as the difference between potential manufacturing GDP in 2022 (@25% of
overall GDP as per National Manufacturing Policy) and current share of manufacturing sector (~15%) applied to the projected GDP in 2022
GDP growth in India
has largely been driven
by the services sector,
though with minimal
impact on new job
creation. For example,
the banking/insurance
sector contributed ~7%
to the GDP but only
0.6% to employment.
In stark contrast, the
textile industry
contributes 2% of the
GDP but employs 8%
of the workforce
Manufacturing GDP
CAGR of 21%


LABOR REFORMS

Contents

Stifling labor laws in India ................................................................. 5
BJPs push towards labor reform ......................................................... 6
States taking the lead: Labor reforms by stealth! ................................... 8
The Gujarat experience ................................................................... 10
Indias need of the hour: Labor reform and
transition towards formal labor ....................................................... 13
Global success in labor reforms ........................................................ 19
Implication of labor reforms for India ................................................ 20
Annexure I: List of Labor laws in India ............................................... 21
Annexure II: Delhi Mumbai Industrial Corridor .................................... 23


LABOR REFORMS

Snippets from Indias archaic labor laws
Factories must be whitewashedDoes it matter that plastic paint is available these days?
Earthen pots filled with water are requiredWhy cant one use water coolers?
Red-painted buckets filled with sand are required by the RulesFire extinguishers anyone?
The Factories Act says that the State Government may prescribe the number of latrines and urinals to be
provided in any factory
State may make rules prescribing the number of spittoons to be provided and their location in any factory.
State government may make rules requiring the provision therein of suitable places for keeping clothing not
worn during working hours and for the drying of wet clothing.
There must be crches within the factoryHow about dropping kids to crches outside the factory?
Shops and Establishments Acts prescribe which day of the week must be observed as a weekly holiday.
Restrictions on employing women outside mandated working-hours.


LABOR REFORMS

Stifling labor laws in India
There are 47 national and 200 state-level labor legislations in India that apply only
to the organized manufacturing sector. As the size of a factory grows, it
increasingly becomes subject to more legislation. The Industrial Disputes Act (IDA)
mandates firms employing more than 100 workers to obtain the state permission to
retrench or lay off workers. States have often been unwilling to grant permission. In
this regard, India is the only country in emerging markets which requires the firm to
take permission from both the government and the unions in retrenching workers.
The IDA also lays out procedures for change in terms and conditions of work, which
introduces additional inflexibilities for firms. For example, worker consent is
required to modify job descriptions or move workers from one plant to another in
response to changing market conditions. Hence, most fresh job creation has been
contractual in nature as ~ 85% of the Indian workforce (67.5% of non-agricultural
work force) is engaged in the informal sector.
Labor laws fall under the Concurrent List which means both Centre and States
have purview over the regulations with the condition that the Centre would prevail
in case of any inconsistency (Article 254(1) of the Constitution of India). Central
legislation requires a lengthy parliament process for amendment but state legislation
is relatively easier to amend and enact. However, for the State legislation to be
enacted under the Concurrent List, the Presidents assent is necessary (Article 254
(2) of the Constitution; there is some uncertainty over the degree to which states can
amend central legislation). This requires the recommendation of the Centre and
given the PMs stance on greater independence to state, we believe this route could
be used by States to achieve labor reforms and, hence, attract greater investment.

India is the only country in
emerging markets which
requires the firm to take
permission from both the
government and the unions
in retrenching workers
Labor laws apply mainly to
the organized mfg sector
Labor laws fall under the
Concurrent List: States
can modify laws with
Presidents assent


LABOR REFORMS

BJPs push towards labor reform
The push towards labor reforms could not have come at a better time. BJPs
manifesto says it will review outdated, complicated and even contradictory labor
laws. In its poll manifesto, the BJP had said it considers youth as the most productive
asset of the nation, who have played a key role in taking the country to a near
double-digit growth. BJP indicates that it will accord high priority to job creation
and opportunities for entrepreneurship.
In the run-up to the elections, Mr Narendra Modi has made his stance clear that
labor reforms are the most important step in revitalizing the manufacturing sector.
He has also emphasized the need for skilled labor several times in recent weeks.
The political economy challenge of the BIMARU states: Three decades since the
coining of this term (meaning sick in Hindi), the states of Bihar (B), Madhya
Pradesh (MA), Rajasthan (R) and Uttar Pradesh (U) have remained the poster child
of stagnancy in growth and employment. In what seems to be the biggest
demographic challenge for India, the BIMARU states alone are expected to
contribute half of the 1.1 bn working age population addition up to 2021.
Region-wise working age (15-59) population addition up to 2021BIMARU Exhibit 4:
states expected to contribute half of working age population addition

2011-21 Net additions (mn) % of net additions
BIMARU states 541 49
Other northern states 114 10
Eastern India 185 17
Western India 163 15
Southern India 111 10
Total 1,114 100

Source: Registrar General of India, Axis Capital

The BIMARU states are noted for the demographic stickiness and electoral might
(together they represent 172/543 Lok Sabha seats). One of the key reasons for
NDAs thumping victory in General Elections 2014 has been its splendid
performance in these statesit won 154 of the 172 seats in these states. More
importantly, these four states represent ~ 45% of NDAs overall seat tally of
343 seats. Hence, it is the BIMARU states where the BJPs development agenda,
Indias demographic dividend and NDAs continued electoral power will be put to
its ultimate test.
What has the Centre done so far?
The NDA government has initiated action on the sensitive subject of labor law
reforms. To begin with, the labor ministry has sought suggestions from all
stakeholders, including industries, trade unions and experts, on its proposal to
amend the 66-year-old Factories Act. This exercise was undertaken soon after the
BJP government in Rajasthan approved amendments to key labor laws. The
government is trying to put in place a National Employment Policy that is
responsive to the aspiration of youth and in synergy with the economic growth.
This policy first evaluated in 2008 through an inter-ministerial group in the UPA
regime though nothing concrete emerged. This time around, the new government is
trying to build consensus as it is looking towards structured feedback from three
key segments:
To restore the health of
the economy, a number of
steps need to be taken. The
first and the foremost will
be to bring back the focus
on infrastructure and
manufacturing sector.
We are very clear that we
have to focus on the
manufacturing sector
because that is where jobs
are generated The next
war that is going to be
fought globally is the
jobs war. We must
prepare our country to face
that challenge.

Mr. Narendra Modi,
Prime Minister
BIMARU states: Ultimate
test for BJPs development
agenda, Indias
demographic dividend
and NDAs continued
electoral power
BIMARU states were crucial to
NDAs thumping Lok Sabha
victory it garnered 154/172
seats in these states


LABOR REFORMS

Trade unions, institutions, associations and the public: Suggestions on
employment generation, enhancing productivity, reform in labor laws,
increasing participation of youth and women in workforce and increasing
entrepreneurship
Ministries and departments: Key schemes and programs on employment
achievement in the past five years and projection for the next five years.
Information on social security measures for workers and their achievements and
target for the next five years. Suggestions on transforming informal skills into
formal skills
Industry: Suggestions on target for job creations, memorandum of
understanding and bilateral or multilateral arrangements for improving labor
productivity, etc.
As of now, the Centre is learnt to be mulling the following amendments:
Business disputes not be treated as criminal offence
Possibility of companies being given clearances on the basis of
"self-certification (This has already been implemented in Gujarat)
Doubling the provision of overtime from 50 hours a quarter to 100 hours in
some cases and from 75 hours to 125 hours in others involving work of
public interest
Improved safety of workers
Higher penalty for violation of the Act
Relaxed norms of female participation in certain industry segments
Reducing to 90 from 240 the number of days that an employee needs to work
before becoming eligible for benefits like leave with pay
Raising the limit from 15% of workers to 30% for registration as a
representative union
Uphill task for the Centre: India is a unique country in that all major political parties
have a trade union wing. This means political parties are reluctant to legislate on
labor flexibility, since this would antagonize their own trade union wings.
The last time the BJP was in power (1999-2004), the then finance minister
Mr Yashwant Sinha tried to relax key labor laws including some provisions of the
Industrial Disputes Act. One of the changes Mr Sinha suggested was that the Act
should apply when 1,000 workers are retrenched (vs. 100 as per the Act).
However, he beat a hasty retreat after facing opposition from within as well as
outside the party. The UPA government had ruled out labor reforms when it was
in power.

The last time the BJP was in
power (1999-2004), the
FM tried to relax key labor
laws. BJP beat a hasty
retreat after facing
opposition from within as
well as outside the party


LABOR REFORMS

States taking the lead: Labor reforms by stealth!

Rajasthan draws first blood: BJP-ruled states are expected to lead the path towards
labor reforms. Rajasthans Chief Minister, Vasundhara Raje Scindia, made a first
move to initiate one of BJP's key election manifesto promisesa review of India's
archaic labor laws. Media reports indicate Rajasthans cabinet ministers have
cleared amendments to The Industrial Disputes Act, The Factories Act and The
Contract Labor Actthree of the key laws among 47 central and 200 state laws
regulating labor in India. These are proposed to be introduced in the state assembly
(where the government has majority) next month and then sent for the Presidents
assent. The proposed labor reforms will benefit 18 companies, which have or are
investing ~ Rs 344 bn in several projects across Rajasthan. These investments are
taking place under a new Bharatiya Janata Party (BJP) dispensation that won
163 of 200 seats in December's Assembly elections. A few of the key changes that
have been proposed are
The state will not require the Centres permission for the retrenchment of up to
300 employees, against the current 100
Contract Labor Act will be applicable to companies with more than 50 workers,
against the current 20
Factories Act will be applicable to units with more than 20 employees, against
the current 10
Time limit of three years for raising industrial disputes
Tougher laws for registration of labor unions
Why Rajasthan?: The extreme step taken by Rajasthan hardly comes as a surprise
to us given the crucial role that the state is expected to play in the Delhi Mumbai
Industrial Corridor. We believe that Rajasthans step towards labor reforms can
recreate the Mauritius EPZ success in the DMIC (Refer to page 19 & 23). Rajasthan
CM Vasundhara Raje has also promised 1.5 mn jobs and labor reforms in the
run-up to state election in 2013. The government has no choice but to undertake
strong measures to create a flexible labor environment in the state.
So far, states like Gujarat, Maharashtra, and Rajasthan have introduced laws that
reduce the number of inspector visits. The associate official and unofficial costs of
compliance are relatively lower in these states. State governments (Andhra Pradesh,
Gujarat, Karnataka, Madhya Pradesh, and Maharashtra) which have tried to make
labor laws more flexible have seen encouraging trends of investment and lower
worker differentials in organized vs. unorganized labor. Labor flexibility has played
a significant role in special economic zones (SEZs) and other special enclaves.
However, states have so far dithered from making far-reaching changes to the
existing labor laws.
If successful, Rajasthans bold step could lead to decentralization of labor markets
and the creation of 29 labor markets in India (one in every state) and provide
recruitment flexibility that could hitherto only be accessed through the back door
(entailing higher corruption costs).

Rajasthans cabinet
ministers have cleared
amendments to labor laws.
These are proposed to be
introduced in the state
assembly (where the
government has majority)
next month and then sent
for the Presidents assent.
Labor reforms will be key
to job-generation in
Rajasthan, especially
considering the crucial role
that the state is expected to
play in the Delhi Mumbai
Industrial Corridor
Industrial states like
Andhra Pradesh,
Gujarat, Karnataka,
Madhya Pradesh,
Maharashtra have tried to
make labor laws flexible
(mainly by encouraging
contract labor) which has
led to encouraging
investment trends


LABOR REFORMS

Manufacturing projects in Rajasthan will gain from reformed labor laws Exhibit 5:
Company Project Amount (Rs bn)
Proposals received before Dec 2013 but being implemented now
Kalyani Steel Steel Project 15
Welspun Textile 80
Super Smelters Steel Project 32.5
GL Steel Steel Project 4.5

Total 132
New Proposals under Implementation

Hindustan Zinc Expansion of zinc smelter 80
Amtech Industries Engg goods 25
Chambal Fertilizers Fertilizer 25
Hero Motocorp Motorcycle/2-wheelers 10
Eicher Polaris Personal vehicles 5
JCB India Heavy machinery equipment 5
Cadila Medicinal formulation 3
Mankind Pharma Medicinal formulation 3
Sunbeam Aluminium casting 2
PetroIndia ATM machines 2

Total 160
New Proposals in the pipeline

Rashtriya Ispat Steel plant 25
Vacmet India Polyester films 15
Gitanjali Steel plant 10
Mayor Uniquoters Synthetic leather 1.8

Total 51.8

Grand Total 344

Source: Media reports

Spanner in the works?: The Rajasthan governments recent moves on labor reforms
have drawn flak from central trade unions, including Bharatiya Mazdoor Sangh,
which is affiliated with the Rashtriya Swayamsevak Sangh. The unions have
dismissed the term labor reforms as baseless and have strongly opposed the state
governments move to tweak the Industrial Disputes Act, 1947, the Factories Act,
1948, and the Contract Labor Act, 1971. The unions believe that the amendments
would lead corporate houses to disregard wage, safety and job security norms.
Article 254 (2) suggests that laws made by a state, even if it is "repugnant to" an
earlier law from Parliament, can prevail in that state if it receives the President's
assent. However, experts have pointed out that some readings of recent Supreme
Court judgments suggest that the states' ability to amend existing central legislation
can be limited. Rajasthan, therefore, may have to endure a complicated legal battle
over the constitutionality of its labor law amendments.

Rajasthans bold step could
lead to decentralization of
labor markets and the
creation of 29 labor
markets in India (one in
every state)
Projects of ~ Rs 344 bn
stand to gain from
reformed labor laws
in Rajasthan
Rajasthans recent moves
on labor reforms have
drawn flak from central
trade unions, including
Bharatiya Mazdoor Sangh,
which is affiliated with
the Rashtriya
Swayamsevak Sangh


LABOR REFORMS

Case Study: Gujarats experience in sustainable labor reforms
In 2008, when Mr Modi was the CM of Gujarat, the state initiated an exercise for formulating the Industrial Park Act and
submitted the proposed ordinance to the Centre for Presidential Assent. The Centre had reservations with certain provisions
pertaining to labor laws and hence the state could not enforce the Act then. In the ensuing discussions,
Mr Modi officially communicated to the Centre that fast-growing states like Gujarat should be allowed to undertake labor
reforms as per their own requirement. He explained that the ground realities are different in Gujarat as compared to, say,
West Bengal".
The state of Gujarat has performed a remarkable balancing act in reforming labor laws to promote investment as well as
nurturing the labor force for sustainable growth:
First state in India to an independent office of the Rural Labor Commissioner for the implementation of the minimum
wages of the Agriculture Workers
Formed State Labor Commissionerate to formulate industrial friendly policy to simplify the complexity of various Labor
Laws. First state to create "Umbrella Legislation" for informal sector labor in the state (~93% of total labor) to provide
social security and other benefits
Set up an Unorganized Workers Board for unorganized or informal workers in the state. It covers more than 3 mn
workers employed in a variety of unorganized ventures in the state
One of the first states in India to set up a Rural Labor Commissionerate to take various measures to improve the
conditions of unorganized rural labor
The state took a lead in overseeing and enforcing the following provisions/amendments in labor laws:
Permitting self-certification by units covered under labor laws
No Work, No Pay: If a worker is terminated illegally and reinstated by the employer after an order of a labor court, he
is not entitled to any payment for the period for which he was terminated
Workers employed in SEZs do not have the right to complain if they are retrenched. However, liable for retrenchment
compensation of 45 days for a year of work vs. 15 days for ordinary workers
Reduction in the number of registers to be maintained under labor laws to two. Meant to reduce the number of
inspections and weaken inspector raj
Skill development: Under the leadership of Mr Narendra Modi, the state of Gujarat entered into an agreement with
TeamLease to set up the first ever vocational education university that aims to address the skills gap via its 22 community
colleges that offer short associate degree programs in conjunction with employers and increased access to technology.
Impact of labor reforms:
Lower man-days lost: Number of man-days lost due to strikes and disputes which was relatively high earlier has been
reduced to bench-mark level.
Higher workforce participation: Rural workforce participation in Gujarat was 48.7% against 42.2% in India. The urban
workforce participation was 37.7% in Gujarat against 35.4% in India.
Lower unemployment, especially in rural areas: Rural unemployment rates in Gujarat at 4.0% vs. 7.1% in India. Overall
employment level in also better than that of India as a whole.


LABOR REFORMS

States will go the distance in legislating labor reforms: Contract labor woes
and clear advantage of labor flexibility
Initially targeted for ad-hoc employment, contractual employment is now central to
Indian manufacturing, especially in the industrial states of Haryana, Gujarat,
Andhra Pradesh and Tamil Nadu. State governments have been lax in
implementation of existing laws and have tweaked them to provide flexibility to
employers (for example avoiding contract work in the core activities). This has led to
a rapid growth of contract labor with curtailed power of unions in industrial states.
We believe that this strategy has reached its saturation point. In several factories,
contract workers are now in a majority and have been able to unionize themselves.
Lower stake in the long-run prospects and younger demographic vs. regular workers
has prompted them to push aggressively for their demands. Companies in the auto
sector such as Maruti, Toyota, Mahindra and Mahindra and Bajaj are increasingly
facing union troubles more than before. The only route available for states is to
create a conducive regulatory environment for catering to the demands of workers
as well of employers.
There is clear evidence that states like Gujarat and Maharashtra which made
amendments to the Act generated more industrial employment, and greater output,
than others which legislated for tighter, worker-friendly regulations.
States with flexible labor laws have created more employment, especially in labor intensive industries Exhibit 6:
All manufacturing industries Labor intensive manufacturing industries
0.0
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Source: India Economic Survey, http://indiabudget.nic.in

Contract labor has reached
saturation as several
contract workers have
been able to unionize
themselves. Lower stake in
the long-run prospects of
the firm and younger
demographic vs. regular
workers has prompted
them to push aggressively
push for their demands


LABOR REFORMS

Real output in flexible labor markets have outperformed inflexible markets Exhibit 7:
19.6
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(GVA)
GVA in Labor Intensive Industries in Flexible Labor Markets
GVA in Labor Intensive Industries in Inflexible Labor Markets


Studies suggest that firms in labor intensive industries and in states with flexible
labor laws have 14% higher total factor productivity than their counterparts in states
with more stringent labor laws. Moreover, this difference continues to increase over
time. Also, states with relatively inflexible labor regulations have experienced
slower growth of labor-intensive industries and employment vs. flexible states.
This gives the states direct incentive to undertake hard-hitting labor reforms.

Studies suggest that
states with flexible labor
laws have higher
productivity, growth and
employment prospects


LABOR REFORMS

Indias need of the hour: Labor reform and transition
towards formal labor
The basic force that will drive Indias GDP growth of 14.5% (real 8.5%) is growing
working age population, capital accumulation and productivity growth. Indias
enviable demographic advantage has been touted for several years now but its
dividends are yet to be realized. GDP growth has largely been driven by the
services sector with minimal impact on new job creation. For example, the
banking/insurance sector contributed ~7% to the GDP but only 0.6% of
employment. In stark contrast is the textile industry which contributes 2% of the GDP
but employs 8% of the workforce. At the threshold of liberalization, global
opportunities were abound for India in both manufacturing and services. One can
argue that the key factor for the phenomenal rise in contribution of services sector to
the GDP has been lower interference from government, especially with respect to
labor laws.
Indias GDP growth and dependence on working population Exhibit 8:
0
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1500
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4
E
2
0
1
6
E
2
0
1
8
E
2
0
2
0
E
(USD)
Nominal GDP / cap Consumption Exp. / cap (RHS)

2005 2010 2015 2020
61 62 63 63
58 55 52 49
Source: CSO, Axis Capital

Formalization of labor and
creation of skilled
workforce is a topic
particularly close to
Mr Narendra Modi, PM
> 50% of Indias
population is under the
age of 25
Working
Population %
Dependency
ratio %


LABOR REFORMS

Despite high GDP contribution, service sector has lagged behind manufacturing Exhibit 9:
sector in employment generation
Sector % of GDP % of workforce
Agriculture 18 57
Services 56 24
- Wholesale/retail trade 14 11
- Community services 11 8
- Transport 5 4
- Banking and insurance 7 0.6
- Dwelling/real estate 8 0.6
- IT/ITES services 3 0.4
- Communications 6 0.2
- Hotels/restaurants 2 0.2
Industry 26 19
- Textile 2 8
- Infrastructure/Construction 7 6
- Automotive 2 3
- Mining and quarrying 2 0.6
- FMCG 2 0.6
- Other manufacturing 6 0.8
- Utilities 2 0.3
- Metals 3 0.1
TOTAL 100 100

Source: CSO, Axis Capital

Stringent and archaic labor laws have only encouraged informal employment in the
unorganized manufacturing sector (if it uses power and employs fewer than
10 people or does not use power and employs fewer than 20 people). Informal job
creation has almost tripled from 8.6 mn (2000-05) to 22 mn (2005-10). This has
come in a backdrop of slower GDP growth as overall employment in India
increased by 2.2 million between 2005 and 2010 as against 92.7 million between
2000 and 2005. ~ 85% of the Indian workforce (67.5% of non-agricultural work
force) is engaged in the informal sector.
The modus operandi of an entrepreneur to escape stringent labor laws is to keep
business operations small. India's average factory employs 75 people, compared to
191 in China. The gap between the letter of laws and interpretation/enforcement
has led to significant corruption costs and multiple inspections. A semi-official rate
card exists for most exemptionspermissions for 365 working days or extended
hours are almost never denied but entail significant cost in most
industrialized states.
GDP growth in India has
largely been driven by the
services sector, though with
minimal impact on new job
creation. For example, the
banking/insurance sector
contributed ~7% to the
GDP but only 0.6% to
employment. In stark
contrast, the textile industry
contributes 2% of the
GDP but employs 8% of
the workforce.
85% of the Indian
workforce (67.5% of
non-agricultural work
force) is engaged in the
informal sector
India's average factory
employs 75 people,
compared to 191 in China


LABOR REFORMS

Informal sector dominates workforce for India vs. peers Exhibit 10:
0 20 40 60 80 100
South Africa
China
Brazil
Argentina
Mexico
Sri Lanka
Indonesia
Pakistan
India
% employed
in the informal sector
% in informal employment
outside the informal sector

Source: World Bank, World of Work Report 2014

Casual jobs are the leading contributor to workforce addition in India Exhibit 11:
65.5
18.6
8.6
92.7
(25.5)
5.7
21.9
2.2
(40)
(20)
0
20
40
60
80
100
Self-employed Regular jobs Casual jobs Total
Changes in employment in India (mn)
1990-00 to 2004-05 2004-05 to 2009-10

Source: Mahambare and Nadkarni (2011)

Why should India formalize its workforce? Exhibit 12:

Source: Axis Capital

2
1
4 3
Lower
productivity
and innovation
in unorganized
sector
Low skill
development in
informal sector
High entry
barriers for
organized
manufacturing
Lower Tax
Revenue from
unregistered
manufacturing
Need for
formalization


LABOR REFORMS

High entry barriers for organized manufacturing
The current labor laws leave little room for free contracting. Manufacturing firms
with volatile demand patterns (Example fashion garments, electronics) may want to
offer workers higher wages but with a leeway to lay off workers within a month's
notice. Such businesses are not viable under current regulations though significant
opportunities for quick obsolescent, volatile demand products exist both globally
and locally.
Lower productivity and innovation in unorganized sector
World Bank studies conclude that high levels of informal employment are
associated with acute and widespread poverty. Larger firms are likely to be more
productive, innovate more, and be competitive in export markets. Studies have
suggested that formal sector workers are likely to be 10 times more productive than
contractual labor. The capital-labor ratio has also shown a consistent increasing
trend, pointing to the declining productivity of labor vs. capital. Therefore, transition
to formal employment is a matter of when rather than if. A first step towards this
transition would be creating a conducive environment for labor flexibility while at
the same time retaining workers security in a reasonable manner. Experts have
pointed out that flexible labor is also associated with faster employment growth.
Formal sector workers are likely to be 10 times more productive than Exhibit 13:
contractual labor
0
20
40
60
80
100
Informal worker
in Informal Sector
Informal worker
in Formal Sector
Formal worker
in Formal Sector
Normalized average value added per worker

Source: World Bank (2012) More and Better Jobs in South Asia (Formal worker in formal sector = 100)

Industry needs to
accommodate a high
degree of flexibility in its
operations in order to
respond effectively to the
changing markets and
business environment
Larger, organized firms are
likely to be more
productive, innovate more,
and be competitive in
export markets.


LABOR REFORMS

Increasing capital-labor ratio in India signals declining labor productivity Exhibit 14:
50
100
150
200
250
300
350
400
450
500
550
1
9
8
2
1
9
8
3
1
9
8
4
1
9
8
5
1
9
8
6
1
9
8
7
1
9
8
8
1
9
8
9
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
(Rebase 100)

Source: Has Indias Growth Story Withered? (2013), Ministry of Finance, Government of India

Low skill development in informal sector
Majority of the employment in the informal segment is unskilled in nature, thereby
lowering demand for skilled labor and Indias competitiveness. Smaller firms are
unable to invest adequately in employee training. Welfare programs like NREGA
have further bolstered unskilled labor at the added cost of wider fiscal deficit. India
has the lowest proportion of skilled labor entering the workforce when compared to
global peers.
Indian firms rank low in providing in-house training to employees Exhibit 15:
18%
48%
55%
68%
70%
0%
20%
40%
60%
80%
India Europe &
Central Asia
East Asia Brazil China
% of manufacturing firms undertaking formal in-service training

Source: BCG-CII report - People productivity: Key to Indian Manufacturing Competitiveness

Increasing capital-labor
ratio in India signals
declining labor productivity
Indias smaller
manufacturing firms
have been unable to
invest adequately in
employee training


LABOR REFORMS

Proportion of skilled labor entering workforce is significantly low when Exhibit 16:
compared to global peers
13%
30%
21%
58%
76%
4%
6%
39%
18%
11%
0%
20%
40%
60%
80%
100%
India Brazil China Russia South Korea
Vocational education Higher education

Source: BCG-CII report - People productivity: Key to Indian Manufacturing Competitiveness

Under the leadership of Mr Narendra Modi, the state of Gujarat entered into an
agreement with TeamLease to set up the first ever vocational education university
that aims to address the skills gap via its 22 community colleges that offer short
associate degree programs in conjunction with employers and increased access
to technology.
Lower Tax Revenue from unregistered manufacturing
The informal sector has contributed much less to the tax revenue of the government
as compared to the formal sector. Moreover, the weightage of the unregistered
manufacturing sector is < 5%.


LABOR REFORMS

Global success in labor reforms
Strong manufacturing growth has been a key component of successful developing
countries. Manufacturing in India has been stagnant and largely driven by small,
inefficient firms hiring contractual labor. The share of micro and small enterprises in
manufacturing employment is 84 per cent for India versus 27.5 per cent for
Malaysia and 24.8 per cent for China.
Small firms dominate Indias apparel industry as compared to China Exhibit 17:
0
20
40
60
80
100
<8 8 -18 19 - 50 51 - 200 201 - 500 501 - 2000 >2000
Fi rm size by no of employees
(% of total apparel industry employment)
India China


Case Study: Successful Export Processing Zones (EPZ) with flexible labor
laws bolstered Mauritius growth
Mauritius, initially prophesized for a bleak future, stunned its critics by remarkable
economic growth between 1977 and 2006 (Per capita GDP growth at ~ 4.2% vs.
~0.7%for the rest of Africa). Key to this growth trajectory was creation of successful
EPZs with efficient management and flexible labor laws.
Key differentiators for Mauritiuss EPZs were that they were not geographically
bounded; subject to centralized wage setting and assurance for minimal labor
unrest; flexibility in work hours and layoffs and greater participation of women.
We believe that Rajasthans step towards labor reforms can potentially recreate
Mauritius EPZ success in the DMIC.

Structural changes in Mauritius an their consequences Exhibit 18:


Share of micro and small
enterprises in
manufacturing employment
is 84% for India vs. 27.5%
for Malaysia and 24.8%
for China


LABOR REFORMS

Implication of labor reforms for India
Emerging economies are at an inflexion point in the battle for global manufacturing
supremacy. With China losing sheen in manufacturing over the last few years, India
is theoretically well poised to tap the ~ US$8.5 trn global manufacturing pie. On
paper, Indias demographic profile and cost competitiveness create a distinct
advantage. It remains to be seen whether India can unshackle the self-created
chains of archaic and inflexible labor laws. We believe that labor reforms lie at the
heart of helping realize the aim of taking manufacturing share of GDP to 25% by
2022 (as per the National Manufacturing Policy). A let-up, however, could cost
India ~US$ 470 bn
1
besides million heartaches from the ~10 mn people getting
added to the workforce every year.
Labor reforms can fuel a virtuous cycle in Indian manufacturing Exhibit 19:

Source: Company, Axis Capital

Manufacturing sector set to take center stage Exhibit 20:
Mfg,
US$ 263bn
15% share

Source: Axis Capital, CSO

Mfg,
US$
1,168bn
25% share

Source: Axis Capital, National Manufacturing Policy

Manufacturing GDP in 2022 Exhibit 21:

Share of manufacturing
15% 20% 25%
N
o
m
i
n
a
l

G
D
P

g
r
o
w
t
h
12% 653 871 1,088
13% 701 935 1,168
14% 752 1,003 1,254
Manufacturing GDP CAGR 2014- 22 Exhibit 22:

Nominal manufacturing GDP growth
15% 20% 25%
N
o
m
i
n
a
l

G
D
P

g
r
o
w
t
h
12% 12% 16% 19%
13% 13% 17% 21%
14% 14% 18% 22%
Note 1: The cost (US$ 470 bn) to the economy in 2022 is calculated as the difference between potential manufacturing GDP in 2022
(@25% of overall GDP as per National Manufacturing Policy) and current share of manufacturing sector in the GDP (~15%) applied to the projected
GDP in 2022
Manufacturing GDP
CAGR of 21%


LABOR REFORMS

Annexure I: List of Labor laws in India

Labor Laws may be classified under the following heads:
I. Laws related to Industrial Relations such as:
1. Trade Unions Act, 1926.
2. Industrial Employment Standing Order Act, 1946.
3. Industrial Disputes Act, 1947.
II. Laws related to Wages such as:
4. Payment of Wages Act, 1936.
5. Minimum Wages Act, 1948.
6. Payment of Bonus Act, 1965.
7. Working Journalists (Fixation of Rates of Wages Act, 1958.
III. Laws related to Working Hours, Conditions of Service and Employment:
8. Factories Act, 1948.
9. Plantation Labor Act, 1951.
10. Mines Act, 1952.
11. Working Journalists and other Newspaper Employees (Conditions of Service
and Misc. Provisions) Act, 1955.
12. Merchant Shipping Act, 1958.
13. Motor Transport Workers Act, 1961.
14. Beedi & Cigar Workers (Conditions of Employment) Act, 1966.
15. Contract Labor (Regulation & Abolition) Act, 1970.
16. Sales Promotion Employees Act, 1976.
17. Inter-State Migrant Workmen (Regulation of Employment and Conditions of
Service) Act, 1979.
18. Dock Workers (Safety, Health & Welfare) Act, 1986.
19. Building & Other Construction Workers (Regulation of Employment &
Conditions of Service) Act, 1996.
20. Building and Other Construction Workers Welfare Cess Act, 1996.
21. Cine-Workers and Cinema Theatre Workers (Regulation of Employment) Act,
1981.
22. Dangerous Machines (Regulation) Act, 1983.
23. Dock Workers (Regulation of Employment) Act, 1948.
24. Dock Workers (Regulation of Employment) (Inapplicability to Major Ports) Act,
1997.
25. Employment of Manual Scavengers and Construction of Dry Latrines
(Prohibition) Act, 1993.
26. Industrial Employment (Standing Orders) Act, 1946.
27. Mines and Mineral (Development and Regulation Act, 1957.
28. Plantation Labor Act, 1951.
29. Private Security Agencies (Regulation) Act, 2005.


LABOR REFORMS

IV. Laws related to Equality and Empowerment of Women such as:
30. Maternity Benefit Act, 1961.
31. Equal Remuneration Act, 1976.
V. Laws related to Deprived and Disadvantaged Sections of the Society:
32. Bonded Labor System (Abolition) Act, 1976.
33. Child Labor (Prohibition & Regulation) Act, 1986.
34. Children (Pledging of Labor) Act, 1933.
VI. Laws related to Social Security such as:
35. Workmens Compensation Act, 1923.
36. Employees State Insurance Act, 1948.
37. Employees Provident Fund & Miscellaneous Provisions Act, 1952.
38. Payment of Gratuity Act, 1972.
39. Employers Liability Act, 1938.
40. Beedi Workers Welfare Cess Act, 1976.
41. Beedi Workers Welfare Fund Act, 1976.
42. Cine workers Welfare Cess Act, 1981.
43. Cine Workers Welfare Fund Act, 1981.
44. Fatal Accidents Act, 1855.
45. Iron Ore Mines, Manganese Ore Mines and Chrome Ore Mines Labor Welfare
Cess Act, 1976.
46. Iron Ore Mines, Manganese Ore Mines and Chrome Ore Mines Labor Welfare
Fund Act, 1976.
47. Limestone and Dolomite Mines Labor Welfare Fund Act, 1972.
48. Mica Mines Labor Welfare Fund Act, 1946.
49. Personal Injuries (Compensation Insurance) Act, 1963.
50. Personal Injuries (Emergency Provisions) Act, 1962.
51. Unorganized Workers Social Security Act, 2008.


LABOR REFORMS

Annexure II

The Delhi Mumbai Industrial Corridor

The DMIC seeks to develop a series of futuristic infrastructure-endowed smart
industrial cities that can compete with the best international manufacturing and
industrial regions. The master plan has a vision for 24 manufacturing cities.
Potential production sectors include general manufacturing, IT/ITES components,
electronics, agro and food processing, heavy engineering, pharmaceuticals,
biotechnology, and services with investment is pegged at $90 billion. Goals are to
double employment potential in 7 years, triple industrial output in 9 years,
quadruple exports from the region in 8-9 years, and target 13-14% growth per
annum for the manufacturing sector on a sustained basis over next three years. In
the first phase, it is expected to create ~8.5 million jobs.

Delhi-Mumbai Industrial Corridor and its influence area Exhibit 23:

Source: DMIC


LABOR REFORMS

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