Despite growth, manufacturing’s share of GDP remains low: Here's why

The constant criticism one hears about Indian manufacturing is that despite policy initiatives, the much-touted goal of raising its share in GDP to 25 percent is as far from reality as it was ever. The question is why is this not happening? Manufacturing’s share in GDP even seems to be slipping, sometimes even falling below that of agriculture.

The Economic Survey 2025-26 gives us both an explanation for why this is so and what the real challenges are. It gives us three reasons why manufacturing is still on a slippery slope (oversimplified here to give readers a snapshot): one, the excess political attention given to agriculture makes its terms of trade vis-a-vis manufacturing better; two, the relatively easy regulatory environment for services makes  entrepreneurs gravitate more towards that sector; and three, inverted duty structures make domestic manufacturing less competitive with imports. The survey adds that manufacturing’s share has not fallen in constant price terms, just in relative terms.

Says the Survey: “Regarding industry, a concern is often raised about its declining share in GVA (gross value added). The compression in manufacturing’s GVA share stems from relative price effects rather than reflecting a decline in manufacturing activities…and higher intermediate consumption, which reduces net value added relative to sectors with greater pricing power, particularly services. In real (constant) price terms, manufacturing’s share has remained steady at around 17-18 per cent. Manufacturing’s gross value of output (GVO) has remained broadly stable at around 38 percent, comparable to services, indicating that output has been sustained.”

In short, the relative decline in manufacturing’s share of GDP is not the result of any actual decline in manufacturing growth or output, but relatively higher growth in agriculture and services. The former is driven by state mollycoddling of the farm sector, the latter benefits from having to deal with far less regulatory cholesterol than manufacturing.

The Survey explains further: “It is observed that the agricultural GDP deflator has grown faster than the other sectors. By FY25, it is at 2.17 relative to the 2011–12 base year. The GDP deflators of industry and manufacturing rose at a slower pace - 1.55 for industry and 1.41 for manufacturing by FY25, while that of services was better off at 1.75. Accordingly, the terms of trade for the manufacturing sector with respect to the agriculture sector, i.e., the ratio of the manufacturing deflator to the agricultural deflator, starts high (1.29 in FY05) and steadily declines by 50 percent to 0.65 in FY25, while its ratio with the service sector deflator declines by 25 percent to 0.81 by FY25.”

Explanation: The GDP deflator is a measure of the general price trend in the economy, and we arrive at real GDP by deflating nominal GDP by the deflator. Each sector has its own deflator, which means that if the deflator is higher for agriculture, its nominal share of GDP will be higher.

Says the Survey: “Unlike agriculture, where prices may have risen due to the prevalence of government support, which sees an annual guaranteed price increase, or services, which enjoy more pricing power, manufacturing is usually characterised by global competition, cost-cutting technologies, and narrower margins, which might be accounting for this decline in terms of trade. This declining terms of trade also translates as lower share of manufacturing in the GVA in current price terms, which has seen a decline from 17-18 per cent two decades ago to around 14 per cent in FY25, while its share in GVA in constant price terms and share in gross value of output (GVO) have remained fairly constant at 18 percent and 38 percent, respectively.”

The Survey underlines the risks in mollycoddling agriculture too much without actually saying so. “Better terms of trade in favour of agriculture might encourage resource shift towards agriculture, i.e., more land put to agricultural use, labour going back to agriculture, the evidence of both of which is visible in the Indian economy. On the other hand, declining relative prices for manufacturing mean that the sector might face tighter margins as input costs (especially those from agriculture) rise, and this could deter investment if it is prolonged.”

India’s export sector is bolstered by services, which face fewer tariff hurdles, rather than manufacturing. This services tilt is a stabilising factor for the current account deficit, but it also implies that governments face no pressure to reform the playing field for manufacturing. 

The Survey notes: “International experience indicates that while service exports are economically valuable, they do not systematically compel broad upgrades in state capacity, as successful firms can bypass weak institutions, relocate easily, and generate limited economy-wide pressure on governments to reform. Unlike manufacturing exports, they do not impose hard fiscal, employment, or logistical constraints on the state, allowing institutional weakness to persist even alongside globally competitive firms. So, manufacturing matters.”

Policy-makers tend to support agriculture and services because one forms a crucial electoral base, and the latter needs very little reforms at the ground level. The real challenge for reformers is to make manufacturing competitive, and that should be India’s priority No 1 for Centre, states and local bodies.

Over the last five years since 2020, the relative growth rates in services and merchandise exports tells its own story. The Survey notes that “the compounded annual growth rate of total exports has been 9.4 percent, while that of merchandise exports has been only 6.4 percent.” No wonder manufacturing seems to be slipping. 

The mathematical issue is stark: if manufacturing has to grow to 25 percent of GDP, it must grow at a faster rate than services for a sustained period, both domestically and in exports. Reform in regulations and ease of doing manufacturing business is key.

The free trade agreement with the European Union and the tariffs deal with the US will, hopefully, light a fire under bureaucracy and force governments at all levels to make life sweeter for manufacturing units. Services should be the icing on the cake, not the cake itself. Over the long term, manufacturing is the cake that will make the icing taste even better.