Rational Expectations: Can’t let PLI scheme go bust, nurture it

This includes carrying over FY21’s PLI due to force majeure, allowing Chinese players in & ensuring WTO compatibility

Since such localisation targets are also WTO-incompatible, it is not clear why such schemes are being planned; investors get wary if they feel the schemes can be challenged at WTO.
Since such localisation targets are also WTO-incompatible, it is not clear why such schemes are being planned; investors get wary if they feel the schemes can be challenged at WTO.

Coming as it does, on top of the new labour laws and a dramatically reduced corporate tax rate, it is not surprising there is a lot of excitement—including within the government—about India’s new production-linked-incentive (PLI); at an average of 4.5% of turnover in the case of mobile phones over five years, the PLI will significantly boost profits of a firm manufacturing phones here. After the initial Rs 40,951 crore scheme, spread over five years, the government cleared another Rs 160,000 crore for schemes in 10 other sectors. Unlike mobile phones, though, what the Cabinet gave was an in-principle approval last November, with the exact details of each scheme to be announced later by various line ministries.

Apart from stimulating domestic investment, the scheme is a smart workaround to boost exports. The older MEIS export scheme ran into trouble at the WTO as it was said to be subidising exports which is categorised as trade-distorting. The PLI got over this hurdle by giving incentives for domestic production; except, the incentives were designed in such a way that a large part of the production would be exported.

In the case of mobile phones, the PLI is given for producing phones with an ex-factory price of $200. Since there is limited local demand for phones that retail at $300+, most production will be exported. Let’s say a firm produces 100 phones with an ex-factory value of $200; it then gets a PLI of $900 (based on an average PLI of 4.5%). But what if 30 of these phones are sold in the local market at $300 apiece, surely that’s a wasted $270 of PLI since the scheme is aimed at boosting exports? Not really, as it happens, since these 30 phones will pay a GST of $1,620 (based on an 18% rate on the retail price). Simple maths tells you that if more than a sixth of the phones produced are sold locally, the scheme is revenue-surplus for the government, apart from the big boost to exports. As per the plan, over five years, a total production of over Rs 900,000 crore of mobile phones is expected from the 16 firms that have availed of the scheme; the government estimates around 60% of production will be exported.

The scheme, however, is in danger of getting derailed for a variety of reasons. The original permissions for the mobile phone manufacture were to be in by the beginning of June or July so as to allow production to start by August, but came only in the first week of October; this gave the firms around a third less time to achieve their targets for the year. Surely the government must take responsibility for this? If this wasn’t bad enough, thanks the lockdown and the rapid spread of the virus as well as the aftermath of the tension with China, things got a lot worse.

Most firms found it difficult to import their components—there is a worldwide shortage of chips, for instance— or to get Chinese technicians to come and install their assembly lines as visas were tough to come by. It didn’t help that Chinese technicians didn’t want to travel either, given the way Covid-19 was flaring up; the curbs on Chinese investments in India also came less than three weeks after the PLI scheme became operational.

With most firms apart from Samsung, which already had large manufacturing facilities in India, unable to meet their production obligations, they have asked the government to declare FY21 a zero year, in a sense. So, instead of the scheme starting in FY21, they are asking for it to start in FY22. Considering the magnitude of the disruption—the government has stepped in to help most sectors of the economy for this very reason—declaring FY21 a force majeure year is hardly a big ask, more so as there are no extra revenue implications of doing so. Interestingly, in the PLI scheme for medical devices that has an outlay of a mere Rs 3,420 crore over seven years, while the scheme was notified on February 11, 2021, commercial production is to start from April 1, 2022!

What is worrying more than the PLI amount itself is that, over time, as in all manufacturing, the various PLI schemes will face all manner of hurdles, and the government will be called to fix the problems; if it can’t fix a relatively simple thing for mobile phone manufacturing, all the schemes are in danger of running aground like the famed SEZ schemes of the past. Indeed, if potential PLI entrants believe the government isn’t going to help them negotiate problems, they may shy away as well.

Equally worrying is the issue of WTO compatibility. Some schemes, such as the one for laptops and tablets ,link part of the incentives to localisation targets. Since such localisation targets are also WTO-incompatible, it is not clear why such schemes are being planned; investors get wary if they feel the schemes can be challenged at WTO.

Nor is it clear if the government has clearly thought out its position on Chinese investment in India. The purpose behind the PLI, especially in the case of mobile phones, was to woo firms like Apple that were producing phones in China. That has worked to the extent Apple has shifted some part of its assembly lines to India, and Samsung has added to its local capacity as well. But that is just the first step. If value addition in India has to rise, Apple and Samsung need to move their second- and third-tier suppliers from China and Vietnam to India as well; the shifting of second- and third-tier suppliers from Japan, not surprisingly, is how Suzuki’s indigenisation levels rose in India several decades ago. But these suppliers of mobile phone components are almost wholly Chinese and are not being allowed to invest in India following the worsening of relations between the countries. Roughly half of the world’s exports of mobile phones, keep in mind, emanate from China, and this rises to 75% if you add Vietnam and Hong Kong where it is mainly Chinese firms that are doing the production of phones and their components.

If keeping the Chinese out is India’s policy, that is fine, but keep in mind that this will also keep indigenisation levels low; given how India’s electronic imports are rising, greater value addition in India—from around 15% now to around 35% in five years—was a primary goal of the PLI scheme.

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