Production incentives are fine, but why high tariffs?

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The unstated but intended purpose of the Production-Linked Incentive (PLI) scheme is to promote exports by ramping up production capacity within the country and building economies of scale. Since World Trade Organisation (WTO) rules do not allow exports to be subsidised or incentivised, the scheme makes no difference between production for domestic and export markets. The expectation is that the domestic market will be unable to absorb the incremental production and exports will be compelled.

So far schemes have been announced for 13 industrial categories including advanced chemistry cell batteries; electronic technology products; automobiles and auto components; pharmaceuticals; telecom and networking products; manmade fibres and technical textiles; high efficiency solar photovoltaic modules; air conditioners and LEDs; speciality steel; food products; mobile manufacturing; next-gen automobiles and drones.

The incentives add up to Rs 1.97 lakh crore over five years. The official press release says the target is to achieve additional production of Rs 37.5 lakh crore and employment for at least 10 million people.

Rosy projections are necessary to make large giveaways acceptable; whether they will stand up to scrutiny is another matter.

The categories have been well-chosen. For example, the world textile and clothing trade is skewed towards synthetics. Between 2010 and 2015, world synthetic apparel trade grew by 3.5 times that of cotton apparels and the per capita consumption (in kg) of synthetic fibres outpaced that of natural fibres. But India’s market and exports are natural-fibre oriented. The Indian textile and clothing industry is also fragmented; weaving is largely in the unorganised sector and quality varies; there is not much investment in advance technologies and our skills match our low wages. This is the reason that Indian exports of textiles and apparel at 31.4 billion in pre-pandemic 2019 were four percent of global exports of this category while China with $284.5 billion had a 34 percent share.

The PLI scheme hopes to correct this by incentivising two levels of threshold investments: Rs 100 cr and Rs 300 cr. To be eligible, the turnover has to double in the second year and it will have to rise by 25 percent a year every year thereafter for five years. The incentives will be a percentage of turnover, reducing by one percent a year over five years.

“The threshold level is too high,” says S. Shaktivel, Executive Secretary of the Tirupur Exporters Association. About 75 exporters in that cluster have a combined annual turnover of about Rs 13,000 cr, he says, which is about half of the total. Of the remaining about 900 exporters, 600 do less than Rs 10 cr each. They will not be able to make the required investment, he says, nor will be it easy for them to find a large global market in a very short time.

The high ambition is necessary, says Ajay Sahai, Director-General of the Federation of Indian Export Organisations (FIEO), to attract large companies. Ancillary units will spring up around them, much as component makers and sub-assemblers did around Maruti, Hyundai and Ford, he says.

But the synthetic fibre orientation of the global textile and clothing market is not a recent development. If our exporters have not been able to take advantage of the global opportunity despite a plethora of government export incentive schemes (which had to be scrapped for falling foul of the WTO rules) and technology upgrade schemes, it is a moot point whether that objective will be achieved with another set of incentives.

The timing of the incentive scheme is right, though. The United States and Europe want to reduce its dependence on China, which they perceive as an emerging threat. The pandemic has disrupted global supply chains and multinational companies are following a China Plus One strategy. India wants to be an alternative source of supply. So ‘Make in India for the world,” makes sense.

But will raising import duties help achieve that objective? Or will we end up with ‘Make in India for India’ conflating import substitution with self-reliance, 1970s style? An assessment of the PLI schemes for the 13 sectors will have to wait for two or three years, but the Indian electronics industry might throw some pointers.

India has been trying to increase domestic manufacture and exports of mobile phones and electronic components since 2012 with various policies, the make-in-India initiative, the phased manufacturing programme and a scheme for remission of duties and taxes paid on exported products. An August 2021 study by ICRIER, a research agency based in Delhi, says these initiatives have raised Indian exports of electronic items from $9 billion in 2014 to $15 billion in 2019.

But India performance compares unfavourably with that of Vietnam. Its exports of electronics saw a 15-fold jump from $7billon in 2010 to $100 billion in 2020. The country began from scratch in 2000. The singular reason, the researchers say, was the entry of Samsung in 2010.

India’s imports of electronic items also increased to $51 billion in 2019 (of which $19 billion was form China). So the overall trade deficit was $36 billion. Most of the items that India imported bore no duty and were covered by the Information Technology Agreement, or free trade agreements with Asean, Singapore, Japan, Korea and the preferential trading agreement with Malaysia. But it is wrong to blame them for the trade deficit, the researchers say, because it has given Indian consumers a choice of high-tech and affordable products and also contributed to the competitiveness of the exports of modern services.

The researchers are disquieted by India’s growing protectionism. China, whose exports of electronics are 60 times that of India, saw its exports rise after it opened up the economy while Malaysia lost its edge because it failed to keep pace with technology and market shifts. Vietnam has also signed free trade deals with many trading partners, they say. An open and liberal trade regime is necessary for competitive exports.

India’s tariffs on smart phones have increased steadily from 10 percent in 2016-17 and are now about 40 percent on high-end mobile phones including basic customs duty, GST and welfare cess. The study estimates that about 55 percent of the domestic sales of mobile phones are in the grey market and the government is losing about Rs 2,400 cr in taxes owing to smuggling.

Incentives for capacity creation are fine if the intention is to build scale, but why shelter the industry behind high tariffs. That might end up attracting rent-seekers rather than risk-takers, say Arvind Panagariya, former Vice-chairman of NITI Aayog and Deepak Mishra, Director of ICRIER, in a recent article. Risk takers will produce for export even without protection.

Sahai says higher tariff will be needed but they should have a sunset clause. That is not how it happens. Sunset clauses have a habit of prolonging the dusk.