On December 20, the Indian government approved a Rs 357.17-crore incentive for Foxconn India, under the Production-Linked Incentive scheme for the Large-Scale Electronics Manufacturing sector.

According to government think tank Niti Aayog, Foxconn India is the “first global company” approved under the scheme for mobile phones and to receive an incentive for its manufacturing between August 1, 2021 to March 31, 2022.

This development could help raise foreign investors’ sentiment towards India. More importantly, it could aid the government in clarifying to the global markets that India’s push for self-reliance, or “Atmanirbhar Bharat”, is not protectionism.

There is the hope that the production-linked incentive schemes will transform the Indian economy, similar to the way in which China was lifted by its Special Economic Zones. Established in the 1980s, Special Economic Zones by the 2000s contributed 2% of China’s gross domestic product, 45% of total national foreign direct investment and 60% of exports.

According to the World Bank, Special Economic Zones transformed China’s urban and rural landscape by creating close to 30 million jobs. They also increased the income of participating farmers by 30%, accelerated industrialisation, agricultural modernisation, and urbanisation.

Economic, strategic goals

The Indian government’s Production-Linked Incentive schemes were announced in March 2020 for three sectors. They were expanded to cover 11 sectors in November that year and then to 14 sectors by September 2021. The initiative is aimed at helping India break into the ranks of the top manufacturing countries.

It seeks to attract investments in core areas and bring in state-of-the-art technology to make India-based manufacturing firms globally competitive. This, the government hopes, will ensure efficiencies, enhance exports and make India an integral part of the global supply chain, creating economies of scale that will reduce costs as the scale of production increases.

From a geo-economic lens, the Narendra Modi-led government aims to position India as an alternative manufacturing hub to China. This will reduce India’s dependence on China (the trade deficit was $51.5 billion in the April-October period this fiscal year) and also benefit other countries by decongesting global supply chains. In the long run, having a strong industrial manufacturing base is critical to help India to balance the Chinese threat, monetarily and militarily.

The scheme extends an incentive – simply put, a cashback – as a percentage of incremental sales (net of taxes) over the base year of goods manufactured in India, for a period of five years. For example, if a company has sales of Rs 500 crore in 2020-’21 and scales up to Rs 1,250 crore of sales in 2021-’22, Rs 750 crore will be considered as incremental sales. The incentive will be provided on this amount to the company.

These cashbacks range 1% for electronics and technology products to 20% for key starting materials and other drug intermediaries.

The production-linked incentive scheme has an outlay of Rs 2 lakh crore. Most of the 14 sectors covered by the scheme are labour-intensive, such as textiles, food processing, and could help the government overcome the job crunch. Some sectors are strategically important but vulnerable to global supply-chain disruptions. They include pharmaceuticals and solar photovoltaic modules.

As of December, 650 applications had been approved under 13 schemes. More than 100 micro, small and medium enterprises were among the beneficiaries. Among companies whose applications were approved were technology and consumer technology giants Apple, Samsung, LG, Panasonic and Mitsubishi.

As a testimony to the scheme’s success, Rajeev Chandrashekhar, the Union Minister of State for Electronics and Information Technology, stated that mobile phone exports rose from “nearly zero” in 2015-’16 to Rs 45,000 crore in 2021-’22. The total production of mobile phones has increased from six crore units in 2014-’15 to 31 crore units in 2021-’22.

Addressing problems

But there have been many criticisms of the schemes. Former Reserve Bank of India Governor Raghuram Rajan, in a co-authored article in September, questioned the claim that the Production-Linked Incentive schemes will create a domestic research and development and manufacturing ecosystem. Rajan said the schemes are actually subsidising imports and leading to items being resold domestically at a higher price.

Second, a December report by Credit Suisse highlighted that capital expenditure growth due to various production-linked incentive sectoral schemes varies drastically. Capital expenditure refers to large-scale investment in permanent assets such as land and equipment.

The highest annual incremental increase in capital expenditure by Production-Linked Incentive scheme companies will be in speciality steel (processed steel for advanced use) at 17%, followed by textiles (14%) and automobiles (10%). Other sectors will witness a modest increase at 4% (this excludes nascent areas such as advanced cell battery manufacturing where a local manufacturing base is being built).

Similar is the case of investment: major investments under the Production-Linked Incentive schemes will come from sectors such as automobiles and speciality steels ($5.1 billion each), followed by textiles ($2.3 billion) and pharmaceuticals ($1.9 billion).

In most other sectors, the capital investment is modest, at less than $1 billion. The Credit Suisse report also highlighted challenges such as the lack of experience, poor access to technology, and the relatively small balance sheets of many players that have signed up for the scheme.

Besides, across sectors, only a handful of firms have been able to meet the threshold to qualify for government incentives. For instance, under the Production-Linked Incentive scheme for information technology hardware, of the 14 eligible firms, only two or three companies met their first-year targets for the financial year ending March 2022. Companies have blamed either the low incentives and the continued global supply chain disruptions.

This points to a couple of other structural problems associated with the schemes. To start with, in many sectors, there are so many eligible companies that the division of the corpus leads to an insignificant allocation to individual companies. Next is the inability of the schemes to distinguish between boosting general manufacturing and boosting the manufacturing of critical materials and parts to build supply chain resilience.

Further, the government remains slow to address hurdles in developing India’s manufacturing ecosystem. This includes problems of infrastructure and logistics, such as last-mile connectivity, especially to Tier-1 and tier-2 towns that have a potential to grow, ease of doing business beyond big cities, and physically safe conditions for operations.

It is important to remember that global capital looks for safety and certainty, underwritten by the effective rule of law.

Finally, from the perspective of the international economy, the government mistakenly assumes and irrationally expects that other countries will be willing to buy goods manufactured in India without gaining access to the emerging Indian market to sell their own products as well.

Pulling out of regional economic treaties, like the American-launched Indo-Pacific Economic Framework, further signals that the Indian government is neither confident in dealing with international competition nor is its marketing campaign as the next global manufacturing hub credible.

Though the government is aware of these problems, the bureaucratic movement on addressing them is slow. Its focus is on creating new sectoral schemes rather than addressing the structural problems of the production-linked incentive scheme.

To pull off something on the scale of China’s transformation, the Indian government will have to take these criticisms seriously and work to make its schemes more effective. The decision-making apparatus needs to be agile and responsive so that it can align processes, structures and policies with the desired outcomes of the schemes.

Siddhant Bajpai is a researcher at the Council for Strategic and Defense Research, New Delhi. His research focuses on international politics, security issues, and Indian foreign policy. His Twitter handle is @siddhantIND.

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