Production Linked Incentives: India’s Now or Never Manufacturing Moment

“No country is ever successful in the long term... without a really strong and vibrant manufacturing base.” No other country, more than India, needs to reflect on this quote by Alan Mulally, former president and chief executive officer of Ford Motor Company.

For years, Indian policymakers have talked about increasing the manufacturing share in Indian gross domestic produce (GDP). But the needle has moved sporadically and in fits and starts.

India’s deindustrialisation, which started with the British policies of exporting Indian raw materials and India totally missing the modern industrial wave, has only expedited in the last few decades. Globalisation after the end of Cold War hastened Indian manufacturers becoming traders, even as we gained on the services front.

The world is looking to diversify outside China, if not replace China altogether. China’s labour force peaked at just over 800 million in 2015. Since then, China has lost 30 million in industrial workforce, going from 100 million then to 70 million industrial workers now. Strategically as well as operationally, the next few years are the ‘now or never’ moment for ex-China manufacturing diversification.

Offering production-linked incentives (PLIs) to get foreign and domestic firms to ‘Make In India’ is perhaps India’s last throw of the dice. The good news is that finally it appears that Indian policymakers have designed something pragmatic, result-oriented and impactful. India will never become China, but the PLI programme has the potential to significantly add to Indian manufacturing base, solving several economic malaises over the next decade.

The PLI programme offers about Rs 2 lakh crore worth incentives over five years to 13 key sectors based on incremental output delivered by the chosen firms in these sectors.

The programme debuted with incentives for mobile handset production in May 2020, which attracted key global manufacturers to set up shop in India over the second half of the year. Subsequently, the programme was extended to the pharma and medical sectors in October this year. Finally in October, the government announced the applicability of the programme to 10 more sectors.

The incentive design under PLI programme is fully World Trade Organization (WTO)-compliant. The earlier Merchandise Exports From India Scheme (MEIS) has been challenged by countries like the US on the grounds that the scheme provided direct export subsidisation. The MEIS ends in December 2020. The Rs 0.5 lakh crore annual outlay for the MEIS will now be utilised for the PLI programme.

The PLI programme design has four unique characteristics, which boost its chances of succeeding.

Firstly, the PLI programme has chosen sectoral specialisation with a futuristic view. Automobile, battery production, drugs, medical devices and processed food sectors will see higher incentivisation compared to the MEIS. The share of jewellery and chemicals sector will reduce.

Agriculture export incentives will be channelled towards processed foods, thus shifting raw material exports to local value add and processed goods exports. Auto sector including the ancillary businesses, already forms almost 40 per cent of the Indian manufacturing and is a big exporter. The PLI programme backs the intersection India’s strengths on one hand and favours the growth sectors of the coming decades on the other.

Secondly, the PLI programme is designed to back large companies, promoting scale. Rather than adopting the MEIS principle of trying to keep every firm happy, the PLI programme incentivises a few large firms, which will put in bold and immediate capital expenditure (capex) investments. This approach may lead to some opposition next year led by small firms. But the government is banking on a trickle down positive impact for small players in time.

Thirdly, the programme is time-bound and new manufacturing incentives come with an expiry date. The firms can use this time to gain scale and make a difference to the Indian economy in turn. After the incentives expire, these firms will have to stay competitive and use labour productivity for differentiation.

Fourthly, the incentive design promotes investments in the labour intensive part of the value chain. The programme does not make any grandiose claims to move entire supply chains to India. The design enables Indian participation in global value chains (GVCs) in a way that addresses Indian need for labour expansion.

To take an example, the assembly cost for a mobile phone can be between 4 per cent (high end phones) and 8 per cent (low end phones) of the cost of the phone. Targeted incentives for mobile assembly — the first PLI from May this year — can cover anywhere between half and full cost of assembly. This is a no-brainer for firms in the assembly business to set up shop — and that’s already happening, with all large firms in the space firming up India investment plans.

A Credit Suisse report titled “India Market Strategy – PLI Schemes: A new pro-growth template for India’s Industrial Policy” predicts that this programme will add 1.7 per cent to Indian GDP by financial year (FY) 2027. The report outlines how bulk of the additional $144 billion sales across these 13 sectors will be exported, thus also shrinking Indian trade deficit by $50 billion. The following picture depicts sector-wise details of these estimates by Credit Suisse.

The PLI programme will also have a positive second order effect. Since the PLIs will kick in within the next year or so, the firms have to make their capex plans immediately after their programme participation has been approved. This will mostly happen in FY 2022, ie, within the next year. The capex itself will create new jobs even before the actual manufacturing commences.

While eventually, textiles and mobile sectors may contribute to most manufacturing jobs under this programme, the initial capex will be seen in automobile, batteries, mobile and food processing industries.

Of course, for any national programme to work in India, many stars need to align. Federal cooperation tops the list of the prerequisites for any new investments to fructify. 2020 has been a strange year for Indian federalism. On one hand, there has been meaningful cooperation between Centre and the states during the Covid-19 pandemic. On the other hand, several states have overtly or covertly opposed or delayed new infrastructure creation as well as central welfare schemes.

The PLI programme is indeed ineluctable in purely its business rationale. But states will also need to do some heavy lifting in terms of maintaining law and order, providing local infrastructure, not locally complicating soon to be implemented new labour codes and put a lid on localised corruption.

Time is of the essence. This is true for the central government notifying the PLI programme for all sectors, choosing the champion firms to back. This is also true for the states to get on with the nitty gritty of land allocations, enabling permits and a facilitative operating environment.

Henry Ford, the founder of the Ford Motor Company had once remarked — “Time waste differs from material waste in that there can be no salvage. The easiest of all wastes and the hardest to correct is the waste of time, because wasted time does not litter the floor like wasted material.”

If the PLI programme does not materially change India’s manufacturing fortunes, quite likely, nothing else will.

The author acknowledges the Credit Suisse report titled India Market Strategy – PLI Schemes: A new pro-growth template for India’s Industrial Policy for inputs to this article.