What is the best way to promote electronics manufacturing in India? Will free import of all inputs help?

A report ‘Globalise to Localise’, released on August 29, makes bold recommendations for increasing electronics exports. It says India should allow duty-free import of all inputs and should not insist on any local value addition. Also, India should stop giving any preference based on value addition to local firms in government purchases.

The Indian Council for Research on International Economic Relations (ICRIER) and the India Cellular & Electronics Association (ICEA) have prepared this Report.

At variance with the current government strategy, the report’s recommendations are bold, and hence merit an examination.

India’s current policy framework allows duty-free imports to exporters. A firm can import needed inputs or capital goods to manufacture and export electronic items using the Advance Authorisation and Export Promotion Capital Goods schemes. Also, the firm can use SEZ, 100 per cent Export Oriented Units, or manufacture under a Customs bond scheme for duty-free imports with no localisation requirements.

But the government policy differs for firms making and selling products in the domestic market. The critical schemes are: (i) the Phased Manufacturing Programme (PMP), (ii) preference in government purchases based on local value addition, and (iii) the Production Linked Incentive (PLI) Scheme.

The PMP for mobile phones seeks to build domestic capacities through calibrated import duty reduction of components. This involves gradually increasing import duties. In contrast, the Report recommends withdrawing import duty on all inputs.

The Public Procurement norms for electronics enable local firms who do 50 per cent value addition to get preference in government purchases. The Report recommends that the government should do away with all such preferences to provide a level playing field for imports.

The PLI Scheme for smartphones provides a 4-6 per cent cash incentive on the value of a unit’s incremental production over the last year. The scheme expects firms to carry out specific minimum local value addition. The Report wants PLI to continue without local manufacturing or value addition conditions.

Will implementing these recommendations lead to an immediate increase in imports? Will it lead to shutting down of firms doing value-added manufacturing as they come under pressure from imports. This issue needs further study and analysis.

New firms will likely assemble a mobile phone from nearly ready imported kits. They will pack and go as soon as Government incentives disappear. Sounds harsh. Look at a few examples from the recent past:

Recent experiences

One, making smartphones using tax arbitrage. During 2015-17, many firms started assembling smartphones from imported SKD kits. Tax arbitrage provided this opportunity. To promote manufacturing, the government announced a differential tax policy.

Import of components to manufacture phones attracted only one per cent Countervailing duty. But importing for sale attracted 12.5 per cent duty. The arbitrage disappeared with the introduction of GST in July 2017. All such firms disappeared simultaneously.

The annual loss to the government was ₹5,000 crore on the ₹40,000 crore domestic turnover. The ventures created low paying 40,000 more jobs. Each job cost over an annual ₹12 lakh to the government.

Two, export to get more incentives. Export of mobile phones multiplied eight times in a single year. From $200 million in 2017-18 to $1.6 billion in 2018-19. Reason: the government increased the cash incentive under the MEIS from 2 to 4 per cent. Industry sources say many firms rerouted the same mobile phones many times. The cost of routing was less than 0.3 per cent. The rest made products from ready-to-assemble kits imported from China. The difference in cost of components and finished goods is just 2-3 per cent.

How to promote electronics manufacturing in India?

India’s current exports at about $15 billion are small, compared with China & HK China & HK ($1.2 tillion), Taiwan ($183 billion), South Korea ($148 billion), Singapore ($126 billion), and Vietnam ($123 billion). We need to promote deep manufacturing and not a simple assembly of components. A five-way strategy will help.

5-way strategy

One, invite a few large global anchor firms to set up complete mobile manufacturing in India. Like Nokia did in 2006 when it helped a large number of the component manufacturers to locate nearby. India has a large domestic market, expertise, and export potential to become a significant manufacturing hub for mobiles. Low PC penetration may not justify this strategy for computers at this moment.

Two, encourage component manufacturing units in India. We may start with manufacturing plastics and sheet metal parts and components. These account for 30-40 per cent of the product cost, and India has the required expertise.

Three, create an import credit system for manufacturers. Based on the quantum of production, allow them to import components duty-free for their use. Not every part can be made in India at this point.

Four, set up component hubs near the ports to ensure a prompt supply of components. This will help thousands of units in completing their export/domestic orders. Business logic: high cost of warehousing in China, Hong Kong, UAE, and 4-6 weeks in imports.

Component hubs will be Bonded Cargo warehouses. This will allow vendors to import and store components without payment of duty. The hubs will trigger domestic electronic and IT hardware goods eco-system development.

Five, align the Centre and State incentives. Many States offer significant incentives like a refund of State GST. But an investor considers the government, States, and other incentives together for making a decision. States should keep such sheets ready while devising incentive packages. Today, this is not the case.

We must test drive all recommendations, and adopt policies that serve long-term national interest. We need to eschew the lure of shortcuts.

The writer is a former Indian Trade Service Officer