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Production-linked incentives: A well-designed scheme

One little-noticed scheme is bringing large manufacturing capacity to India. Lost in the news shuffle caused by the pandemic, the government’s production-linked incentive scheme (PLI), instituted in April 2020 for large-scale electronics manufacturing in India, has gained significant traction over the past year. It offers a simple and direct incentive based on incremental sales, designed to boost domestic manufacturing and attract large investments in mobile phone and specified electronic component manufacturing units. In November 2020, the PLI scheme was extended to ten more sectors, including food processing, battery storage, automobile components and specialty steel.

The PLI scheme is designed with four objectives: 1) Target specific product areas; 2) Introduce non-tariff measures in order to compete more effectively with cheap imports; 3) Blend domestic and export sales to make manufacturing competitive and sustainable; and 4) Promote manufacturing at home while encouraging investment from within and outside India. The reason it has caught on is that the application process is not complicated, and the incentive offered is very simple and tied to conditions that are specific and easy to calculate. The incentive is 4-6% of incremental sales with a defined base year.

Incentives for electronics have been availed by several firms, including Samsung, Foxconn, Hon Hai, Rising Star, Wistron and Pegatron. Of these, Foxconn, Hon Hai, Wistron and Pegatron are contract manufacturers for Apple iPhones. Among Indian mobile phone companies, Lava, Micromax, Padget and Optiemus have been approved as beneficiaries. In the pharma sector, 130 companies have submitted expressions of interest, particularly as the incentives relate to active pharmaceutical ingredients (APIs) and medical devices. In the electronic components sector, companies like Ascent Circuits, Visicon, Neolync and Vitesco have applied. If all these companies deliver on their projections, the incentive payments would total about ₹2 trillion. The biggest chunk of that is for automobile and auto component companies ( ₹57,000 crore), electronics and components ( ₹51,000 crore) and pharmaceuticals and APIs ( ₹15,000 crore). Of the companies that have been in the programme the longest, only Samsung has been able to meet its investment and production criteria. Other companies are now petitioning the government to move the benchmark year forward by declaring the pandemic as a ‘force majeure’ event.

Globally, the incentivization of manufacturing mostly takes a handful of different forms: 1) Special Economic Zones: by creating special jurisdictions, tailored logistics and specific incentives, many countries have boosted manufacturing, most notably China in its Pearl River Delta; 2) Tax-based and credit-based approaches: Many countries, particularly those with federal structures, offer credit and/or tax incentives in their provinces to attract investment and employment; and 3) Productivity and research and development-based approaches: Countries have chosen to incentivize technology clusters (advanced batteries in China, for instance, and nano-technology in the US) and research in specific areas like plant biology or the human genome.

India’s PLI scheme resembles the ‘piece rate’ method, which has actually been in decline worldwide. In this concept, which dates back to an era when it was common for producers to make only one product off an assembly line, teams and companies were incentivized to raise output. As manufacturing grew more complex, incentives grew in complexity as well, and generally today focus on productivity and quality rather than quantity.

India’s quantity-based PLI scheme appears to be one-of-a-kind. Its elegance is that it has been fully thought through, and is extremely simple in its incentive construct. Think of it as a ‘subsidy’ for sales; i.e., a straight boost to the top-line. Tax incentives matter only when companies become profitable. Credit incentives often turn into non-performing assets. Revenue incentives kick in immediately and encourage companies to get off the investment fence. If companies invest, then employment and development in that region follow, and with incentive payments, a virtuous cycle sets in. The scheme has been carefully constructed to adhere to World Trade Organization (WTO) rules. By its very construct, the PLI scheme does not link the eligibility or quantum of its subsidy to exports and local value addition, thus making it WTO-compliant. Its details (for instance, offering the subsidy to phones with price tags of over ₹15,000) influence companies to commit themselves to exports and local value-addition targets, but indirectly.

After a string of botched implementations (demonetization, goods and services tax), the government has got a major scheme right. It should go all out to enable all companies to meet their targets. Given the way the scheme is structured, the selected companies are large and fully capable of taking care of their own needs. The government can ease their way by further improving logistics, ensuring water and electricity, and generally enabling companies to produce and get their products to market. This will not only work in favour of employment and production, but also kick-start private investments that have remained anaemic for over four years now. Livemint

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