A pro-growth turn in government policy

The growth impact of PLI schemes could start showing up in FY22

Total central government spending in FY22 should be unchanged from the government’s revised numbers for FY21, with the pandemic-triggered allocations to save lives and firms replaced by allocations to water and sanitation, affordable housing and vaccinations. Even though these have stronger and lasting effects on growth, will they be sufficient to bring the economy to its pre-pandemic path? Missing from this debate is the growth impact from the production-linked incentive (PLI) schemes announced in mid-November for 10 new sectors.

They were the first sign of a pro-growth turn in government policy. Three PLI schemes had been announced before that, in handsets, bulk drugs and medical devices, but the underlying motives were different. The last two targeted self-sufficiency, triggered by the government’s alarm at foreign suppliers of essential healthcare items pulling back from committed orders in the early days of the pandemic, as they served their own countries’ needs first. The one on handsets seeks to increase handset assembly in India for exports, and promising as it is, it is mostly the next phase of the PMP (phased manufacturing programme in electronics) launched a few years earlier.

It was the launch of PLI schemes for 10 additional sectors— using the template of the first three — that was a significant departure from the norm. The government’s unprecedented move to provide significant incentives to companies if they cross pre-specified output targets is not the only novelty. An equally important change is in the distribution of incentives. In earlier schemes, if, say, Rs 100 was available for incentives, and there were a hundred firms, each would get a rupee each. While this appeared fair to these hundred firms, it did not help growth, and was thus unfair to the millions of taxpayers funding these incentives. In PLI schemes, on the other hand, the government pre-selects a few (say five or 10) of these firms, who get Rs 10 each, but only if they deliver on some objective performance criteria. Even more interestingly, if 20 firms apply for 10 slots, the largest 10 are to be selected.

While these are PLIs, the sectors chosen are mostly where a meaningful part of production is already exported, such as automobiles and textiles. Any incremental production would thus be exported: In such a situation, larger firms are likely to be more capable of competing globally, and efficiently utilising the incentives to boost India’s share of global trade. Export incentives are not compliant with the World Trade Organization norms, but PLIs are.

About Rs 1.46 trillion worth of incentives has been made available in these sectors over five years: The PLI for handsets runs from FY22 to FY26, and the rest from FY23 to FY27. Details are not known yet for the 10 sectors, but the template appears to be provision of 5 per cent to 10 per cent of revenues above a certain annual output level and some threshold for additional investments.

illustration: Binay Sinha

One may wonder if a 5 per cent incentive would suffice. It can, in our view: The incentive is on value of output, and not value-added, making it attractive for downstream companies, as assembly costs are generally not more than 10 per cent of manufacturing value. For a product where assembly is 10 per cent of value, a 5 per cent incentive would mean a 50 per cent support to the assembler. Thus, assembly, the most labour-intensive part of most supply-chains, can be attracted to India in sectors like electronics and textiles. In food processing, it may help raise India’s share of global exports and thus provide an outlet for rising food surpluses.

The incentives are also time-bound, like they should be for any “infant industry” support scheme. The underlying assumption is that in five years the industry can reach a scale where it can survive without the incentives: The infant being weaned off mother’s milk, so to say. To achieve this, local supply chains must develop to provide inputs for these sectors, like electronic components for handsets and laptops, or automotive components for car manufacturers. Indeed, a critical measure of their success would be the development of these suppliers.

These are early days, with details of the schemes for the 10 sectors still not finalised. Deciding on the right level of incentives can be challenging: Not too little, or else the industry would not be interested, and not too much, or else the government may end up routing taxpayer funds to a few companies (the adventures of Goldilocks come to mind). Various responsible ministries appear to be in consultation with industry bodies, who themselves must come to a consensus on where incentives must go. For example, some may want a large part of the automobile PLI to be allocated to electric vehicles, whereas others may want more for car production (and hence exports) to maximise impact on gross domestic product.

While it is in the companies’ interest to sound disinterested so that the government makes the schemes more attractive, suitably designed schemes can get competition to whittle down this arbitrage. Firms also realise that a competitor gaining these incentives could drive it to a different competitive level in terms of size in five years. State governments are also competing to attract companies, promising cheap land, goods and services tax benefits, and speedy approvals.

Some observers have correctly raised risks that a more interventionist state can engender: Crony-capitalism (the scheme details can be designed to benefit some firms), resource misallocation due to lack of knowledge (who decides which sectors must get the incentives?), scope creep (as news of the PLI schemes has spread, there appears to be intense lobbying to expand these), requests for relaxation of targets (some firms are already requesting an extension to timelines, given the lockdowns during Covid), and rent-seeking (are targets sufficiently objectively defined to minimise discretion in paying out incentives?). Indeed, policymakers must guard against these, but at the same time, strong network effects in most supply chains mean that these schemes could meaningfully accelerate investments and growth. “Infant industry support” has been part of the policy toolkit of many nations in history.

We estimate that even without building in second-order effects, these schemes could add 1.7 per cent to FY27 GDP, implying a 0.3 per cent to 0.4 per cent addition to annual GDP growth till then. The direct impact is likely to be more on labour (we estimate 2.2 million new jobs) than capex, but as component supply chains sprout closer to the location of final assembly, even aggregate investment may start to pick up. The impact may be sooner than one thinks too: Companies selected for these schemes running from FY23 onwards would need to start building their factories in FY22 itself.

The writer is co-head of APAC Strategy and India Strategist for Credit Suisse