From electronics to semiconductor, MNCs in search of policy stability

Global manufacturing majors seek a less unpredictable policy environment before investing more 'China-Plus-One' dollars in India

Prodded by their automobile clients to hedge their bets against China global Taiwanese-headquartered outsourced semiconductor assembly and test companies (OSAT) are scouting for other Asian destinations to shift part of their production. Their favourite alternatives: Malaysia, Vietnam and the Philippines. Note, India is missing from that list. And this is despite an attractive financial incentive scheme for OSAT players.

The reason, said a senior executive of a US chip company who had a meeting in Taiwan just a few weeks ago, is that “they want more predictability in government policy because they plan to put in big money.” OSAT players, he argued, want some alignment by the Indian revenue department to global incentives offered in countries competing to attract foreign investment.

There is no doubt that the Indian government is leveraging like never before the opportunity opened up by geopolitical tensions between the US and China. It is pushing hard to convince global companies to shift part of their manufacturing to India and make it one of their export hubs. But US, European and Asian multinationals are spoilt for choice with a bevy of Asian and Latin American countries also wooing them aggressively -- and offering them what they want.  

In particular, electronics and semiconductor conglomerates are seeking long-term policy stability. On top of their agenda is low and stable tariffs that are not tweaked on an ad hoc basis and impact their viability, forcing them to rework their plans every so often.

Nor do they want coercive tax regimes followed by long legal battles against the revenue department in highly import-intensive export businesses. This is what happened with Chinese mobile brands. Xiaomi, for example, which was raided for alleged foreign exchange regulation violations and is fighting a legal battle against attachment orders by the income tax department, which has seized its fixed deposits. Or Vico, which was raided for alleged money laundering. And even South Korea’s Samsung, which has chosen Vietnam as its global hub, was subject to investigations for alleged duty evasion.

Investors are asking for deeper consultation between the nodal ministry and the revenue department so that they are in sync. And they are seeking more liberal labour laws (especially longer and more flexible work hours) as an essential condition to investing.

An interim study sponsored by the India Cellular and Electronics Association (ICEA) of 120 MFN (most favoured nation) tariff lines for electronics inputs shows that India is top of the table at 9.9 per cent compared to Vietnam (5.6 per cent), Mexico (3.5 per cent), Thailand (5 per cent), Malaysia (6.2 per cent) and the Philippines (3.9 per cent). This puts India at a big disadvantage with these competitors for global conglomerates’ “China-plus-one” investment dollars. Importantly, despite the geopolitical tensions, China still has an attractive average MFN tariff of 3.2 per cent.

The difference becomes even more striking if the average tariff is weighted for Free Trade Agreements (FTA). It is only 1.1 per cent in Vietnam compared to 7 per cent in India. Vietnam has signed up FTAs covering over 56 countries (the latest is with EU) aggressively lowering tariff barriers to transform the Indo-Chinese nation into a supply chain strategic hub for global giants.

India is a laggard in the FTA game, opting out of the 15-nation Regional Comprehensive Economic Partnership (RCEP), the world’s largest free trade agreement, in 2020. That apart with no restrictions on Chinese companies Vietnam has also been able to woo 30-odd supply chain majors to shift capacity from China. On the other hand, Beijing’s incursions on the northern border prompted India to slap restrictions on Chinese investment, which is likely to delay the creation of a robust electronics supply chain.  

Complicating matters are frequent policy changes that disrupt global manufacturers’ costing. All of them had lapped up the Manufacture and Other Operations in Warehouse (MOOWR) scheme of 2019 with its focus on exports under the “Make in India” programme, which included the Production Linked Incentive (PLI) schemes because it provided for deferred payment of import duties to reduce capital costs and also exemption from Goods and Service Tax (GST) for exports.  

But the last Budget suddenly proposed to withdraw the GST exemption on inputs imported for export production. Global manufacturers have taken up the issue with the government but a notification to reverse this withdrawal is still awaited.

“This ad hoc measure will impose a 2 per cent additional cost, so more working capital is now required because the GST refund for exports takes months to come,” said a senior executive of a leading global player whose contract manufacturers use this route.

Such a “critical change in the scheme that serves as a major instrument of manufacturing and exports,” he added, “disturbs the cost structure and may force investors to rethink expansion plans in the country”.

The government’s objective of tinkering with tariffs to incentivise local manufacturing of components has also proved disruptive. For instance, at the end of April, the finance ministry abruptly increased the duty on open cells, used in LCD and LED displays for televisions, from 5 to 15 per cent. ICEA wrote a strongly worded letter to the ministry of electronics and information technology (Meity) saying the “sudden, overnight” move “without the consultation with the industry” or the nodal ministry would be a “threat to the Make in India initiative” for LED TV manufacturing. The finance ministry has since rolled back this provision.

Many complain that the incentives the government is offering under PLI are being taken away via higher tariffs and taxes – ironically to finance the allocation earmarked for PLI. For instance, the announcement of a mobile device PLI scheme in 2020 was followed within a day by an increase in GST on those devices from 12 to 18 per cent. “What it meant was that the government offered $5.1 billion as incentive for five years but financed the entire amount through a GST increase, which mobile device players passed on to consumers within two years. It’s a short-term approach,” said a senior executive in a mobile device company.

The principal apprehension is that tax aggression could seriously unsettle electronics manufacturers’ import-intensive export strategy. More so because value addition even in PLI schemes for mobile devices ranges from 15-20 per cent.

Many recall how Nokia in 2014 was forced to suspend manufacturing after a lengthy dispute with tax authorities. Or how Samsung is still awaiting disbursements of money under the PLI scheme for mobile devices after two long years owing to differences in policy interpretation. And many companies are worried about the plethora of notices sent to importers followed by demands for additional duties, which have to be paid up-front. Challenging such imposts in the courts sharply raises the costs of doing business.

These are glitches that need to be resolved quickly if India wants to move ahead in the global sweepstakes for becoming an alternative factory to the world.