India put up tariff walls. To revive factories, it must bring them down

By Andy Mukherjee

Now that a jobs crisis is weakening his hold on power, how serious is Prime Minister Narendra Modi about reviving India’s factories? We will know in next week’s budget, a chance to remedy a disastrous lurch toward protectionism.
 

Without fixing that folly, the country could miss an opportunity to join key global supply chains, such as those for smartphones and consumer electronics. A large home market will keep assembly lines busy — but crucial parts will be made by Chinese and Vietnamese labour. What could easily be a $100 billion-plus boost to annual factory production by the end of the decade might fail to materialise.

 

Trouble began in 2018 with New Delhi’s “calibrated departure” from more than two decades of greater trade openness, and an increase in import duties on mobile phones to 20 per cent from 15 per cent. Soon it was the turn of components: In 2020, the tariff on printed circuit board assembly and display units was raised by 11 percentage points.

A downward spiral in China-India relations, following border clashes the same year, didn’t help. The Modi administration made it mandatory for Chinese firms to obtain permission before investing in India. Visas for Chinese engineers started taking four to five months to process. 

On paper, the idea was to prevent opportunistic acquisitions of vulnerable firms during the pandemic and promote local industry. However, the measures haven’t had the intended effect. Quite the opposite, in fact.

Yes, India manufactured $102 billion of electronics last year, led by mobile phones, up from $60 billion in 2018. But that’s mostly just putting together the finished goods. From the lithium-ion cell in batteries to the precision machine work needed in phone casings, and the fabrication required in display units, most of the actual value is being added in China, South Korea, Japan, or Vietnam.

According to a recent report by the Confederation of Indian Industry, it would be 8 per cent to 10 per cent more expensive to make flexible printed circuit boards — the kind that can be folded to fit into tight spots — locally. No wonder then that even with booming smartphone exports, India is becoming a larger net importer of electronics.

The Modi government’s  answer to this cost disadvantage has been to offer a 4 per cent to 6 per cent subsidy on domestic production. But as the CII, the county’s biggest lobby group, noted in its report, the fiscal support is “grossly inadequate” to offset the gap with China and Vietnam. “Industry players are seeking a low tariff regime,” it said. 

There has been a lot of talk — but little progress — about becoming self-reliant in semiconductors. What policymakers should pay more attention to is less capital-intensive production. Taken together, circuit boards, cameras, displays, batteries and enclosures account for more than two-fifths of a smartphone’s production cost. Yet, very little domestic capacity has come up to make these at home because of a faulty trade policy.

Most of the stuff that goes into making electronic components can be imported duty-free into China and Vietnam from free-trade partners, whereas a 10 per cent to 15 per cent tariff is the norm in India. To think that restricting imports will encourage domestic production is an outdated idea. All it does is keep the country out of global supply chains that require free movement of goods — and people — across a seamless international network of factories. Make it too onerous for Chinese firms to invest (or their engineers to visit), and the production base they could help move from China would remain where it is. Which is why India had an $83 billion goods trade deficit with the People’s Republic last year, up from $55 billion in 2018.

The jobs crisis in the most-populous nation has assumed alarming proportions. Young graduates are nine times more likely to be unemployed than those who can’t read or write. Even outside the national capital, politicians are panicking and pandering to populist causes. Karnataka, home to the tech hub of Bengaluru, has invited a huge backlash by trying to introduce a law to reserve half or more of private-sector jobs in the state for locals.

Just as India Inc. is now raising its voice to keep internal markets free, it should also have insisted on more external openness when autarky crept back into trade policy six years ago. Back then, however, captains of industry joined the chorus around Modi’s slogan of self-reliance even as the promised revival in manufacturing and factory jobs continued to elude.

An unexpected loss of parliamentary majority for the ruling party has come as a wake-up call. According to media reports, Tuesday’s budget could tweak the government’s industrial policy. Its five-year, $24 billion production-linked incentive program might be supplemented with subsidies for firms that hit employment targets.

Yet, no amount of additional fiscal resources will help in the presence of high tariff walls. The ongoing shift in global supply chains, triggered by the pandemic-era disruptions and a growing estrangement between Beijing and Washington, is a once-in-a-generation opportunity for New Delhi. But it won’t last forever. The time for a course correction is now.

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Disclaimer: This is a Bloomberg Opinion piece, and these are the personal opinions of the writer. They do not reflect the views of www.business-standard.com or the Business Standard newspaper