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Dislodging Vietnam and China and making Make in India a reality

ICEA argues for a strategy shift and conducive investment environment, higher than China and Vietnam to get the handset manufacturers to shift to India, and set up facilities here.

The Indian electronics market is growing at a fast pace and is expected to reach USD 150-175 billion by 2025 from a level of USD 69.6 billion in 2018.

Electronics and System Design Manufacturing is of strategic importance and a high priority area for India because of its ever-expanding influence on various facets of modern living, as well as its potential to generate sizeable direct and indirect employment.

Mobile manufacturing in India started with Nokia, Samsung, Motorola, LG, and Sony Ericsson in the mid-2000s and grew steadily between 2008-2012, reaching over 155 million handsets per annum. Nearly 70 percent of the mobile phones valued at ₹12,000 crore were exported in 2012. However, due to a freeze on assets as a consequence of a tax dispute, Nokia stopped production in 2014. As a result, the component ecosystem that Nokia had built in India had to shut down. In 2014, India’s production dipped to just 58 million units, with marginal exports.

In a bid to rebuild the mobile phone industry, the Indian governemnt implemented certain subsidy schemes and an import substitution strategy Phased Manufacturing Program (PMP) in 2015. Later in 2017, post GST, basic custom duty at the rate of 10 percent was imposed on mobile phones and this created a positive arbitrage of 10 percent for mobile phones manufactured in India. Current rate of basic custom duty on mobile phones is 20 percent.

Coupled with CapEx subsidy under the Modified Special Incentive Package Scheme (M-SIPS), Merchandise Export Scheme of India (MEIS) and support from state governments, the mobile phone manufacturing activity in India has gained pace. There are 268 factories manufacturing mobile phones, chargers, battery packs, wired headsets, and other components. In 2018-19, India manufactured 290 million mobile phones, valued at ₹1,81,200 crore.

Though these are impressive production levels, India’s domestic demand is high and exports very small compared to the major exporters in the world. India has the potential for becoming both a major producer and exporter of mobile phones in the world, provided appropriate policies are implemented for achieving this potential.

Ambitious targets of national policy on electronics, 2019
The National Policy on Electronics 2019 (NPE 2019), the successor to the National Policy on Electronics 2012 (NPE 2012), lays special emphasis on promoting the growth of mobile manufacturing. The ambitious target set for 2025 encompasses producing 1 billion mobile handsets in India worth USD 190 billion, of which 400 million phones valued at USD 80 billion would be sold domestically and 600 million mobile phones worth USD 110 billion would be exported.

By 2025, NPE 2019 hopes to achieve 3.4x (1000/290) the volume and 7.6x (190/25) the value and 69x (110/1.6) the value of exports achieved in 2018-19. To achieve these targets, India will need a coordinated work plan between the government and the private sector, including large lead firms, who can help build an ecosystem for component/assembly manufacture in India along with R&D, and higher domestic value addition.

Highly conducive investment environments of Vietnam and China
Considering the scale of investments, the technology requirements and the imperative of creating an ecosystem to cater to the domestic demand and exports, the importance of attracting investments, especially from global firms, assumes special significance.

The Indian Cellular and Electronics Association (ICEA) has identified 10 major factors (with different individual weights), that influence investment decisions. A qualitative comparison of India, Vietnam, and China based on these factors has been made. The assessment reveals that Vietnam is 1.7x more attractive for investors, while China is twice as attractive compared to India.

China and Vietnam offer incentives and support policies to investors which makes manufacturing competitive at the global level: Making available quality infrastructure and skills; low charges for use of the infrastructure made available; subsidies for reducing costs and improving competitiveness; improving the ecosystem for the development of the supply chain in the domestic market; ease of doing business; focus on attracting lead firms in global value chains, with additional incentives; and stability of policy, with periodic reviews to revise the incentive and facilitation schemes as required.

The cumulative impact all of these incentives and support schemes in Vietnam and China vis-a-vis India has been estimated. It reveals that the cost reduction or competitiveness gains for investors ranges from 9.4 percent to 12.6 percent for Vietnam and 19.2 percent to 21.7 percent for China.

In addition to creating a strong export base, these policies also aim to enabling creation of large domestic firms, particularly in China. In India, this would be eminently possible particularly for the entry-level smartphones, provided appropriate policy/incentivization support is made available.

Limitations on domestic value addition
A common trend visible across geographies is that 100 percent value addition for a mobile phone does not take place in a single country. Even in the case of Vietnam and China, value addition in mobile phones is 23 percent and 35 percent, respectively. Value addition in China is 50 percent for smartphones and 90 percent for feature phones.

The results of the PMP, focused on increasing domestic value addition, have begun to plateau. In spite of tariff intervention, manufacturing operations of five assemblies/ components could not be started. The PMP-2019 for two assemblies – display and touch panel/cover glass assembly – was deferred as it was understood that India should not increase the cost base of the domestic industry and make it less competitive since the focus was and is shifting to exports of CBUs.

PMP cannot trigger large-scale shift of component manufacturing to India as it is a function of scale of production and the requisite skills and operational conditions to produce complex technological parts and components. The domestic market in India is not big enough for the component manufacturers to shift base to India. While the initial phases of PMP focused on relatively lesser complex products, now the products covered by PMP are not easy to produce within the country. As a result, it is difficult for the strategy of import substitution aimed at increasing value addition to succeed. In this situation, an import substitution strategy cannot arrest the rising import bill of components required for the strong domestic demand for mobile phones.

Uncertain investment environment in India. The Indian export subsidy measures challenged by the US in the World Trade Organization (WTO) were: MEIS; Exports Promotion Capital Goods Scheme; Duty Free Imports for Exporters Program; Export Oriented Units Scheme and sector specific schemes; and Special Economic Zones (SEZs). The challenge at WTO has created uncertainty in the investment environment and companies are deferring the decision to invest in India till there is clarity on the continuation/replacement of the above schemes. The WTO in its panel report has held the five subsidies schemes to be inconsistent with the Subsidies and Countervailing Measures (SCM) Agreement, on account of being prohibited subsides that are contingent upon export performance. In view of the same, the WTO has stipulated time periods for withdrawing these schemes-90 days for DFIS, 120 days for MEIS, EPCG, EHTP, and 180 days for SEZ scheme.

Strategy shift needed
In view of the disabilities, the following recommendations may be proposed: continuing with or modifying existing policies that are considered beneficial; new schemes or initiatives to offset disabilities; schemes for enhancing competitiveness and ease of doing business.

The support schemes implemented by China and Vietnam, the concerns and suggestions of the Indian industry, an incentive of 8-10 percent of the turnover would be adequate to attract global scale investment that would achieve the production and export objectives of NPE 2019.

For the huge increase in domestic production and demand, net foreign exchange outflows would continue unless exports and domestic value added are increased. If exports are 130 percent of the domestic production and value addition is 35 percent, then net foreign exchange earnings could become positive. Hence, the focus of government policy should be on export promotion and not on import substitution through greater value addition; even the increase in domestic value addition requires large additional investment and production, with access to a global demand much larger than India’s domestic demand.

China (61%) and Vietnam (11%) together account for about 72 percent of global mobile phone exports. The manufacturing operations of the lead firms (i.e., global large firms that control global value chains) are also based in China and Vietnam. Thus, for India to gain an appreciable share of exports, a substantial part of the manufacturing operations of the lead firms must shift to India.

For this to happen, India needs to position itself as an attractive manufacturing and exporting hub, by offering suitable incentives and improving ease of doing business. This strategy would yield significant positive results through achievement of economies of scale, technological upgradation spurred by large global firms, and a strong push to domestic capacity building. For this, an ecosystem involving both domestic and global firms will need to be nurtured.

Way forward
India’s domestic mobile market is currently to the tune of USD 25 billion with exports amounting to USD 1.6 billion. This translates to a mere 0.5 percent share of the global exports market of USD 283 billion. The mobile export market is currently being served by two countries – China and Vietnam. The trade issues between China and USA have created an opportunity for some of the largest mobile manufacturing companies and their ecosystems to consider shifting their manufacturing out of China. India should aim to increase scale and tap the export market. Increased exports will lead to increase in foreign exchange flow into the country. This would ensure a significant contribution to India’s GDP.

Even though India has the potential to serve the export market but due to various disabilities including cost of production, lack of matching incentives, logistics, infrastructural and procedural deficiencies, mobile manufacturing companies consider India as less attractive compared to Vietnam and China. Vietnam is considered 1.7 times and China twice more attractive than India.

In order for India to compete with Vietnam and China, India needs to address these disabilities. However, this will take time, therefore India will need to provide incentives to offset these disabilities. These incentives cannot merely equal what Vietnam and China are offering. These incentives have to be better than the incentives provided by both countries or at least those that are being provided by Vietnam. Setting up manufacturing in a country is a long-term decision which involves huge capital infusion, therefore, unless there is a significant cost advantage, the manufacturing companies will not have any incentive to shift their manufacturing facilities to India. The facilities in India will be a combination of small number of new facilities and large number of facilities that will shift from existing destinations. The shifting process and consideration is even more difficult.

Finally, countries like China are acutely aware of such pressures and therefore they are willing to do more than earlier to retain high tech investments which are labor intensive, high value and have massive future growth potential. The threat to these companies from the trade fight between US and China is from US tariffs, not from the Chinese or Vietnamese administration. In fact, China and Vietnam will make a deeper effort to retain these companies both by improving the environment and striking special deals.

Currently, by comparison it is not attractive to manufacture in India primarily because there are disabilities, on one hand and on the other, there are no matching incentives to export from the country.

Earlier, large manufacturing companies which committed to investing ₹1 crore to ₹5000 crore were entitled to 20-25 percent capital subsidy under M-SIPs. On one hand, M-SIPs has ended, on the other, export-linked incentives like MEIS are under WTO contention. MEIS provided 4 percent incentive to mobile exporters and component manufacturers received an incentive of 2 percent. In light of the WTO dispute, it is likely that MEIS will be phased out soon.

The government has constituted a committee under the chairmanship of CEO, NITI Aayog to create an enabling policy framework to identify disability vis-à-vis other potential investment destinations, opportunity arising out of trade dispute and possible fiscal and non-fiscal interventions compliant with the WTO mandate. Recently, the Ministry of Finance (MoF) has taken some measures to address some of the disabilities. The Finance Minister Nirmala Sitharaman recently reduced the Corporate Income Tax for new manufacturing companies to 25.17 percent. However, where China and Vietnam are concerned, there are sufficient examples that they are willing to offer negotiated CIT or zero CIT for multiple years since they are looking to negotiate with only two or three companies in this space. Therefore, the impact of this announcement in effect in the handset and component sector will be in the range of 0.3-0.5 percent at best.

In addition to the corporate income tax, MEIS has been replaced by another scheme called Remission of Duties and Taxes on Exports (RoDTEP). The MoF has allocated a sum of ₹50,000 crore towards RoDTEP. The handset industry will have a legitimate claim to this, however it remains to be seen whether RoDTEP will be in the same range as MEIS for handsets and component manufacturers.

These measures are not sufficient to address the disabilities of India’s manufacturing. In light of the existing disabilities coupled with withdrawal of both M-SIPs and MEIS, the government must consider an incentive which is a combination of: Corporate Income Tax + RODTEP + Production Subsidy + Others.

The government must ensure that the incentive formulation is expedited. It is crucial that MEIS support is not discontinued under any circumstance before introduction of an alternative. A seamless transition from MEIS regime to the new regime will ensure that investment decisions are taken without policy uncertainty. There is clear evidence that the mobile handset sector has performed exceedingly well (800% growth in exports) after the increase of MEIS from 2-4 percent. If the policy support of both the M-SIPs and MEIS are taken away, exports are sure to collapse. The much touted Make in India story needs the government to step up and provide incentives to the mobile manufacturing sector to leverage the manufacturing and trade global winds without any disruption.

It is high time that India positions itself as an attractive manufacturing and exporting hub and creates a vibrant ecosystem for mobile phone production.
Based on ICEA’s Study on Disabilities and Smart Policy Measures

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