Manufacturing Missteps: The High Cost of India's PLI Program

 

Despite Narendra Modi's ambitious PLI scheme, India's manufacturing sector remains sluggish, with exports in critical industries like textiles and electronics growing at or below the rate of GDP.

In the early 1990s, India embarked on a significant shift from its swadeshi (self-sufficiency) principles, embracing liberalization and global integration. This transition saw the scrapping of subsidies and a dramatic reduction in import levies, leading to a notable drop in average tariffs from 125% in 1991 to 13% by 2014. As a result, exports soared, transforming India into a services superpower. However, despite these advancements, India's role in global manufacturing supply chains remains minimal, particularly in sectors like generic drugs and electronics. Narendra Modi, who is likely to secure a third term as Prime Minister, faces the challenge of addressing this imbalance through his ambitious "production-linked incentives" (PLI) scheme.

Launched in 2020 with a hefty price tag of 2 trillion rupees ($24 billion), the PLI scheme aims to incentivize firms in 14 crucial industries, such as electronics and textiles. The scheme offers a handout equivalent to 4-6% of the value of any sales above pre-2020 levels, contingent upon meeting specific conditions. The government's intention is to stimulate growth and exports by making India a more attractive destination for manufacturing.

Initial reports from the government have been promising. The scheme is credited with nearly $13 billion in investment and the creation of 700,000 jobs. The Annual Survey of Indian Industries reveals that the largest and most productive manufacturers are expanding faster than smaller, less dynamic ones. However, these figures prompt a critical question: how much of this progress can be attributed directly to the PLI scheme?

The analysis of export data for five major industries reveals a mixed performance. On the positive side, phone and electronics exports have surged ahead of GDP growth since the introduction of PLIs. Morgan Stanley highlights that India's share of global electronics exports has climbed from 1% a decade ago to over 3%. Phone exports, in particular, have more than tripled in value since 2019, with 14% of iPhones produced in the past year reportedly assembled in India, a significant increase from 7% the previous year.

However, beyond electronics, the outlook is less encouraging. In other industries, exports have grown at or below the rate of GDP. The textile sector, which is second only to agriculture in terms of employment, has seen exports decline. Former Reserve Bank of India Governor Raghuram Rajan has pointed out that the boost in phone exports is primarily driven by the assembly of imported parts, a process that contributes minimally to India's GDP. Rajan even suggests that once the cost of subsidies is factored in, the PLIs might not have had a net positive effect on GDP.

A significant issue is the lack of coherence among government policies. Despite the PLI scheme, India's average tariff has risen from 13% to 18% over the past decade, a move aimed at encouraging local consumption and production. However, this increase in tariffs on intermediate inputs undermines the subsidies provided through the PLIs. Badri Gopalakrishnan, an economist formerly with the government’s think-tank, notes that these tariffs have absorbed some of the benefits intended by the PLI programme. Pranay Kotasthane of the Takshashila Institution warns that India is attempting to "globalize and localize" simultaneously, suggesting that prioritizing globalization might be more effective.

Administrative inefficiencies further hamper the scheme's effectiveness. Despite its high profile, the PLI programme is managed by committees in different ministries, leading to inconsistent execution. Firms frequently encounter onerous requirements and risk-averse administrators. Consequently, only $1 billion of the original $24 billion has been disbursed, reflecting the scheme's bureaucratic sluggishness.

Critics argue that the PLI programme might distract from more fundamental reforms. In the mobile phone industry, the star performer, it is challenging to attribute Apple's investment solely to financial incentives. Apple’s strategic interest in diversifying its production base beyond China suggests it might have invested in India regardless. An industrialist benefitting from PLIs notes that the scheme's primary value lies in signaling the Indian government's commitment to regulatory reform, reducing uncertainties related to land acquisition and energy access. Thus, broader regulatory improvements across the board, rather than targeted incentives, could potentially yield more significant benefits.

Despite these challenges, it would be premature to declare the PLI scheme a failure. History shows that countries like China and South Korea began their manufacturing ascent in low-skill areas before moving up the value chain. India's initial success in electronics, driven by assembly, might set the stage for more advanced manufacturing in the future. Apple’s plans to boost iPhone production in India could attract other suppliers, potentially establishing a robust electronics industry.

Recent adjustments indicate that India’s strategy is evolving. The electronics PLI has been streamlined to reduce bureaucratic hurdles, an approach the government plans to extend to other industries. The latest budget includes a reduction in tariffs on imported electronics components from 15% to 10%, addressing concerns about high import costs.

However, if the PLI scheme is to avoid becoming a costly misstep, further improvements are essential. Streamlining administrative processes, aligning tariff policies with industrial incentives, and focusing on comprehensive regulatory reforms could transform the scheme into a genuine catalyst for growth. Without these enhancements, the risk of squandering trillions of rupees remains high, jeopardizing India's ambition to become a global manufacturing powerhouse.