India’s Reforms- A Game Changer

Summary

In recent months, the Government of India (GOI) has announced several major structural reforms. These include Production Linked Incentives (PLI), Labour laws, farm reforms, and a sweeping privatization & asset monetization program. Once implemented, they will be game-changers- creating new opportunities and challenges for Indian firms in a rapidly evolving economy.

Structural Reforms in India

With the pandemic slowing the economy in 2020-21, the GOI has announced a series of structural reforms to stimulate growth. The major measures are :

1. PLI (Production Linked Incentives)
2. Labour law rationalization
3. Farm sector reforms
4. Privatization of public sector undertakings (PSUs) and asset monetization.

These steps come on the back of several far-reaching reforms implemented in earlier years, such as:

• GST (Goods and Services Tax)
• Lower rates of income tax- 25% (without incentives & exemptions) and 17% for new manufacturing units
• Insolvency and Bankruptcy Code (IBC)

The earlier reforms (GST, Tax rates, and IBC) have already taken root. However, the four new reforms will be game-changers. Their collective impact is likely to be wide-ranging, affecting most sectors of India’s economy.

The PLI Scheme

Announced in 2020 to boost domestic manufacturing, the incentive structure ranges between 2% and 12%  of incremental sales or exports for different sectors and periods, with 2019-20 typically the base year. With this scheme, India aspires to become a global hub for manufacturing taking advantage of the international need to diversify supply chains.

The scheme covers 3 sectors (Table 1) notified in early 2020 and an additional 10 key sectors (Table 2) announced in November 2020 – a total of 13 sectors envisaging an outlay of about Rs 2 Tn over a five-year period.   (Source: PIB).

Table 1: Earlier Notified 3 Sectors

 

The scheme for these 3 sectors has evinced keen interest. Applications have been received and numerous approvals have been given.

• Cell phones: Approvals under the scheme have been granted to five global manufacturers  (e.g. Foxconn and Samsung), five domestic firms (e.g. Lava and Micromax), and six electronic component makers (e.g. AT&S and Ascent Circuits). Once implemented, India will emerge as a major manufacturer of mobile phones for domestic sales as well as exports.
• Active Pharma Ingredients(API): Approvals have been given to 19 companies, including Aurobindo Pharma and Aarti Speciality, for producing a range of APIs with value addition of 70% to 90% across categories. Production is expected to commence from April 2023 with the PLI payable over 6 years.
• Medical Devices: Applications from several firms e.g. Siemens Healthcare and Wipro GE Healthcare have been approved.

Table 2: PLI Scheme- 10 Key Sectors

 

While the details of the scheme as applicable to these ten sectors are still evolving, several significant announcements have been made.

• Advanced Batteries: The subsidy will be linked to production and the achievement of 60% value addition within five years of commencement. Any new technology that evolves over the next 10 years will also be eligible for a subsidy.
• Electronic Products: A scheme for laptops, tablets, PCs, servers and electronic components has been announced where incentives will be paid on incremental output.
• Auto & Components: The incentive is expected to be paid on incremental exports and will cover vehicle manufacturers as well as component makers.
• Pharma/Drugs: The scheme aims to diversify the product mix to complex generics & patented drugs, move up the value chain, and eventually create global champions. Incentives will be given for increased production over a nine-year period till March 2029.
• Telecom Equipment:  The scheme covers the production of routers, Internet of Things (IoT) access devices, radio access networks for 4G and 5G, and wireless equipment.
• Textiles:  The incentives will apply to incremental production in 50 product categories (40 man-made-fiber-based garments and 10 technical textiles) over a five-year period starting FY22. The incentives will be linked to a threshold investment level and incremental turnover.
• Food Processing: Incentives will be based on incremental sales after a committed level of investment for expansion of processing capacity and branding abroad. The products covered are ready-to-cook and ready-to-eat foods, processed fruits and vegetables, marine products, and mozzarella cheese.
• Solar PV Cells: PLI will be disbursed for five years on sales of high-efficiency solar PV modules. The incentive will increase with higher module efficiency and greater local value addition.
• Air Conditioners: The incentive will apply to incremental production of components and subassemblies not currently made in India.
• Speciality Steel: The scheme is likely to be targeted at the production of specific grades of steel that are either imported or where there is potential for exports.

One controversial aspect is the increase in import duties on components and sub-assemblies in several sectors e.g. batteries and solar cells. These duties protect domestic producers and may promote import substitution. But they raise the cost structure and inhibit export competitiveness. They need to be reduced to ASEAN levels over time if India is to become an export hub with a globally competitive cost structure.

Over the next five years, GOI expects corporate India to make incremental investments of over Rs 2.7 Tn under the scheme, generating over $520 bn (~Rs 39 Tn) of additional production, 7.25 mn jobs, and exports of over Rs 13.5 Tn. The largest PLI outlays are for Auto & auto components (~Rs 57,000 Cr), Smartphones & Components (~Rs 41,000 Cr), Advanced cell batteries (~Rs 18,000 Cr), and Pharmaceuticals (~Rs 15,000 Cr).

Labour Laws

29 disparate and occasionally contradictory labor laws have been replaced with four considerably more coherent codes that make labor markets far more flexible and employment friendly. The new labor law gives employers the right to terminate workers in enterprises with 300 or fewer workers (up from the previous threshold of 100 workers). More importantly, it gives states full freedom to raise this threshold.

Gujarat and Uttar Pradesh governments, which had recently wanted to suspend labor laws for three years, can now raise the threshold to, say, 10,000 workers – to encourage large enterprises and create stable jobs. The new labor codes also cut inspector raj, lower compliance burden, and empower women to work night shifts. These reforms are intended to facilitate the setting up of large-scale manufacturing units with the support of state governments.

Farm laws

Farm reforms relate to the marketing of agricultural produce, contract farming, and controls on transportation, storage, prices, and distribution under the Essential Commodities Act (ECA) of 1955. The Vajpayee government had initiated marketing and contract farming reforms in 2003 through a model act to be adopted by states. But the states implemented it only partially. The problems remained largely unsolved. As regards ECA, economists have called for its repeal or restrictions on its use for decades. The government has finally enacted these reforms. Farmers can now choose whether to sell through traditional markets or enter into contracts with buyers, preferably through FPOs (Farmer Producer Organisations).

Privatization & Asset Monetization Program

The budget for 2021-22 announced the privatization of two public sector banks (PSBs) and one general insurance company with a total disinvestment target of Rs 1.75 Tn for the year. The government has also released a privatization policy under which  PSUs in four strategic sectors will be retained with 3 to 4 units in each sector. The remaining PSUs will be privatized, merged, or brought under a holding company structure. A complete exit is proposed from non-strategic sectors. The total number of central PSUs numbering over 300 is expected to reduce to under two dozen units over the next few years. While details are still awaited, this policy marks a radical departure from the commanding heights philosophy that has held sway for the public sector since the 1950s.

Further, an ambitious asset monetization program (e.g. for roads/highways, power transmission lines & substations, railways, oil & gas pipelines, land, airports, and seaports) of about Rs 2.5 Tn for central ministries and around Rs 3 Tn for states over three to five years has been proposed. The funds raised will enable the government to contain the fiscal deficit even as it aggressively expands infrastructure investments.

Way ahead for India Inc.

The reforms outlined above will significantly change the regulatory framework and competitive landscape for most manufacturing firms. Each firm will have to assess its opportunities and challenges and decide its next moves.

Broadly, firms will fall into two categories of sectors for implementing the PLI Scheme. The benefits of the new labor codes and the lower tax rate of 17% for new units will be applicable for all manufacturers.

• Sectors with few or no domestic players: The PLI scheme, coupled with the new labor code, presents an opportunity for domestic and global firms in sectors like  Mobile phones, Medical devices, Active Pharmaceutical Ingredients (APIs), Solar PV cells, Advanced batteries, Telecom equipment, and Electronic products- to address the local market initially and export to other markets over time. Firms interested in these sectors need to decide, meet scheme criteria, and move forward. Contract manufacturers of cell phones (e.g. Foxconn, Wistron, Dixon, and Pegatron) have already received approval, as have producers of medical devices and APIs.
• Sectors with numerous domestic firms: In sectors like Auto & Components, Pharma, Textiles, Food Processing, Speciality steel, and White Goods, the scheme is likely to incentivize incremental exports or the production of products or components not made in India. Firms in these sectors have to assess their eligibility and ability to fulfill future investment and growth commitments. Those who decide to proceed need to get approval under the scheme and quickly ramp up investment and output. The rest have to consider aligning with larger firms or continuing with their current strategy and distinctive proposition.

The PLI scheme is an ambitious attempt by the government to promote global-scale manufacturing in India. Success is most likely in sectors with little domestic presence where firms will find it attractive to substitute imports. Even if the PLI scheme succeeds in some sectors and is only partially successful in others, it will still be a huge gain for India- in terms of additional output, value addition, revenues, employment, and exports.

Agri produce is used for further value addition by firms in many areas e.g. dairy products, food processing, and retailing of food & vegetables. FPOs already have supply contracts with such firms to varying degrees in different states. As farm laws get implemented, perhaps to different levels across states, firms can pursue such direct dealings and contract farming more extensively and build farm to fork or farm to factory supply chains.  FPOs will be able to optimize cropping patterns to meet market demand- potentially raising farm output and incomes.

The PSU privatization program, as it gets implemented,  will unleash a spate of mergers and acquisitions. This can be a great opportunity for firms seeking inorganic growth.  It will also lead to the emergence of re-energized businesses with greater capabilities increasing the competitive intensity in most sectors. Concurrently, the asset monetization program will create enormous investment opportunities for corporates and fund managers- domestic and global.

 

Conclusions

The recent structural reforms (PLI, labor, farm, and privatization & asset monetization), once rolled out,  will change the ground rules and competitive landscape across sectors. Even if partially implemented, they will create huge opportunities as well as challenges for firms and their supply chains. Companies that have clear strategic objectives and move quickly are likely to benefit the most. The economy as a whole will see greater growth, more employment, rising incomes, and improved competitiveness.