Did Raghuram Rajan’s Criticism Force The Government To Introduce PLI 2.0?

The PLI 2.0 scheme for IT hardware has included incentives for domestic components manufacturing. Former RBI Governor Raghuram Rajan had cited the lack of components manufacturing as one of the biggest problems of PLI for hardware
Former RBI Governor Raghuram Rajan.
Former RBI Governor Raghuram Rajan.

The government's ambitious vision to transform India into a manufacturing hub through the Production Linked Incentive (PLI) Scheme has faced criticism from numerous economists. One of the most prominent critics of Prime Minister Narendra Modi's flagship scheme was former RBI governor Raghuram Rajan. In his assessment, Rajan used the strongest language in his paper to describe the scheme as "a failure in the making.”

According to Rajan, India's PLI scheme failed to promote in-house production of electronics and other goods; instead, it encouraged the import of hardware from other countries, significantly increasing India's imports. Rajan supported his argument with data showing a substantial rise in imports of electronic components such as semiconductors, PCBAs, displays, cameras, and batteries. He questioned whether India was genuinely manufacturing finished products in its factories or merely assembling them.

The government fiercely defended its position. Rajeev Chandrasekhar, Minister of State for Electronics & Information Technology, countered Rajan, stating his aim behind the criticism to, "purely mislead readers, sensationalise the trade deficit, and put down the PLI scheme as a failure.”

However, regardless of the government's defence, it appears that Rajan's criticism has compelled the Centre to incorporate some of his suggestions into the PLI 2.0 scheme, which has been announced for the IT hardware sector.

What Is PLI for Hardware?

The Production Linked Incentive Scheme for IT Hardware was introduced by the Indian Government in 2021 with the aim of turning India into a manufacturing hub and reducing its reliance on other countries, especially China. Under the scheme, the government promised incentives based on incremental sales of locally manufactured electronic products, including laptops, tablets, all-in-one PCs, servers, and ultra-small form factor (USFF) devices.

The scheme had a budget of Rs 7,350 crore and provided incentives of approximately 2 percent.

This initiative led to significant growth in India's exports of electronic goods, particularly mobile phones. According to the India Cellular and Electronics Association (ICEA), India exported phones worth $11 billion in 2022-23 and imported phones amounting to $1.6 billion. This represented a significant turnaround for a country whose exports stood at just $334 million in 2017-18, with imports at $3.6 billion.

However, Rajan, in a note published in January this year, said "While the value of mobile exports has been going up since the scheme started, the value of imports has also been going up, initially very significantly. So net exports turned significantly negative in the early days of the scheme.”

The former RBI governor, who has been criticising the scheme since last year, elaborated further in a detailed paper published in May, after the PLI 2.0 scheme was announced.

"We need to consider not just exports but also imports (as well as royalties and profits taken out by foreign manufacturers) to assess the scheme's impact on our external account," said a paper jointly published by Rajan. According to his calculations, the combined net exports of phones and components fell from -$12.9 billion in FY17 to -$21.9 billion in FY23.

Rajan's criticism didn't stop at the increased pressure on imports. He also raised questions about the efficient use of the government's limited resources.

"Spending on PLI means not spending on something else - that's the essence of a tight budget. For instance, the government could allocate more funds to create high-quality schools and universities to nurture the talent that will drive our future," the paper argued.

He opined that India lacks an ecosystem for components used in the production of goods targeted under the scheme, which he saw as a significant flaw. Therefore, Rajan believed that government finances should be better utilised in developing the country's strengths, particularly in its service sector.

What Is PLI 2.0?

After receiving a lukewarm response outside the mobile phone segment and facing backlash from Rajan, the scheme has undergone revisions. With a budget of Rs 17,000 crore, the updated scheme offers incentives of approximately 5 percent for electronic goods manufactured in India over a period of 6 years.

However, the highlight is the additional 3% incentive for producing components as well. The scheme's new focus on developing the supply chain for components and sub-assemblies in the country represents a response to one of Rajan's major criticisms.

"There was no true value addition in the previous scheme. We were only assembling. But it is a gradual process, and the revision is certainly an improvement. While the first one focused on manufacturing, the second one emphasises value addition," noted Prachir Vardhan Singh, Senior Research Analyst at Counterpoint Research.

For the revised scheme, a total of 38 global and domestic players have applied, and the IT Ministry deems the response satisfactory. This claim to add value directly addresses the arguments put forward by Rajan before the revision was announced in May this year.

"The overwhelming response to the PLI 2.0 scheme marks a new chapter in India's IT hardware sector, demonstrating the government's receptiveness to industry inputs and their determination to translate words into action," said Pankaj Mohindroo, Chairman of ICEA.

Challenges Ahead

 While the intention behind Rajan's criticism and its subsequent incorporation into the Centre's PLI 2.0 scheme is well-meaning, it poses challenges for IT companies to source components from local manufacturers.

Global brands like HP, Dell, among others, source their components from manufacturers located near their assembly lines. Components like HDDs, cables, motherboards, and display screens are procured from other global brands such as Motorola, Samsung, Sony, and others. This makes the process of locally sourcing components complex, as these component manufacturers would need to establish local manufacturing for brands like Dell or HP to maintain product quality.

Sidharth Tandon, partner-indirect tax, BDO India, says, “In case component manufacturers do not set up local manufacturing facilities, it could have several adverse consequences on the IT hardware manufacturers. Firstly, the additional incentive of up to 3 per cent could be lost.” He added that the companies could also lose out due to the minimum localisation criteria set in the scheme for different target segments.

The official guidelines for the scheme clearly dictate the requirement of localising components. It said “ The applicant is required to localise at least PCBA (PCB Assembly) and assembly of Target Segment Finished Goods from the first year. Accordingly, in the first year, manufacturing sales on which assembly and PCBA has been carried shall only be considered for incentive claim.”

Printed circuit boards are used in most electronic devices and are considered as a key part. The assembly process involves the placement of components onto the board. The government is looking to push the localisation of this process.

Anitha Rangan, Economist at Equirus Group, strikes an optimistic note. She believes that every ecosystem requires nurturing, and these corporate giants will have to play a role in nurturing the component ecosystem. “They [manufacturers] are getting mouth-watering subsidies, which they will not let go. The companies will grow, and with them will the ecosystem,” she adds.

 With the government's determination to make India an independent manufacturer and Rajan's multifaceted criticisms of the chosen methods, the country's economy faces the challenge of time to determine whether the scheme is a potential failure or the foundation of success.

(With Inputs From Vinita Bhatia, Editor, Outlook Start Up)

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