Will Budget 2022’s Latest Manufacturing Push Via Tax Policy Work?

We are likely to see a huge rush for imports of plant and machinery till concessional project import benefits end by Sep 2023.

<div class="paragraphs"><p>A trainee learns welding at a training institute. (Photographer: Adeel Halim/Bloomberg)</p></div>
A trainee learns welding at a training institute. (Photographer: Adeel Halim/Bloomberg)

As a nation, we have come to believe that we must not only encourage industries but must also be self-reliant in the entire value chain. Our foreign trade policy, has some interesting schemes to incentivise exports, where inputs and raw materials can be imported duty-free for manufacturing goods for export, or where one could import plant and machinery and use these capital goods to manufacture goods for export. But these are schemes that were initiated in the days when India was in dire need of precious foreign exchange, which is no longer a concern. Budget 2022 attempts to therefore transition to Act Two, which is, to indigenise the entire value chain by creating capacity, both at the stage of production of inputs, as also building capital goods. This change is important especially with the International Monetary Fund forecasting a dip in India’s economic growth from 9% in FY22 to 7% in FY24 due to a variety of reasons.

Previous Policy Thrusts For Manufacturing

The idea to reinvigorate the manufacturing sector took seed in the year 2011, with the then government announcing a National Manufacturing Policy. The aim was to increase the share of manufacturing in GDP to 25%, which had been hovering at 15-16% since the mid-1980s. The improvement was only marginal even by 2016 when the National Capital Goods Policy was laid out. India was manufacturing low ‘value-add’ products and was extensively relying on imported capital goods to meet the demand of domestic industries. Other issues such as skill development, availability of land as well as not being able to contain the environmental impact all contributed to the sluggish growth of this sector.

In 2017, GST was introduced, which after undergoing teething problems, seems to have grown into a cheerful and eager toddler. Businesses are getting used to the law while officers have begun to creatively interpret the law, and we lawyers, well, can’t really complain. The next step for the government was to focus on increasing and improving infrastructure and freight transportation systems. The Finance Minister, in her budget speech for FY20, had announced that Rs 100 lakh crore would be invested in infrastructure over the next five years. The National Infrastructure Pipeline was thus launched in 2019 to this end and since then there has been considerable investment in this sector. This is key if manufacturing and export have to succeed.

In 2020, the product-linked incentive scheme was announced which now covers 14 crucial sectors such as – pharma, electronics, solar modules, automobile and components, and textiles. The scheme incentivises exports in key sectors where India has already gained enough momentum in the past so as to be able to derive gains by moving towards becoming a global heavyweight.

‘Heavy’ ‘Duty’ Move

This year’s budget has shifted the focus to the indigenisation of the entire value chain and manufacturing capacity, the effects of which will be felt in sectors such as agriculture, infrastructure and roadways, manufacturing of capital goods as well as inputs, textiles, and electronic hardware. The customs duty changes for inputs and capital goods used in these sectors should nudge growth in these sectors in order for India to become self-reliant.

Infrastructure projects, as well as the manufacturing sectors, have relied on ‘project imports’ schemes all along to import plant and machinery into India at concessional rates or even duty-free in some cases. However, this has had the effect of disincentivising investment in the manufacture of heavy machinery and capital goods. The present budget attempts to do away with these different concessional rates for project imports while imposing a uniform rate of 7.5% for all such project imports. What will be the impact of withdrawing these concessions? The immediate impact will be faced by businesses who have ongoing imports under the scheme or who had planned to opt for the scheme in the near future.

With the benefit of concessional project imports purported to end by September 2023, we are likely to see a huge rush for imports of plant and machinery till then in sectors such as textiles, oil and gas exploration and refining, coal mining, irrigation, and power projects.
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Medium-Term Impact

The impact in the moderate future should be positive. It has been seen in the past that having a moderate customs duty on imports (around 7.5% for project imports from September 2023 onwards) gives the industry the flexibility to attempt local sourcing. Simultaneously, this year’s budget also grants duty benefits to various inputs and raw materials used for manufacturing capital goods and heavy plant and machinery. Take, for example, the exemption to goods used for manufacturing plastic processing machines, or on imports of ferrous waste and scrap, etc. This should incentivise domestic players to increase domestic capacity building for the manufacture of capital goods. We should hopefully see increased investment in heavy industries in the coming years.

The electronics sector, specifically the manufacture of smartwatches, audio devices, and smart meters is also being gently pushed to indigenise capacity all along the value chain. A new and adventurous phased manufacturing program for these three products has been introduced. The duties for various components imported to manufacture these products are structured over the next four years in such a way that slowly manufacturers of these three products will be disincentivised to source the components from outside India.

Thus, an immediate area of potential investment—manufacturing various parts and components for smartwatches, audio devices, and smart meters—has opened up.
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Accompanying Action Required

Before I part, I cannot but caution that there are several ancillary areas where the government needs to take swift and firm action if the gambles of these past few budget changes yield results.

  • First, to set up or expand factories to manufacture capital goods one requires large parcels of land, continuous access to labour, power, water, etc. These work best when they work on economies of scale. The state governments need to identify land parcels where industrial parks can be set up in an efficient and sustainable manner taking care to also mitigate any ecological damage that may occur. However, land acquisition in India has been a thorny issue and discourages foreign direct investment in these sectors.

  • Second is the need for investment in skill development. Some of the sectors India is seeking to expand involves high precision engineering or sophisticated technology, requiring a technically qualified skilled workforce. India has historically created industrial training institutes but their course patterns must be in sync with what India seeks to achieve in the near future.

  • Third, our regulatory laws, be it food safety, BIS, legal metrology, environment, and labour regulations need to be more stable allowing industries to plan compliances beforehand.

  • Finally, our intellectual property laws need to be strengthened and implemented in order to boost research and development, file patents, and secure inventions so that industries can realise value in their innovations.

With the proposals announced during the union budget and initial work in play, there still seems to be a long way to go to achieve the ambitious domestic production targets. It will be an interesting next five years to see how this vision of the government finally pans out.

Charanya Lakshmikumaran is Partner at Lakshmikumaran & Sridharan.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.