What the PLI scheme needs to succeed

The Indian government launched the Production Linked Incentive (PLI) in 2020, starting with the Large-Scale Electronics Manufacturing Sector. When launched, it was heralded by the government as one of the major initiatives to increase the share of manufacturing in the country. However, the short-run results have been a bit of a mixed bag. Success appears to be sector dependent – on the one hand, the PLI scheme proved to be relatively successful for electronics. Mobile phone exports have doubled to Rs. 90,000 crores during 2022-23, and approximately 80% of these exports were by PLI companies[1]. On the other hand, the scheme was unable to see the same success in six sectors: textile, battery, automotive, white goods and solar panels.

In this article we examine the role that financial incentives such as the Production Linked Incentive (PLI) play in attracting investments. They typically serve as catalysts, setting the stage for progress. However, the path to success is a complex one, as such incentives have inherent limitations. In the journey ahead, it is crucial for India to chart its path forward carefully, recognizing that financial incentives are just one piece of the puzzle.

Herein, we seek to answer multiple questions – What are financial incentives like the PLI intended to do? What makes a successful incentive? And finally, what more needs to be done for these incentives to meaningfully contribute to India’s growth journey?

A deep dive on India’s PLI scheme

The PLI Scheme was launched as a part of the country’s push to achieve Atmanirbhar Bharat and was initially given to 14 sectors, and will soon be extended to three new sectors, which includes toys, leather and new age bikes. This will increase the number of sectors under the PLI scheme to a total of 17. The allocation for the entire PLI also marginally increased from an initial Rs.1.97 lakh crore to Rs. 2.06 lakh crore[2].

The aim was to generate employment, increase exports, cut imports, and attract core knowledge competency. Those eligible to avail the scheme would get an incentive of 4%-6% on incremental sales (over the base year) of goods manufactured in India for a period of five years.

With a few years under the belt, the PLI scheme has been beneficial for some sectors but for others it has seen a tempered response. Electronics is one such sector that has seen a boom following the PLI. Estimates by DPIIT state that value addition in the electronics sector and mobile phone manufacturing has increased to 23% and 20% respectively (although further clarity on the data is unavailable)[3]. Mobile phone exports have doubled to Rs. 90,000 crores during 2022-23, and approximately 80% of these exports were by PLI companies[4].

However, most other industries are struggling. For instance, there has been no incentive disbursal in six sectors of the PLI so far – textile, battery, automotive, white goods and solar panels[5]. Overall, out of the Rs. 1.97 lakh crore allocation, only Rs. 2,900 crore was disbursed[6], which is only 1.5% of the allocated funds.

Several reasons contribute to the challenges faced by companies in fully leveraging the PLI scheme. Global supply chain disruptions, such as the recent chip shortage, have resulted in production delays and a shortage of critical components. These disruptions have affected companies’ ability to meet the production targets outlined by the scheme. The IT Hardware PLI scheme, for example, prompted the government to revise the eligibility criteria due to companies’ difficulties caused by the disruptions. Some other challenges quoted by companies include insufficient incentives and inadequate SOPs under the scheme.

Similar lukewarm responses have been observed with other schemes, including the semiconductor Design Linked Incentive (DLI) introduced by the Indian government in 2021. Although valued at $10 billion and offering a 50%[1] subsidy for setting up semiconductor fabs and display fabs in India, this subsidy alone was not sufficient to attract semiconductor manufacturers. Designing advanced chips, such as a leading-edge node (5nm) chip, costs around $540 million[7], making it a costly and complex affair. Projects like Vedanta-Foxconn also faced challenges in securing a technology partner and manufacturing-grade technology license for producing 28 nm chips[8].

These factors emphasize the importance of giving a great deal of importance to the complexity that external factors and market dynamics bring when designing and implementing financial incentives. Additionally, they raise questions about the purpose of financial incentives, and success factors.

What helps financial incentives succeed?

Governments, by providing financial incentives like the PLI, aim to attract investments which they hope will have spillovers into the remaining economy and promote economic growth. And indeed, such schemes can play a crucial role in signalling the government’s commitment to stimulating economic activity. In the case of the PLI, the government’s stated attempt was to reduce ‘cost disabilities’, and it did this by linking incentives to investment and production targets. However, as we will see ahead – more needs to be done to ensure that PLI achieves its objectives.

One aspect in common across most successful incentives is that they are not isolated packages. According to a McKinsey study conducted in 2019[9], the most significant returns to initiatives come from those that form a part of a broader, comprehensive strategy aimed at fostering economic growth. It is these efforts that typically drive long-term growth and competitiveness, while the financial incentives only sweeten the deal, as we see below.

Let us take the case of the incentives offered to Samsung in Vietnam. With the intent to become competitive at manufacturing, Vietnam focused on reducing the cost and difficulty of doing business. This already made Vietnam a good place to do business. To make it more attractive, the government provided a simple and large tax holiday incentive to companies like Samsung which began investing in Vietnam in 2008. Today, Vietnam is one of the most favoured locations for labour intensive manufacturing. Samsung alone has set up 25+ factories and contributes roughly 65 USD billion to the country’s exports[10].

Similarly, China’s earlier success has often been pinned on incentives. Yet, every foreign investor in China first and foremost extols how easy it is to do business there. There is a great deal of power devolved to local authorities allowing for quick decision making, great infrastructure and business friendly rules within special economic zones. No doubt, incentives in the form of cheap capital and subsidies also had a role to play, but without the other factors, China would not have succeeded in growing fast.

As also highlighted in the study by McKinsey, businesses are not enticed just by standalone financial incentives. Instead, non-financial factors are critical; these typically include improved ease of doing business, formation of clusters, workforce with the appropriate human capital, and investment in infrastructure. Incentives supported by non-financial factors tend to be more enduring, as they generate long-term effects that extend beyond the lifespan of a single investment.

What can we do to help PLI succeed?

While financial incentives such as the PLI and DLI can do their best to provide short-term solutions to address cost disabilities and attract investments, they alone are not sufficient for India to fully integrate into global value chains (GVCs). For India to truly benefit from financial incentives and become a significant player in the global market, additional holistic measures are necessary, especially given that our current share of global merchandise exports is less than 2% (Read more in why India needs to focus on exports). We need to take cognizance of successes of other countries like Bangladesh and Vietnam, which have recently achieved notable success in manufacturing and exports.

Improve ease of doing business

Streamlining business processes, enhancing ease of doing business, simplifying (and reducing) taxation and promoting transparency will create a favourable environment for companies to set up and expand their manufacturing facilities. India has made some progress but is still lagging behind its competitors. (Read more on EODB in Bangladesh)

These measures will drastically help in creating industry clusters (as in the example of Vietnam and China) that bring together related businesses, suppliers and supporting services. They will provide opportunities for collaboration, and most importantly, economies of scale. They are essential in India enhancing its manufacturing competitiveness.

Reduce trade barriers

India seems to be pulling at least some of the wrong levers. Instead of striving to integrate into GVCs, India is adopting protectionist measures that restrict its supply chain. According to a research paper by Viral Acharya, former Deputy Governor of RBI, India is contending as the “tariff king,” ranking fourth globally in 2021 with an average tariff rate of 18.3%[11]. These import barriers are counterproductive as they increase the cost of Indian goods, making them globally uncompetitive, and discouraging efficient investments. Over the years, the reliance on imported raw materials and intermediaries for export production (import intensity of exports) has significantly increased, meaning that import restrictions automatically limit our exports as well.

Measures that could countermand such protectionist measures are being undertaken. India is currently negotiating with 37 countries / blocks, and new BITs / Investment Agreements have been signed with 4[12]. Till 2015, India entered Bilateral Investment Treaties (BITs) with 83 countries, out of which 74 were ratified[13]. However, the country decided to terminate BITs with 68 countries, leaving only 6 BITs still in effect[14]. Additionally, in the past, India chose to abstain from major trade blocs such as RCEP, IPEF, and CPTPP, while Vietnam is a member of all three[15].

This decision of being out of trade blocs may hinder India’s prospects of becoming a top contender in the “China +1” strategy, given that many companies are relocating from China to Vietnam, Taiwan, Thailand, and other countries, with only a few choosing India. In fact, according to an article in Fortune India, the percentage of “active” foreign companies decreased from 80% in FY14 to 66% in FY21.[16]

Enhance public infrastructure

Improving infrastructure is crucial for India’s manufacturing sector to thrive. The cost of logistics in India is approximately 13-14% of its GDP. This is much higher than in other countries. Further, based on the World Bank Enterprise Surveys, about 12% of firms in India identified transportation as a major constraint, as against 8% and 2% in Vietnam and China respectively. Furthermore, firms in India reported average losses of 3.6% of annual sales due to electrical outages, as against 2.2% and 1.3% for Vietnam and China respectively[17].

A robust infrastructure network, including efficient transportation systems especially port capacity, reliable power supply, and state-of-the-art industrial parks, is essential for attracting investments and ensuring smooth operations.

In conclusion, India needs to do more, and do it quick, to see the PLI succeed. Although it is working on some measures (e.g., streamlining business processes albeit slowly and with limited impact), on others it is yet to make significant improvement . India needs to foster a conducive ecosystem by addressing challenges related to ease of doing business, protectionism, and infrastructure. This will help in the creation of industry clusters for its manufacturing sector to thrive, integrate into global value chains, and emerge as a formidable player in the global market.

[1] Disbursed Rs 2.9k-cr so far under 14 PLI schemes: DPIIT – The Indian Express

[2] It’s time to measure the impact of PLI, DLI schemes – Fortune India

[3] PIB Press Release: PLI Review

[4] Disbursed Rs 2.9k-cr so far under 14 PLI schemes: DPIIT – The Indian Express

[5] Amid tepid utilisation of funds, govt to review PLI scheme on Tuesday – Business Standard

[6] PIB Press Release: PLI Review

[7] India’s semiconductor push should focus on revamping the DLI scheme – Hindustan Times

[8] It’s time to measure the impact of PLI, DLI schemes – Fortune India

[9] How state and local governments win at attracting companies – McKinsey

[10] Local news article by VN Express

[11] Research paper by Viral Acharya

[12] PRS India – Report summarising India and Bilateral Investment Treaties