The sector has witnessed double-digit growth on the back of the efforts by the Ministry of Finance (MoF), Ministry of Electronics and Information Technology (MeitY) and the private sector players. Growth in the sector has been augmented with strong support of fiscal incentives and a Phased Manufacturing Program (PMP) to provide a stable and predictable tariff structure to increase the depth of domestic manufacturing.
As part of the PMP, the MoF ensured that import tariffs on finished products and their inputs are increased in a phased manner while the industry ramped up domestic manufacturing capacity utilising a slew of incentives offered by MeitY in the form of Modified Special Incentive Package Scheme (M-SIPS), Production Linked Incentives (PLIs) and Scheme for Promotion of Manufacturing of Electronic Components and Semiconductors (SPECS).
Increase in tariffs
The delicate balance of levying tariffs on components, slowly going up the value chain and providing incentives for investment and production seems to have been disturbed by Notification 03/2021- Customs (Notification) presented by Finance Minister Nirmala Sitharaman in the recent Union Budget that amended Notification 57/2017-Customs. Overnight, the Notification has levied additional tariff on electronic components used for manufacture of mobile phones and accessories.
Increase in tariffs seems to have caught a number of mobile phone and accessory manufacturers by surprise. These manufacturers had made their medium-term investment decisions assuming duty free import of key components. These companies now find their end-products uncompetitive vis-à-vis cheaper import substitutes of similar finished products from China and Vietnam.
The FM in her budget speech mentioned how India should strengthen its participation in global value chain by leveraging custom duty policy that would help India get onto global value chain and export better. Global value chain is created when countries start importing certain parts and components; process them to their advantage: India with a low labour cost makes it a potential assembly destination before exporting them as final goods or for further processing.
Global value chains are generally present in sectors such as electronics and electrical products. However, there is a general rise in customs duty in electronic products per the budget statement. Eg: exemptions on parts of chargers and sub-parts of mobiles have been removed. Certain parts and components of mobiles that earlier attracted zero duty will now have an import tariff of 2.5% contrary to the government’s hope to strengthen India’s role in global value chain.
Increase in import tariffs, without a simultaneous increase in domestic supply, increases the cost for consumers without achieving the intended goal of import substitution. It is thus imperative that domestic manufacturers are taken into confidence before imposing import tariffs to extract maximum import substitution effect. This is particularly true in cases where import tariffs are levied on components, without increasing tariffs on finished goods. If not done in a co-ordinated manner, the intended effect of a hike in tariff may not be achieved since domestic manufacturers may not be able to ramp up production to offset import of finished goods.
Managing supply chain disruptions
A sudden rise in demand for electronics coupled with supply chain disruptions due to the ongoing pandemic has led to an acute shortage of semiconductors, globally.
The current supply chain shortage is being managed in different countries by incentivising domestic semiconductor fabrication facilities. Currently, around half of the world’s semiconductor fabrication demand is being fulfilled by Taiwan. With the growing importance of electronics in day-to-day products such as automobiles, medical devices and Internet of Things (IoT) devices, the demand for semiconductors is bound to increase.
In India, MeitY’s push to set-up semiconductor fabrication facilities under both M-SIPS and SPECS has not enthused industry participation due to high capital requirement and long gestation period for setting-up a semiconductor fabrication facility. Additionally, lack of incentives for setting-up in-house Research and Development (R&D) facilities by manufacturers is a major stumbling blockfor the electronics industry to keep pace in this dynamic sector.
Introduction of PLI schemes for finished products such as mobile phones and IT hardware to encourage domestic manufacturing does not solve the problem of managing supply chain disruptions.
PLI scheme for finished IT Hardware for domestic manufacturing of laptops, tablets, all-in-one PCs and servers is aimed at large global and domestic manufacturers looking to either expand or set up new operations in India.
According to a press release of February 24, the Union Cabinet approved the scheme that shall select five eligible foreign owned entities and 10 Indian owned companies under the scheme and shall offer incentives of up to 4% per annum for a period of four years to off-set disabilities of doing business in India.
These changes are ad-hoc in nature and don’t address the impending surge in semiconductor demand.
Given the challenges and the dynamic nature of the electronics industry, there is a need to complement import tariffs on electronic components with increase in tariffs on import of finished products such as mobile phones, laptops and tablets. This is, however, subject to provisions under Information Technology Agreement (ITA-1) of the World Trade Organisation (WTO). In order to keep pace with the changing technology, it is also important to bring back incentives for R&D under section 35 (2AB) of the Income Tax Act, 1961. Focus also needs to be placed on development of new fabrication technology by leveraging the Electronics Development Fund (‘EDF’) policy of MeitY.
A comprehensive strategy to encourage domestic manufacturing, levying import duties on finished products, encouraging R&D centres and leveraging developmental funds for setting up state-of-the-art fabrication facilities would help build an eco-system of domestic electronic manufacturing.
(Rakesh Nangi is Chairman and Nischal S Arora, Partner – Regulatory at Nangia Andersen India)