Extending the tax deadline for green field investments by foreign entities may have been overlooked.
Satisfied with the track record in managing the Indian economy thus far, Nirmala Sitharaman, the experienced Finance Minister, presented a well-balanced interim budget that indicated the Union Government is inclined to transition from an intensive oversight to empowering the private sector. Recognizing the need to provide the government with increased fiscal capacity to address its explicitly stated new priorities—women, youth, the poor, and farmers—it has become essential to facilitate investments in India by private entrepreneurs and investors. The assumption that India will automatically become the preferred global investment destination in light of China’s economic challenges is not realistic. This is particularly true for the manufacturing sector, which has not kept pace with GDP growth over the years, with its contribution to the economy hovering around 16%.
Undoubtedly, several positive initiatives have been implemented to boost manufacturing, notably the federal “Make in India” campaign initiated in 2014, the “Atmanirbhar Bharat” (Self-Reliant India) mission of 2018, and the Production Linked Incentive scheme for 14 select industries launched post-2019-20. These, along with a range of well-intentioned programs by provincial governments, have started to show potential, although significant impacts are still forthcoming. Such a gradual pace is to be expected in a democratic and federal structure like India’s, where transformation necessitates considerable diligence, coordination, and patience. Moreover, the process of bolstering manufacturing is in itself a marathon, involving extensive planning and implementation stages. This includes developing reliable sources for raw materials and components, equipment suppliers, plant maintenance services, and a workforce comprising both skilled individuals and support staff, in addition to comprehensive distribution and marketing networks. Continuous technological upgrades are essential to stay competitive and to scale up operations.
The recent international acclaim for India’s economic progress is undoubtedly welcome. This recognition is well-deserved and has been achieved through concerted and systematic efforts. However, maintaining the enthusiasm of discerning global investors is challenging and requires ongoing commitment. Investments by private entities in large-scale production abroad depend on a multitude of factors, often categorized under the Ease of Doing Business. Democratic and federal nations do offer considerable advantages, such as greater transparency and impartiality in decision-making, yet the inherent delays within such systems can be perceived unfavourably. Moreover, the diversity of large countries like India presents both challenges and advantages. The often-discussed demographic dividend can be as problematic as it is useful. Businesses especially seek stability and predictability in government regulations.
China, hitherto the virtual magnet of global investment for at least two decades, has to be viewed in such light. There is little doubt that China’s economy is decelerating, diminishing its status as the default destination for capital, technology, and entrepreneurship from the industrialized world. Complete withdrawal from Chinese ventures is, however, not expected soon, but a strategic de-risking is clearly in progress. This includes adopting the “China Plus One” strategy in supply chain management, restricting the flow of advanced technologies like semiconductors as per the American “CHIP Act,” and levying higher duties on imports from China. Contributing to this shift is the rising labour cost in China, compounded by a declining population and workforce, which is prompting companies to expand their operations in alternative locations.
Encouraging as this may appear from an Indian perspective, it’s important to recognize that Chinese authorities have collectively implemented a series of corrective measures to address the signs of economic weakening. These actions include financial and policy incentives for early marriages and for families to have more than one child. The government in Beijing has made it clear that its focus is on promoting innovation and developing technology-driven industries such as electric mobility, lithium and advanced chemical batteries, solar panels, artificial intelligence, and robotics. These initiatives aim to enhance productivity and mitigate the impact of rising labour costs, as well as to advance high-tech defence industries. In response to the challenge of boosting domestic consumption, China has intensified its export efforts. It continues to leverage its positive image in affluent Southeast Asian nations, which collectively have a population of almost 650 million.
In the mind of many China watchers, the Middle Kingdom will bounce back. While domestic investment may suffice to acquire advanced technologies and boost exports, China’s reliance on the developed world and other large economies is expected to persist. Meanwhile, South Korea, a trade-dependent country and the fourth-largest economy in Asia, has seen a resurgence in manufacturing activity. In January, for the first time in 19 months, its manufacturing output expanded, and semiconductor exports surged, with China snapping up a significant share of these exported chips.
Vietnam, which has attracted huge amounts of FDI in manufacturing during the last four decades continues to remain a favourite base “with its plentiful, young manufacturing workers who are diligent, reasonably well educated and half as expensive as those in Chinese coastal areas” (Economist, 27 January 2024). The exports to the West, particularly of electronic-products, are shifting production from China to Vietnam and the suppliers, including the Chinese, are clustering around them. In the first three quarters of 2023, FDI in Vietnam as a share of GDP at over 5%, was reportedly twice as large as in Indonesia, the Philippines or Thailand.
It is such eventualities that Indian policymakers have to remain cognisant of as they formulate their response and strategy. The shift in focus by trade and industry officials towards sectors ripe for domestic growth is timely. The selection of 14 sectors for the Production Linked Incentive (PLI) scheme on which the government is spending a huge Rs 2 trillion (US$26 bn) aligns well with global market trends, suggesting a strategic move towards enhancing India’s manufacturing position in the emerging global space. The government’s increased capital expenditure, especially in infrastructure development and affordable housing as provisioned in the interim Budget, is poised to bolster the drive towards greater industrial self-sufficiency. Furthermore, the announced significant funding for research and development (R&D) is expected to facilitate the transition to technology based futuristic industries.
However, achieving meaningful and sustainable progress requires the private sector’s active participation in expanding critical infrastructure in transportation, energy, telecom, education, and healthcare. This engagement appears to be lagging—in fact over the years the private companies’ share in gross fixed capital formation as a percentage of GDP had declined from a high 12% in 2016 to 10% in 2022—with a tendency to rely on government expenditure. The Finance Minister’s budget statement, urging private entities to take up more responsibilities, is a call to action. There’s also a clear indication that the PLI scheme’s effectiveness in certain sectors, where financial uptake has been minimal, will undergo a comprehensive review.
The government should also consider developing “plug and play” facilities across both existing and new industrial estates and parks nationwide. Such facilities, which shorten the time to operational readiness, are highly valued by foreign investors and developers. This approach mirrors trends in Southeast Asian nations, where the creation of well-equipped industrial zones featuring essential utilities, housing, and industrial services is becoming increasingly common. Vietnam had developed such huge facilities in Ho Chin Minh City as well as in Haiphong, which were the favourite locations of foreigners. The Indian Special Economic Zone (SEZ) scheme, despite its intentions, has had limited success, with many zones devolving into real estate ventures rather than manufacturing hubs. A recent initiative by the governments of Singapore and Malaysia to establish a large SEZ hub in Johor, aimed at leveraging Singapore’s capital and technology with Malaysia’s land and labour, illustrates a move towards creating a competitive and self-sustaining industrial ecosystem. This model, reminiscent of China’s industrial zones but aiming for higher competitiveness and sustainability, offers valuable insights for India’s own manufacturing strategy.
India’s recent endeavour to attract more iPhone manufacturing has begun to reflect the positive results of a well-conceived support arrangement; with it now accounting for over 7% of the global output. In the fiscal year ending March 2023, India’s smartphone exports had doubled from the previous year to US$11bn. To keep up the momentum and not only get a greater share of the world market through mere assembly work but also to increase the value-addition content, it has virtually rolled out the red carpet for the global biggies like Apple, Samsung, the Taiwanese Foxconn Technologies, and Pegatron. Following their appeal, the Indian Prime Minister, just days before presenting the interim budget on 1 February, reduced import duties on components such as plastic and metal parts, SIM sockets, and screws. This move aims to improve the cost competitiveness of Indian-manufactured phones, particularly against those made in China and Vietnam. The domestic industry leaders have praised the government’s swift action, which is expected to position India as a global hub for electronics manufacturing and exports. This strategy, reminiscent of the initial steps that enabled China to dominate global manufacturing, underscores India’s potential to become a key player in international trade.
In the new budget proposals, the Finance Minister has not made any new tax proposal, adhering to the usual practice of not altering tax structures and rates in an interim budget by an outgoing government. However, she prudently extended the duration of certain tax benefits set to expire before the new government takes office post-general elections—for instance, for startups and investments by sovereign wealth and pension funds, extending their expiry by a year beyond 31 March 2024. Yet, the concessional tax rate of 15% under section 115BAB of the IT Act for foreign investors, aimed at boosting manufacturing through newly incorporated domestic companies established after October 1, 2019, set to expire on March 31, 2024, has not been extended. This rate aligns with those in East and Southeast Asian countries, India’s competitors for foreign direct investment in manufacturing. Without a competitive tax rate, the perceived barriers for foreign investment in India might increase, potentially impacting Indian manufacturing adversely.
The lack of significant foreign investment in India since the tax incentive’s introduction in 2019 might suggest reasons for its non-extension. This stance, however, is open to debate for several reasons: global FDI inflows have decreased significantly during the three years affected by COVID-19, and overseas investment decisions are influenced by a range of factors, not just tax rates. Until these issues are comprehensively addressed, favorable tax rates alone won’t suffice, though unfavorable ones could significantly deter investment. But it is always possible that the omission in the Budget is just an oversight and not a deliberate or a considered policy decision. In that case, introducing a mere amendment to the Budget in the Parliament would be required.
Dr Ajay Dua, a development economist, is an ex Union Secretary, Ministry of Commerce & Industry.