SRI KRISHNA MATHA temple in Udupi, Karnataka, holds a special place in the hearts of millions of devotees, one of whom is the country’s 63-year-old finance minister. “It is the blessings of Sri Krishna of Udupi that gives me strength in life,” Sitharaman remarked on a visit to the temple last year. But unlike Lord Krishna, who inspired a crest-fallen Arjuna to carry on with his duties during the great battle of Mahabharata, the finance minister chided India Inc. at an event late last year about its duty to invest alongside the government in spurring growth in the world’s fifth-largest economy. “Is it, like Hanuman, you do not believe in your capacity, in your own strength, and there has to be somebody standing next and saying, ‘Hey, you are Hanuman, do it’. And who is that person to tell Hanuman? That certainly can’t be the government," Sitharaman had told a gathering of industrialists.

The minister’s angst is understandable as despite incentives — slashing of corporate tax from 30% to 22% without exemptions and from 18% to 15% for new manufacturing units — corporates have stayed away from fresh investments. As a result, India has seen its longest investment cycle downturn with the share of the private sector in gross fixed capital formation falling from a record high of 27.5% in FY08 to 21.8% in FY20.

In fact, Fortune India’s research shows the private investment cycle is now at a two-decade low with fixed asset 5-year CAGR slowing down from 22.93% over FY07-FY12 to 7.90% over FY17-FY22. A further analysis of the numbers shows that capital work in progress — a lead indicator of capex trend — hit the lowest over the same five-year periods from 25.94% to negative -0.32% (See: Going the Asset Light Way). The Reserve Bank of India (RBI), too, had red-flagged in its June 2022 Financial Stability Report that despite rising sales and profitability, a durable commencement of the capex cycle was elusive. “The declining share of fixed assets in total assets pointed to the capex cycle remaining subdued. On the other hand, the share of cash holdings in total assets increased, indicating corporate preference towards cash buffers rather than investing in capacity expansion or new projects,” stated the report. A weak investment appetite also coincided with a record dividend outgo and share buybacks, an indication that India Inc. is not too confident about the business environment.

Raamdeo Agrawal, chairman, Motilal Oswal, believes corporates are unlikely to go the whole hog on investments. “Having burnt their fingers in the past, this time around, corporates don’t want to front-end capacity and then wait for demand to play out. Rather, they would do it the other way round — wait for signs of sustained demand to show up and then play catch-up,” says Agrawal. What’s disconcerting is that rather than ploughing capital back into the business, entrepreneurs and strategic investors are cashing out. Between 2020 and 2022, a record ₹1.40 lakh crore was encashed through offer for sale compared with ₹64,519 crore in fresh capital (See: It’s all my money, honey).

Though bank credit is growing, it’s largely driven by retail loans as capacity utilisation in the manufacturing sector has been oscillating between 75.3% (March 2022) and 72.4% (June 2022), amid industrial production contracting by 4% in October — the worst decline in two years. As a result, GDP growth shrank to 6.3% in the second quarter and 13.5% in the previous quarter, even as the RBI hiked the repo rate for the fifth consecutive time to 6.25% — the highest level since August 2018. Even the government’s chief economic advisor, V. Anantha Nageswaran, admitted early last year that the average level of capacity utilisation, barring steel, cement, and chemicals, was still not at a point where private players would need additional capacity.

Chorus Grows Over PLI

While traditional capex has its own variables at play, the government’s biggest push for manufacturing through the Production-linked Incentive (PLI) scheme is where there seems to be a lot of chatter — and hope. While the China+1 strategy has gained credence in post-Covid world, the fact that countries such as Japan have rolled out 23.5 billion yen ($221 million) as subsidy to encourage companies to disperse their manufacturing sites across ASEAN region goes to show that India’s PLI scheme couldn’t have come at a more opportune time. The government is offering ₹1.97 lakh crore (around $24 billion) in incentives across 14 key sectors, to create 60 lakh jobs and an additional production of ₹30 lakh crore over the next five years. The incentive, which works out to 4-6% on incremental sales over a five-year period after the base year, is equivalent to 1.4% of the government’s FY22 expenditure. More importantly, the Centre expects the scheme to boost capex and create around 1.5 million direct and 5 million indirect jobs — implying 6% incremental manufacturing jobs and 1.2% incremental jobs in the entire economy, mentions a report by Goldman Sachs.

“The PLI scheme is aimed at boosting India’s energy transition, reducing imports, and, eventually, helping India become a global manufacturing hub. Companies have committed $58 billion in capex over the next five to six years, equivalent to 21% of BSE 500 companies’ private capex spend in just one year (FY22). The overall spend will manifest as $7 billion of annual capex spend (excluding semiconductor) and $11.6 billion including semiconductor,” says Sunil Koul, APAC equity strategist at Goldman Sachs.

According to Budget 2023, the scheme has seen a good response. The Department for Promotion of Industry & Internal Trade has approved 717 applications under 14 schemes with an expected investment of around ₹2.74 lakh crore, of which over ₹47,500 crore has already been reported across 12 schemes, resulting in an additional 4 lakh jobs, states the Budget document. More importantly, production and incremental sales of over ₹3.9 lakh crore has been reported across 11 schemes..

In a way, the development also underscores the China+1 strategy. “In our interaction with corporates, the sense we got is that many of them already have factories in China and are not shutting any of those. But if they are open to setting up a new factory, the options are either Indonesia, Vietnam, or India. While Indonesia and Vietnam are 30% cheaper, companies are looking to set up factories in India for the added incentive of a huge domestic market, which neither Vietnam nor Indonesia can offer,” explains Koul. The momentum is already showing with 10 mobile handset makers, including Foxconn, Dixon Technologies, and Samsung, making the most of the scheme. The others such as Wistron and Pegatron are contract manufacturers for Apple iPhones. The scheme seems to have taken off as India ended up manufacturing mobile phones worth ₹2.75 lakh crore in FY22, which five years back was ₹90,000 crore. Of the total production, exports constituted 16% against 1% in FY17 and, as per estimates, handset exports could well go beyond $9 billion in FY23. “We are already seeing good progress given the low capex/technology requirement and a fast-growing domestic market for these products. We think electronics is well-placed for near-term success given that mobile phone exports are up seven-fold since 2017,” says Koul.

Concurring with Koul is Hetal Gandhi, director at Crisil. “The incentive-to-capex ratio varies among sectors at >3 times, it is particularly attractive for mobile phones, electronic components, telecom equipment, and IT hardware, which have high dependence on imports across value chains and relatively lower domestic base. At the other end, capex-heavy sectors and segments such as as advanced chemical cell (ACC) batteries and specialty steel will require higher commitment to set up the ecosystem. If successful, however, these investments will ensure development of the entire ecosystem,” says Gandhi. Crisil has measured the rate of incentives as a percentage of incremental sales over the 5-7-year scheme period and that varies from 4-6% for mobiles and white goods, 5-20% for active pharma ingredients to 8-18% for autos and auto-components. Since most schemes carry a high incentive to capex ratio, it effectively indicates that the capex investment can be spread out over the life of the PLI scheme.

While incentives have their role to play, leveraging the existing ecosystem is an aspect that works in favour of established MNCs.

For instance, taking advantage of the PLI for medical devices, one of the oldest and biggest multinationals, GE consolidated its 14-factory manufacturing footprint in the country. Wipro GE Healthcare set up a new medical device facility in Bengaluru with an investment of ₹100 crore to make equipment such as CT machines, ultrasound scanners, ECG machines and ventilators. “When GE considers enhancing its manufacturing footprint, it takes a holistic view of the global supply chain, and not a country or geography-specific view,” says Mahesh Palashikar, president, GE South Asia. “For example, if GE has to invest $10 in India for a manufacturing unit, then it has to be a globally competitive operation. Currently, GE exports around 80% of its healthcare output, 75% of critical high-tech wind turbine components and 100% of its aerospace output from India. When we invest in the country, we also look at how we could leverage and efficiently serve the global demand,” he adds. In fact, the blade manufacturing plant in India is GE’s largest facility across the globe.

Though the PLI scheme tries to take a holistic approach towards manufacturing, what stands out is that 70% of the PLI capex is linked to green technologies, a sunrise sector wherein navigating through the tech curve will be a tricky affair. “More than half of the proposed capex is in sectors where India does not have past experience of creating a fully backward integrated value chain and wherein the incentive is not only based on simple revenue but also the extent of indigenisation. Besides, demand is the other variable at play as these are relatively new sectors,” points out Gandhi.

What she is referring to is the fact that unlike mobile, telecom gear, in white goods, medical devices and pharma, where there is a strong component of imports involved, there is also a strong visibility of demand as these are proven consumption stories. But sectors such as PV modules, ACC batteries and green hydrogen are still in an evolutionary phase. In fact, with an aim to create a larger manufacturing base for high-efficiency solar PV modules, an additional allocation of ₹19,500 crore was announced in Budget 2022. However, Gandhi of Crisil mentions that these new-age technologies come with their own challenges. “The value chain of mobile manufacturing versus a value chain for solar voltaic panel manufacturing is very different as solar PV manufacturing is lot more complex. Our capability in setting up an ingot and wafer manufacturing plant for solar is yet to be tested,” she adds.

Ideally, these new-age technologies should have seen the interest of established global players, but, besides mobile phones and a handful of other electrical components, the interest of multinationals has largely been muted. A report by foreign brokerage Credit Suisse states that schemes such as white goods have seen MNC participation, but major MNC participation is from entities that already have India presence such as Daikin, Panasonic, etc. However, solar and battery PLI scheme has seen participation from domestic majors such as L&T, Reliance, Ola and Rajesh Exports. Semiconductors, EVs, hydrogen vehicles, ACC batteries, which involve the creation of new industries, have not seen large-scale participation by foreign majors.

Being globally competitive is one big factor that will determine the appetite of MNCs under PLI. “Just as we compete for investments in India, so do our counterparts in China, Vietnam and other geographies. But a final investment decision can only be made if you are competitive to serve the global demand. Anytime you take a narrow view of only a particular market, investments will not be efficient for companies like us,” says Palashikar.

Currently, GE has tie-ups with domestic players, including the Tatas and that’s a win-win deal. Under the PLI scheme, established players will look to deepen their indigenous roots. “An important aspect of becoming competitive also lies in how strong a company’s indigenous content is,” says Palashikar.

Clearly, indigenisation won’t be easy in sectors such as solar modules, ACC battery and semiconductors. “We need to remember that in sectors where we are trying to have backward integration, India is not the most competitive manufacturer globally and, therefore, imports will remain always be an attractive option. “If we are not able to track technology and, hence, indigenisation levels in those segments, then despite achieving the sales target, companies may still not be able to get the complete incentives,” adds Gandhi.

Complexity a Roadblock?

While scale and levels of indigenisation are critical, what makes the PLI pitch more complex is that demand will be a key monitorable for segments such as solar PV modules and ACC battery. For instance, there is a linkage in ACC battery that would require EV vehicle demand to be substantially robust, and more importantly, companies should be able to beat competition by offering those batteries at competitive prices. For example, the PLI for ACC battery storage received 10 bids with capacity of 130 giga watt hour (Gwh), which is 2.6 times the manufacturing capacity (50 Gwh) to be awarded under the scheme. Under the programme, the manufacturing facility would have to be set up within two years. The incentive will be disbursed, thereafter, over five years on the sale of batteries manufactured in India. Going by Crisil estimates of EV penetration, 60-65% of batteries would be needed to be procured domestically. But if the estimates of EV penetration are not met, one might see under-utilisation of capacities, and see a situation wherein auto makers would strongly evaluate importing batteries versus sourcing the domestic pack.

Solar module, ACC battery and semiconductors are complex sectors and if one of the parameters for doling out incentive depends on indigenisation, it remains to be seen if India Inc. can set up ingot and wafer manufacturing plant for solar PVs. We need to remember that in sectors where we are trying to have backward integration, India is not the most competitive manufacturer globally and, therefore, imports will remain attractive. “If we are not able to track technology and, hence, indigenisation levels in those segments, then despite achieving the sales target, companies may still not be able to get the complete incentives,” says Gandhi.

It’s for this very reason that corporates are playing it safe while placing their bets. For instance, Tata Motors, the current market leader in EVs, has participated in the PLI scheme for EVs, but stayed away from the scheme for ACC battery storage. The PLI scheme for manufacturing EVs provides incentives of 13-18% of sales value to OEMs. Shailesh Chandra, president, passenger vehicles business, Tata Motors, told analysts after Q2 FY23 results that though the margin on EVs is not very different from an ICE vehicle, it “should further strengthen from next financial year as the PLI benefits also start coming in.” But P.B. Balaji, chief financial officer of Tata Motors, told analysts post-earnings Q3 FY22 that pre-conditions of the advanced battery PLI scheme did not make the risk-return equation favourable and, hence, the company is staying away from it. As per the scheme, the battery facility has to be set up in two years, while the incentive would be disbursed over five years on the sale of batteries. Tata Chemicals, the world’s third-largest soda ash producer, was spearheading the Tata Group’s interest in batteries with plans for a lithium-ion cells facility in Gujarat. However, R. Mukundan, managing director of Tata Chemicals, went on record to say, “As of now there is nothing specific.”

Koul of Goldman believes that, over time, sectors that involve heavy capex and longer gestation periods, will, eventually, see decent participation from foreign companies and lead to increasing collaboration. “We have, hence, classified sectors in terms of not how important they are in terms of the incentives, capex and revenue potential, but also how ready the sectors are in terms of likely success,” says Koul. In the case of semiconductors, though Foxxcon and Vedanta have tied up together, the association may not necessarily translate into a breakthrough technology. “Taiwan is the global leader in chips and it’s unreasonable to believe that in the next three to four years, India can catch up and start manufacturing sub-10 nanometer chips. But what may happen is that we may engage in analog or less-advanced nodes which are lower in scale and technology know-how, as opposed to very advanced technology. So, it will be a gradual progress on that front,” says Koul.

Though supply-side incentive has always been a debatable topic as empirical evidence even from the most advanced economy, the U.S., shows that tax cuts and sops don’t induce investment growth, India has already walked down the path. In fact, as more and more new-age sectors, including electrolyser manufacturing, get added to the PLI list, the PLI scheme will have to evolve. Gandhi of Crisil agrees: “We’ll need scale-based incentives as well to complete the circle and establish competitiveness from an India standpoint,” says Gandhi. While India will never be able to match China’s scale and manufacturing prowess, the path to self-reliance is never an easy one. “While India needs to dynamically adapt and continuously keep pace with the changing technology needs of tomorrow, we believe PLI is a step in the right direction,” says Palashikar.

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