Emerging markets are widely recognized as the new engines driving the growth of the global economy. There is a shift in the balance of economic power from the developed world toward emerging economies such as China and India. China has already overtaken the United States to become the world’s largest economy in purchasing power parity (PPP) terms, while India currently occupies the third position and is projected to overtake the United States by 2050. The size of the global middle class is expected to increase from 1.8 billion in 2009 to 3.2 billion by 2020 and 4.9 billion by 2030. A bulk of the demand is expected to come from Asia, where 66 percent of the global middle-class population will reside by 2030 and account for 59 percent of the middle-class consumption, compared to 28 percent and 23 percent respectively in 2009.

As digital access becomes more and more affordable, along with increasing product awareness and a shift in lifestyle patterns, consumer spending on electronics and home appliances could see strong growth in the next 5 years. Fuelled by the falling prices of consumer electronics, these radical demographic shifts are expected to further transform the ACE market in India. The current subpar penetration levels compared to the global average for ACE products such as air conditioners, washing machines, and refrigerators, also highlight the significant headroom for future growth. Traditionally, for many consumer electronics products, increasing market penetration has been a key driver of sales growth. There exists a significant opportunity for companies to tap the huge potential, especially in the semiurban and rural markets of India. However, today’s consumers have high awareness and a strong value-for-money orientation. Multinationals worldwide are being forced to work toward building products that can trigger simple behavioral shifts, grow demand, and create business value.

 Incumbent players are realizing that it is no longer important to just achieve scale but equally important to make consumption sustainable and more relevant to consumers by redesigning products and services to meet the needs of local markets. Strengthening distribution and after-sales service reach will also be key for ACE manufacturers in driving innovation and product development at the local level. India’s overall retail opportunity is substantial, and coupled with the demographic dividend and rising Internet penetration, there is strong growth in the e-commerce market. The Indian government’s Digital India project is expected to boost the adoption of e-commerce in remote corners of the country. Higher financial inclusion through mobile and increasing connectivity in rural India will also lead to an increase in trade and efficient warehousing, thereby presenting a potentially large market for ACE products.

In order to tap into the potential of India’s hinterland, Internet retailers are looking to further streamline their logistics and improve turnaround time to effectively cater to the growing consumer demand. With a positive transformation of India’s household income profile that will further boost volumes, the ACE market is expected to grow at a CAGR of 9 percent between 2017 and 2022.

Government Initiatives

A large booming market supported by increasing disposable income, easier access to consumer financing, and improved rural electrification have been the key drivers for the sector. Over the past few years, structural reforms and economic policies introduced by the government have resulted in a favorable business environment, thereby boosting domestic manufacturing. India’s recent significant jump to the 100th rank from 130th on the World Bank’s ease of doing business index highlights the government’s consistent efforts to position the country as a preferred place to do business. The Government of India has prioritized the promotion of electronics manufacturing so as to achieve net zero imports by 2020 and is treating electronics and IT hardware as one of the key pillars of the Digital India program. The push to electronic governance through digital reforms such as Aadhaar has triggered a surge in demand for electronic devices, smartphones, and technology platforms.

Policy reforms such as 100 percent FDI under the automatic route, no industrial license requirement, and no payment of technical know-how fee and royalty for technology transfer under the automatic route have been instrumental in building a conducive investment climate. The government has supported domestic manufacturing with multiple initiatives in the mobile phone and consumer appliances industry. Initiatives, such as Modified Special Incentive Package Scheme (M-SIPS), differential duty structure through Basic Custom Duty (BCD), electronic manufacturing Clusters (EMC), Digital Saksharta Abhiyan (DISHA), and Electronic Sector Skills Council of India (ESSCI), among others have resulted in investments spread across the next 5 years. As the domestic market continues to grow in the future, the industry looks forward to increased domestic manufacturing and hence value addition, thus striving to make the dream of net zero electronics imports a reality.

Challenges Faced by the Indian ACE Industry

A limited component ecosystem and manufacturing disabilities are the root causes of low cumulative value addition. Currently, the domestic value addition component in manufacturing is approximately 40 percent of ACE products and 5 percent for smartphones. While India has good market potential, legacy challenges could lead to muted or stagnant growth in local value add for ACE manufacturing.

Taxation-related concerns. The indirect tax structure for the country has been completely overhauled with the introduction of GST on July 1, 2017. The introduction of GST promised various benefits such as increase in input tax credits due to a liberal credit mechanism, efficiencies in logistics management due to the abolition of various check posts and possible reworking of the distribution network, and lower compliance costs, among others. All these benefits will support the growth of the industry. As with any major tax reform, there are initial teething troubles with the implementation of GST. Clarification is required that part replacement under warranty does not require any reversal of credit, so that future disputes can be avoided. Non-warranty repairs and part replacements are unclear whether they are to be taxed as supply of goods or services or both separately, and it is hence difficult to determine the applicable rate of tax. There is some lack of clarity and operational issues with respect to deductions from taxable turnover in case of marketing and sales promotion schemes launched by OEMs.

Compliance issues. In the case of procurements made from unregistered persons, the registered person is required to make payment of GST to the government under the reverse charge mechanism. While this requirement leads to tremendous procedural and operational issues for registered persons, there is largely no revenue gain for the government, since the credit of such tax paid under reverse charge is available in almost all the cases and hence, it is largely revenue neutral. While the government has suspended this requirement till March 31, 2018, the industry has requested for the removal of this cumbersome requirement. Another concern on the compliance front pertains to e-way bills, which is intended to be implemented on a pan India basis from April 1, 2018. Considering the experience on e-way bills in the VAT regime and due to the increase in compliance, the industry is rather apprehensive about e-way bill provisions and has strongly recommended that these provisions not be introduced. Lastly, taxpayers have faced various issues with respect to compliances on the GSTN portal. The government has already formed a group of ministers to focus on the issues relating to GSTN, and this measure should help in resolving the issues at the earliest.

Anti-profiteering provisions. The GST Act has a provision that requires companies to pass on any reduction in the rate of tax on goods or services or benefit of input tax credit to recipients by way of reduction in prices. However, the mechanism to determine the amount which needs to be passed on has not yet been prescribed. In the absence of such a mechanism, it becomes difficult for companies to take pricing decisions. The industry has urged the government to issue guidelines for complying with anti-profiteering provisions at the earliest. In an endeavor to patronize and propel Make in India, besides the various structural and policy initiatives, the government also introduced certain direct tax reforms in three consecutive finance budgets.

 These direct tax reforms include reduction in the rate of income tax on royalty and fees for technical services from 25 percent to 10 percent, reduced corporate tax rate of 25 percent for all new manufacturing companies incorporated from April 1, 2016, introduction of patent box regime, clarification on the availability of additional depreciation, relaxation of conditions for deduction in respect of employment of new workmen, and most significantly, extending the benefit of investment-linked deduction to semiconductor wafer fabrication manufacturing units, to name a few. It is imperative to reposition India as a value-add partner in the global manufacturing value chain and not just a low-cost manufacturing hub. This will require the government, in addition to facilitating economy pricing, to embolden and incentivize R&D and innovation.

The following are the top three hot spots that may help in not just addressing the current gap but also unleashing the manufacturing potential in India.

Incentivizing the spend on scientific research. Currently, the Income-tax Act, 1961 (Act) provides weighted tax deduction of 150 percent of expenditure incurred by a specified company on scientific research in the in-house R&D facility approved by the DSIR. This needs further incentivization:

  • The weighted tax deduction could be restored back to 200 percent from the current 150 percent. Additionally, the sunset date of April 1, 2021 post which the deduction will be limited to the amount of expenditure could be dropped.
  • The ambit of expenditure eligible for deduction could be widened to include expenditure on outsourced R&D activities and infrastructure solely used for R&D.

Envisaging cost efficiency for foreign technology transfers. Cognizant of the high costs involved in licensing of foreign technology and also the much-needed strategic aid that such technologies can provide at this time to the Indian consumer electronics vertical, the government had reduced the income tax rate on royalty and fees of technical services from 25 percent to 10 percent. To give further impetus to cross-border technology transfers, the income tax rate on royalty and fees for technical services for manufacturing units could be brought down to zero.

Extending the scope of the investment-linked incentive. The existing deduction for capital expenditure under the act to semiconductor wafer fabrication units could be enhanced to weighted deduction of 150 percent given the extent of capital intensiveness. It could be extended to consumer electronics manufacturing as well.

Increasing Cumulative Value Add in India

For domestic manufacturing to flourish in the ACE industry, India needs three critical enablers:

Creating large-scale demand. A large market that provides benefits through economies of scale is needed to create a business case for domestic manufacturing.

Improving cost competitiveness. However, such a domestic manufacturing set-up can be sustained only if profitable returns on investment are generated. Profitability can be driven by either low cost of capital or lower operational costs. Lower input cost will also lead to domestic manufacturing becoming cost-competitive and commanding a higher share in both the domestic and export markets.

Ease of doing business. Finally, investments for such manufacturing set-ups will come in only when the ease of investing and doing business in India is improved.

Recommendations

The following are some proposed actions under each of the enablers that will help the Indian ACE industry usher in change.

  • To create large-scale demand:
  • Expand scope of PMA to air conditioners, LCD TVs, and speakers.
  • Separate products into multiple categories by price points, consumer need, and energy efficiencies.
  • Consider creating a multi-layer GST structure (similar to cars) to reduce the tax on cheaper and energy-efficient goods, which will reduce effective GST on cheaper and energy-efficient goods (four-stars and above) to 12 percent and reduce maximum applicable GST for the category from
    28 percent to 18 percent.
  • Encourage easy consumer finance.
  • Reduce paper work for exports through online forms and implement faster automated processing.
  • Consider increasing MEIS incentive from 2 percent to 5 percent, for high domestic value added products, available for ACE products and models.
  • Expand FTA coverage with export attractive geographies such as Africa.

Presently, almost all ACE products attract GST at 28 percent. However, to encourage the consumption of these products and to meet the aspirations of the general public at large, the government should consider revising the GST rates on ACE products to 18 percent. The government should also consider giving additional tax relief to entry-level products and also to energy-efficient products by taxing them at a lower rate of 12 percent. The export incentives under the MEIS are granted at 2 percent for a majority of the products. To encourage exports from ACE sector and to make India an electronics export hub, the industry urges that the rate of incentive under the MEIS be increased to 5 percent on all the ACE products.

To make domestic manufacturing cost-competitive:

  • Provide loans to start-ups and SMEs at reduced rates of interest.
  • Create a venture fund for investment in IoT and display technologies.
  • Provide training subsidies to companies hiring and training employees on ACE manufacturing.
  • The import duty on components that are not made in India may be brought down for a specific period, say 3–5 years, by which time, the local industry can also gear up to make such products.
  • Create a phased manufacturing plan for ACE products in which incentives will be linked to domestic value addition in India.
  • Keep the incentives available to the companies manufacturing goods in the excise free zones at same level under GST.
  • Consider incentivizing the spend on scientific research.
  • Envisaging cost efficiency for foreign technology transfers.
  • Revise the semiconductor policy to attract investments in semiconductor fabs. Along with capital incentives already in place, provide operational incentives through interest cost subvention and weighted tax deductions/investment linked incentive to make the internal rate of return (IRR) attractive for investors.
  • Provide special packages to attract investments in high-value components such as LCD and LED panels and compressors.
  • Create standards for smaller appliances and components to ensure good quality supplier ecosystem development.
  • The government could consider protecting the interests of the domestic industry by excluding ACE products from future FTAs, especially regional comprehensive economic partnership (RCEP) and increasing the rates of basic customs duty on imports of finished goods made from countries with whom India does not have FTAs. The government can assess levy of safeguard duty on imports made from countries where there are FTAs.

Many OEMs had set up manufacturing facilities in hilly states, where they were enjoying area-based excise incentives in the form of excise exemption/refund. Such incentives have been discontinued under the GST regime. The government recently announced a scheme for grant of budgetary support to these units. As per the scheme, budgetary support in the form of 58 percent of the Central GST (CGST) component paid in cash by such units is granted. This marks a reduction in the quantum of incentives since in the excise regime, such units were eligible to get a refund of 100 percent of the excise duty paid in cash. This reduction in incentives will force manufacturers to increase prices, resulting in the products becoming costly for end consumers. This would reduce the demand for products and impact businesses adversely.

The local industry is concerned about import of goods from countries with which India has entered into an FTA. Considering the well-developed manufacturing ecosystem and scale of manufacturing in these countries, the imports are impacting the domestic industry adversely.

To make domestic manufacturing easy:

  • Amend labor laws to provide relaxations through flexible multiple shift operations and hiring women in multiple shifts.
  • Create centers of excellence for display technologies and IoT.
  • Encourage set-up of new design institutes.
  • Provide better connectivity through roads and railways to reduce transit time and logistics costs on key industrial corridors.
  • Debottleneck key ports by increasing capacity and efficiencies.
  • Open online portal for any government application.
  • Create a strong intellectual property rights (IPR) framework for IoT.
  • Reduce upward revision steps in the standards and labeling program for energy efficiency.

Conclusion

The ACE manufacturing sector will play a key role in India’s development as the nation becomes more urban and industrialized. With support from the government, the Indian ACE industry aspires to increase the local value add by 2×–3×. This increase in value addition, apart from direct contributions to the country in the form of taxation, is expected to attract further investments from global players. Due to rising labor costs in alternative markets such as China and large domestic demand, global companies are turning their attention toward India as the next manufacturing destination. As other growing economies confront a rapidly graying population, India’s young population will not only offer a large consumer market but also fulfill the demand for a skilled global workforce. With the right set of policies and regulatory framework, India can provide a clear and stable business environment that can facilitate growth in the Indian ACE industry. While support from the government is important, the onus is on companies to grow responsibly and foster innovation across the ACE industry.