6. Case Examples
Tech Co.: Preferential Market Access Raises the Cost of Manufacturing
Indian government policies allowing for the duty-free import of high-tech goods promoted technological development and provided incentives for companies to invest. But they also stunted the growth of domestic manufacturing as imported goods became more price-competitive than domestically produced ones. Now a new set of regulations known as preferential market access provides preference to domestically manufactured products in government procurement. The new rules threaten to increase costs for manufacturers. One of the companies affected is Tech Co., a US-based manufacturer of high-tech products. Estimates indicate that local manufacturing costs would be 10% higher than the manufacturing costs in China.
Tech Co. is a US-based corporation that designs, manufactures, and sells high-tech products. The company does not manufacture goods in India but imports them from its other Asian factories.
Recent regulations imposed by the Indian government have altered Tech Co.’s ability to compete in the Indian market. Under the umbrella of India’s Preferential Market Access (PMA) policy, the rules protect India’s domestic high-tech manufacturers by requiring the Indian government to direct a minimum percentage of its purchases in the sector to local companies. Covering almost all telecom and IT equipment, goods qualifying as “local” under PMA are required to meet a minimum threshold of value added in India. Both the percentages and the amount of local value added are slated to increase over time.
Under PMA, domestically produced goods sold to the government are subject to price and quality matching with the lowest bidder. When a domestic bidder is unavailable, the contract will go to the lowest international bidder. As currently applied, PMA’s impact is limited. But as the local content and government minimum purchase requirements ramp up, a shift by one company to locate production in India will require competitors to do the same in order to remain competitive. A further expansion of the regulation to cover sales to private companies would have additional major consequences for the competitiveness of foreign producers.
Although Indian authorities justify the preferences as necessary on cyber-security grounds, they are largely viewed by competitors based outside India and their governments as measures intended to bolster domestic production. In a communiqué sent to India’s prime minister, a consortium of industry and business associations representing foreign manufacturers said that a widening of PMA’s application “would represent an unprecedented interference in the procurements of commercial entities and would be inconsistent with India’s WTO obligations.”
The consequences of PMA would be significant if it sparks reciprocation by other countries. That would result in the decreased international competitiveness of domestic producers deprived of access to overseas markets as well as higher costs, reduced quality and fewer choices for customers.
The cost of producing in India is much higher than in other Asian countries like China. A recent analysis by the Federation of Indian Export Organizations revealed that transaction costs range from 19% to 22% for Indian exporters, compared to 2% to 3% for exporters in developed economies. Based on these costs, a local manufacturer would face a total return on investment of approximately 12% for a 50% value-added product, compared to approximately 34% in China. This translates to a 10% increase in Indian total manufacturing costs per electronic product compared to Chinese total manufacturing costs.
The hit to Tech Co. has been limited so far, since PMA applies only to its sales to the Indian government, which account for between 10% and 20% of the company’s total revenue in India. The consequences would hit much harder, however, if the regulations were extended to private sector customers, which is not unlikely. Total manufacturing costs for producers of high-tech hardware to serve non-government customers in India are nearly six times greater than costs to serve government buyers.
The global high-tech industry broadly believes the Indian government could support domestic production more effectively by following a different course. Rather than apply local content requirements, the industry recommends that the Indian government target the manufacture of select products and gradually ramp up the industry’s capabilities. For example, it might focus initially on supporting the production of low-end commodities like plastics and metal and over the next 10 to 15 years move up the value chain towards production of silicon and memory. Doing this would enable the domestic industry to achieve economies of scale for select IT products that reduce manufacturing costs.
Note: India has a central sales tax of 2%, which affects cost of raw materials and total selling price. *The analysis is done by the Federation of Indian Export Organizations (FIEO) on a 50% value-added product with an assumed sales price of INR100, 0% refund on VAT in India, and 8.5% refund on VAT in China.
Source: Report of Taskforce to suggest measures to stimulate the growth of IT, ITES and electronics hardware manufacturing industry in India.