How to achieve self-reliance in the capital goods sector

SN Roy/Abhishek Agrawal | Updated on May 19, 2020 Published on May 19, 2020

To reduce import dependency for critical products and promote local manufacturing, it’s time for a new captial goods policy with a focus on R&D, financial structure and investments

As underscored by the Prime Minister in his address to the nation on May 12, achieving atmanirbharta or self-reliance is going to be a key national imperative, as we gradually come out of the Covid-19 crisis. Achieving self-reliance is particularly critical for the capital goods sector.

India’s current account deficit (CAD) stood at 2.1 per cent of the GDP in 2018-19. Merchandise trade deficit was $184 billion. The top three items on import bill — crude oil, gold and electronics — have also traditionally been very much in focus for policy formulation and action. The number four on this list, however, often goes unnoticed. This is capital goods or industrial machinery. Pegged at $44 billion, capital goods import contributed a sizeable 8.5 per cent to the total import bill. Exports in comparison were barely half, leading to a CAD of $23 billion on account of capital goods. This is often neglected in public discourse, evident from the fact that capital goods import has risen 11 times over the last two decades. In 2018-19 itself, capital goods imports were higher by 16 per cent compared to 2017-18.

Capital goods exports serve as the hallmark of an advanced industrialised economy, signalling the high quality of local manufacturing. For an economy like Germany, the capital goods sector earns net export revenues of close to €100 billion and generates more than one million jobs. It is also a testimony to the success of SMEs, as 90 per cent of some 6,400 German machinery manufacturers belong to the SME category (“Mittelstand”).

Import dependency of the capital goods sector is a result of many underlying factors. Other than 4-5 large domestic players and a few MNCs, most of the players in this sector belong to the SME segment. These players often struggle on multiple fronts such as accessing finance, attracting technical and managerial talent, innovating on technology, modernising operations and management practices. They tend to underinvest in operations, and particularly in R&D. On an average, about 0.5 per cent of revenues is invested in R&D by Indian players as compared to around 5-6 per cent invested by German players. This makes it difficult for them to be competitive on technical as well as on cost with respect to imports. It is, therefore, necessary to give a renewed focus on the growth of this critical sector in the Indian economy.

New policy

Policy-makers have given thought to the growth of the capital goods sector through the introduction of multiple measures — the National Manufacturing Plan (2012), Make in India (2014) and the National Capital Goods Policy (2016) — to enhance its productivity and competitiveness. The time is right now to work on a new policy for capital goods in India, with special emphasis on emerging areas and targeting to achieve net zero imports by 2025.

This policy should have three specific thrust areas:

First, technology solutions: It should provide incentives to local manufacturers to invest in R&D, such as tax credit on R&D spend, especially in emerging technologies such as waste-to-energy, high-speed railway rolling-stock, energy storage. Recognising a large gap in the maturity of many technologies between Indian and global players, it should also push on government-to-government dialogues to enable Indian players to license technology from global players. SME players could be especially supported for transfer of technology from global players.

Second, level playing field: It should revisit the duty structure for many of the import components. Utilising a balanced mix of import duties and taxes on finished products can have a positive effect on boosting exports, curbing expensive imports and transforming India into a net exporter over time. As it stands today, the industry is facing issue of ‘inverted duty structure’ for many products, whereby importing finished goods attracts lower duty than importing components for local value addition. For instance, in the power sector, boilers and turbines can be imported at 0-5 per cent customs duty under project imports and 10 per cent otherwise. On the other hand, the raw materials used, including seamless alloy steel tubes, pipes and tubes, carbon steel are subjected to customs duty of 15 per cent.

With the policy planning having shifted focus from conventional power plants to renewables and with a slowdown in the power sector, the domestic power plant equipment manufacturing capacity is grossly under-utilised at present to only around 30 per cent. This is significantly impacting the commercial viability of the domestic industry. Sustainability of the sector rests on timely and proactive resolution of the industry’s concerns.

Third, encouraging investments: Policy should support new enterprise for capital infusion in this sector by providing fiscal incentives. The present industrial and trade policies do not provide sufficient incentive for investments in emerging areas. This leaves a gap between the domestic capability and the sector requirements, leading to demand for imports. This could be done as ‘phased manufacturing programme’ where currently imported major machinery items are selected for such incentives. The programme could have a sunset clause linked to the development of sufficient local manufacturing capabilities.

Industry players on their part will also need to do their bit. They would need to bring fresh capital, scale up investments in R&D (especially to adopt new technologies such as Industry 4.0), proactively seek technology licensing agreements with global players, target export markets, and modernise operations and practices to be able to attract best talent.

Executing the above actions will have multiple benefits. Targeting net zero trade deficit in capital goods will add another 0.8-0.9 per cent to the GDP, bring down import bill by $20-25 billion, and could generate four lakh direct jobs, and total of 40 lakh jobs. The capital goods sector has important indirect benefits to both upstream sectors (eg steel manufacturing) and downstream businesses (eg after-sales service). Finally, it is also strategically important to strengthen local supply chains for critical products.

Covid-19 has illustrated the risks of over-dependence on import of critical products. This is especially true for the capital goods sector, as end-user sectors for capital goods such as oil refineries, power plants, railways etc are of strategic importance to the nation. The sector has remained off the radar for far too long. It’s imperative now for policymakers and industry players to bring about a concerted change to promote local manufacturing and achieve the national goal of atmanirbharta or self-reliance in the capital goods sector.

Roy is member of the board & whole-time director, Larsen & Toubro Limited and chair, FICCI Capital Goods committee. Agrawal is Founder, One A Advisors

Published on May 19, 2020

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