How India can harness the full potential of its production-linked incentive scheme

Though the PLI scheme is still in an infantile stage, there are some notable successes under its name.

By Archana Kumari & Kaustubh

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The Production Linked Incentive Scheme (PLI) has been introduced as a key element of the Atma Nirbhar Bharat package to transform the manufacturing landscape of the Indian economy and integrate it into the global supply chains. It has been announced for 13 sectors that were identified on the basis of their growth, employment, and export potential. It offers a production subsidy on incremental sales for products manufactured in India. The objective here is to see the possible impact of PLI on the broader economy and suggest ways to harness its full potential.

Though the PLI scheme is still in an infantile stage, there are some notable successes under its name. The first round of PLI gave an impetus to mobile phone manufacturing in the country and the interest shown by various companies in the second round for different sectors also indicates its future potential.

However, this assessment of the scheme is not holistic, as it is based on a partial equilibrium framework in which its impact is being seen only on supported sectors. For a better analysis of its impact on the wider economy, a general equilibrium framework is warranted. In this framework, the economy is studied as a complex system of interconnected sectors in which a policy change in one sector affects other sectors through various channels. Gauging from this framework, several key insights regarding the broader impact of the PLI scheme are highlighted and discussed subsequently.

The first key insight is that the scheme must be complemented with steps to augment supply of factors of production available in the country. Otherwise, in an economy constrained by the limited supply of factors of production, the scheme would only lead to a movement along the Production Possibility Frontier (PPF) rather than its outward expansion. In that case, the scheme may become a zero- sum game for different sectors of the economy, in which the supported sectors gain at the cost of other sectors of the economy, due to the movement of factors of production from the unsupported sectors to the supported sectors.

Realising the critical role of factor supplies, the government has undertaken several factor market reforms. To ensure labour availability- the government has brought four labour codes aimed at reducing complexities and easing compliance. Its timely implementation in states is crucial along with renewed focus on skilling through schemes such as Pradhan Mantri Kaushal Vikas Yojana (PMKVY). To augment capital availability, the government has undertaken capital market reforms such as promotion of Infrastructure investment trusts (INVITs), Real Estate Investment Trusts (REITs) and bond market deepening coupled with allowing direct foreign listing of Indian firms. To ensure land availability, the government is taking various policy initiatives such as digitisation of land records, ensuring clear and easily verifiable land records through Swamitva scheme and creating land banks.

The second insight is that the PLI is essentially a production linked subsidy which would entail an additional expenditure by the exchequer of the tune of 1.9 lakh crore, earmarked for the next five years. This entails fiscal expansion that may lead to crowding out of private investment thereby negating PLI induced investment in the economy.

Government can address this problem by containing its fiscal deficit through measures such as expenditure management, disinvestment and asset monetization. At the same time ease of doing business reforms need to be stepped up along with further liberalization of FDI policy to ensure that incentives for PLI have the desired impact in terms of larger volume of production in the country. Measures to further attract sovereign wealth funds and pension funds will further add to investment in the economy.

The third insight is that, in a fully flexible exchange rate regime, the subsidy support to domestic production may lead to appreciation of the currency to maintain the Balance of Payment of the economy. It can happen due to increased domestic production competitiveness as a result of the subsidy support. This can hurt exports and would be counter to the export promotion objective of the scheme. Therefore, some forex market intervention may be required to check the likely appreciation of the currency, to realise the full potential of PLI.

However, forex market intervention to check appreciation can lead to inflation in the economy, due to costlier imports. This however will be countered by government undertaking supply side reforms such as the farm laws to promote agri-exports and check food inflation. In addition, the recent mining reforms, impetus to bio fuels and promotion of renewable energy with a focus on enhancing energy efficiency is being done to reduce the dependence on imported crude and minerals.

PLI is a game-changer to transform the manufacturing landscape of the country. However, its success hinges on supporting reforms that realise the full potential of the economy.

(Archana Kumari is an officer trainee with the Indian Economic Service and Kaustubh is a research scholar at IGIDR. The views expressed are their own and not necessarily that of Financial Express Online)