Hope for manufacturing

Govt must follow up tax cuts with administrative reform

The global supply chain for goods is in a state of flux, and this is the time for India to take advantage of it. Costs are increasing in China, for long the hub of global manufacturing, and the Sino-US trade war is disrupting existing supply arrangements. Many companies are looking to set up plants elsewhere in the emerging world — and India should be high on their list of possible destinations. So far, however, domestic risk factors and a high-cost environment have rendered Indian manufacturing relatively uncompetitive and locating in India is thus unattractive. But recent moves from the government can reverse this trend. Most notable among these is the slashing of the corporate income tax rate to 25.17 per cent for large companies, announced last week by Union Finance Minister Nirmala Sitharaman. What was perhaps lost in the middle of the euphoria induced by this step was the fact that new manufacturing firms will be taxed at an even lower concessional rate of 17 per cent including surcharge and cess. This is a sensible attempt to induce new investment in the manufacturing sector. 

A major tax cut of this nature for new investment should significantly alter the return on equity for new investment. Importantly, it is also in the spirit of the larger corporate income tax cut, which intended to make India competitive with peer nations in Southeast Asia. Countries such as Thailand and Vietnam have concessional rates for new investment — which are, however, even lower than India’s new rates. For example, companies that move their regional operating headquarters to Thailand would receive corporate tax rates below 10 per cent, and their foreign employees would be taxed at only 15 per cent. 

The tax cut for new manufacturing companies should be seen in the context of other moves to make the environment more hospitable to new investment. For example, the wage code has been streamlined and some export-oriented sectors have been permitted more substantial use of contract labour. The government also recently provided clarity on foreign investment in contract manufacturing, which is permitted at the 100 per cent level through the automatic route. The finance minister also announced in the last fortnight a package for exporters that would be compliant with Indian obligations at the World Trade Organization, and also promised that refunds of input tax credits would be processed in a time-bound manner. Credit-constrained export-oriented sectors might also benefit from a relaxation of priority sector lending norms for banks. The larger attempt here is clearly to create an environment that is friendlier to those willing to expend capital on the risks that Indian manufacturing entails. Threats to risk capital include high taxes, now being addressed, and high interest rates, which too are being lowered consistently by the Reserve Bank of India, now that inflationary expectations are under control. But more needs to be done. Comprehensive central labour and land law reform is a long-pending demand of the manufacturing sector and cannot be evaded forever. It is also necessary to consider the question of administrative and regulatory risk. Access to international arbitration, clear advance tax rulings, more capacity in the judicial sector, and an independent and apolitical regulatory cadre are a must. Only then will a sustained increase in manufacturing’s share in gross domestic product be visible.