Capital goods are key to manufacturing. And since the Modi government has made boosting India’s manufacturing sector one of its top priorities, it’s no surprise that the new FTP has several provisions to enable this. One such key provision is a minor tweak in the EPCG scheme. But is it going to be enough?

Shakti Shankar Patra | May 2015 Issue | The Dollar Business

For large scale exporter-manufacturers, the Export obligation of six times of duty saved was never really a burden

The Export Promotion Capital Goods (EPCG) scheme is fairly simple. Since capital goods are key to manufacturing and since India isn’t really in the top league when it comes to manufacturing them, the EPCG scheme has always been an intrinsic part of the country’s FTP. The scheme, allows a manufacturer to import capital goods without paying any duty, but the catch is that in doing so, the manufacturer is given an obligation to export a certain value of goods over a certain period of time. While the quantum of the export obligation (EO), and the time period allowed to meet it, has been rationalised several times, the basic essence of the scheme has always remained the same. This is why EPCG has been a very popular scheme in India, with companies from the country’s top two-wheeler exporter – Bajaj Auto – to the country’s largest auto component exporter – Bharat Forge – opting for authorisations under it.

Domestic woos

An often ignored, late entrant, aspect of the EPCG scheme is that after availing an authorisation, if an authorisation holder procures the required capital good from a domestic manufacturer, instead of importing it, its EO was reduced by 10%. Now, the new FTP, in order to facilitate ‘Make in India’, has reduced the EO by a further 1,500 bps and made it 75% in case of domestic procurement. “A person holding an EPCG authorisation may source capital goods from a domestic manufacturer,” states para 5.07 of the new FTP. Prescribing the EO in such a case, the FTP states in para 5.04 (c), “In case of indigenous sourcing of capital goods, specific EO shall be 25% less.” What this essentially means is that while for an importer of capital good(s) under EPCG, the EO is six times the duty saved and has to be met in six years (as was the case earlier), for someone willing to procure from a domestic capital goods manufacturer, the EO is just 4.5x of the duty saved. But since the capital good is procured from a domestic manufacturer and hence, no customs duty is involved, how does one arrive at the ‘duty saved’ figure? Answering this question, the FTP states in para 5.08, “In case of domestic sourcing, EO shall be reckoned with reference to notional customs duty saved on FOR value.” This essentially means in case of domestic procurement, it will be assumed that the procurement was done from overseas; relevant customs duty would be imposed on the FOR (Freight on Road and Rail) value; and then this notional duty value will be multiplied by 4.5 to arrive at the EO. For example, let’s assume a car manufacturer – Company A – has opted for an EPCG licence, but post the authorisation, it purchases the capital good from a domestic manufacturer – Company B, instead of the overseas buyer it had earlier thought of purchasing it from. Let’s also assume that the capital good is purchased for Rs.1 crore and the total import duty on such products is 10%. This means the EO of Company A, now, is Rs.45 lakh, instead of Rs.60 lakh, which would have been the case had it stuck to imports. So that apparently is a plus for exporter-manufacturers willing to procure domestically.

] For a textile manufacturer looking to buy a particular machinery (capital good), importing is not optional. It’s mandatory!

Not enough

Though the government has taken this step to boost the domestic capital goods industry, one is not sure if it will actually make a difference. Firstly, many Indian manufacturers opt to import capital goods, not just because of them being cheaper, but also because Indian companies just don’t have the capability to manufacture them, at least in some sectors. In an exclusive interaction with The Dollar Business, M. S. Unnikrishnan, MD and CEO of capital goods major Thermax, identified textile machinery as one such category, for which, neither has the domestic product basket expanded, nor has the quality of the ones that are offered improved. Hence, for a textile manufacturer looking to buy a particular machinery, importing is not optional. It’s mandatory. Secondly, a 25% reduction in the EO is just too small a figure to persuade a domestic manufacturer to opt for an indigenous product, since EPCG licences are often opted for by companies that are pretty confident of their exports. For example, according to Bharat Forge’s FY2014Annual Report, the company’s share of EO under EPCG in a joint venture was Rs.99.4 crore, against duty saving of Rs.16.6 crore. That the company’s exports in FY2014 alone, at Rs.1,826.9 crore, were almost 20x of this, tells us that the EO never was, nor ever will be a dissuading or persuading factor for a company that’s simply, ‘lofty’. This also tells us that companies like it, which can actually help the government achieve its dream of $900 billion worth of exports, need much bigger reasons to do away with their overseas suppliers in favour of domestic capital goods manufacturers. At the same time, since CENVAT credit is, anyway, available for even capital goods, doesn’t the effectiveness of a reduced EO get nullified? Raising such doubts about the effectiveness of the reduction of the EO, Vishnuprsad K. of Caborundum Universal, told The Dollar Business, “Today, almost all manufacturers and service providers are entitled to take CENVAT credit on the excise duty paid on local capital goods purchased. Except to the extent of providing a chance to avail advance authorisation to a local supplier of capital goods (based on an advance release order/invalidation letter arranged by the EPCG licence holder), I don’t find any specific advantage for local sourcing of capital goods under EPCG scheme.”

For smaller dreams?

The reduction in the EO, however, can be a persuading factor for smaller companies that opt for EPCG licences, primarily to reduce initial investment, and for those for whom meeting the EO is based more on hope. Since such companies are, anyway, prepared to pay the fine that is levied for not being able to meet the EO, a lower EO might persuade them to opt for indigenous capital goods, since in that case, the fine will be lower! But the government’s ‘Make in India’ dream does depend much on the Bharat Forges and Bajaj Autos buying more capital goods domestically too, doesn’t it? To really persuade the world to ‘Make in India’, at least when it comes to capital goods, the government needs to do something bold, like removing all kinds of duties and taxes on capital goods. For, the very nature of capital goods is such that they can’t be misused. They can’t be consumed. They can only be used to manufacture end-products. “India’s capital goods industry has the highest multiplier effect on creating jobs in the country. Since capital goods are very heavy, they also lend a big support to the logistics sector. So, all concessions given to the capital goods industry, indirectly helps the government itself,” Unnikrishnan told The Dollar Business, making a case for the reduction of all duties and taxes on capital goods.

Thumbs up

A welcome omission in the EPCG scheme in the new FTP is that of para 5.8, which allowed for technological upgradation after four years of issuance of the licence. One of the criteria for being eligible for such technological upgradation was at least 50% completion of the EO. The reason why this omission should be welcomed is the fact that the intention of an exporter, who has met just half of its EO in the first four years (of an outer limit of six years) and is now sending the capital good back for upgradation can be, at best, dicey. That the eligibility for such upgradation had already been made more rigorous – in April 2013, the time window for allowing this was reduced by a year and the completion level was increased by 10% of EO – tells us that all was not well with it. Two other positive changes in the EPCG scheme in the new FTP, which will obviously improve the ease of doing business, are the provisions to club two or more EPCG authorisations issued to the same authorisation holder; and easier re-export/replacement of defective capital goods imported under EPCG.

Shock and awe

The EPCG scheme had seen massive changes in April 2013. And the new FTP has kept it, more or less, the same. [A new version of the whole of Chapter 5 to replace the old chapter was released through a DGFT notification on April 18, 2013.] This time around, except for a 1,500 bps reduction in the EO in case of domestic procurement, there are no big changes. There’s definitely nothing that can be termed a game changer. There’s definitely nothing to suggest it could be a catalyst in improving the share of manufacturing in India’s GDP. What India’s manufacturing sector, bearing the brunt of one of the highest rates of interests in the world, needs is nothing short of a shock and awe. To achieve that, the government has to stop looking at everything from a revenue perspective. For starters, EOs can be brought down as low as possible. For, the bigger plan is to increase the share of manufacturing in GDP, not increasing the share of manufactured goods in total exports.  

“It’s more about fiscal prudency than Making ‘Make in India’ a success” – M. S. Unnikrishnan, Managing Director and CEO, Thermax

M. S. Unnikrishnan, Managing Director and CEO, Thermax