IT Taskforce
Basic Background  Report
(BR-2)
8th August 1998




I. NEW POLICY PARADIGM FOR THE IT HARDWARE INDUSTRY

The Hardware Industry and the Software Industry are two sides of the same gold coin representing India emerging as a Global IT superpower. The Government of India approved the 108 recommendations covering IT Software and associated services. The second integral part of this exercise is the matching policy framework for the IT Hardware and associated services. The success of one, whether it is the export of software of $ 50 billion by the year 2008 and IT penetration drive for realising IT for all by 2008, depends on the concomitant success of the other which calls for the creation of the policy ambiance for the IT hardware industry.

The past and the existing policy framework which brought about a high uncertainty discouraging investments in a frequently changing duty regime, with duty on inputs often more than that on finished goods, with cumbersome and counter-productive import/export procedures which impeded the velocity of business, predictably led to the decline in value addition of the hardware industry and eventually to the closing down of many of the units.

In contrast, the software industry flourished with a continuously increasing buoyancy attributable, in part, to the factor advantage of high quality software human resources and partly due to a series of incentives given and procedural simplifications made special to this industry. Being human resource intensive, the software industry was able to convert this advantage into increasing exports.

Techno-economists pose the obvious question: Given the same degree of incentives and simplification of procedures bestowed on the software industry , is there a feasible policy regime which can give similar buoyancy to the Indian IT Hardware Industry inspite of the capital intensiveness of the industry as a whole, without conflicting with the growth of the Software and IT Services industry?

The answer to this question requires careful reconciliation between numerous conflicting factors, some of which are outlined here.

In a controlled economy, different import duties were levied on various components and subsystems going into the manufacture of the end-equipment like Personal Computers depending upon whether the component is made in the country or not. For those made in the country, a suitable higher barrier on import is placed. Added to this, is the financial resource mobilisation for which Government is utilising the import duty as an instrument. Most countries which have succeeded in setting up the hardware industry on a large scale with high value addition, have done so without taking recourse to this route. In India, taking this route in the past was one reason for the progressive decimation of the hardware industry. Higher duty on Personal computers, for example, would mean that the cost of Personal Computers in India will be higher. This in turn, will severely impede the large scale penetration of PC-based applications in the social and economic spheres of the country.

The opportunity cost associated with not having these IT applications in place to the desired levels, is several times the revenue mobilised by the levying of such duties. The adverse price elasticity has resulted in far more adverse demand elasticity. Without having enough population of IT products in the country, the economy of scale got reduced. Producing IT hardware at unviable economy of scale, has resulted in increased cost of production. Thus, the entire industry languished as a small time industry. The flourishing software and IT services industry, which saw this trend as a counter-productive economics, increased the pressure for taking the import route. Thus, they perceived the hardware industry as a stumbling block to their growth and consequently became a direct or indirect agent for de-emphasising the value addition in the hardware industry. The hardware industry, under such pressure, took recourse to a continuously decreasing added value in their manufacture.

The IT hardware industry increasingly got transformed into direct or indirect dealers of foreign brands. When this happened, the software industry and those wanting to promote more and more IT services and applications, began asking a logical question: "why should imports be so channellised only through those who were labelled as hardware manufacturers and why not open out imports through non-manufacturing dealers and get the systems maintained either by themselves or through third party maintenance service units?"

Based on the recommendations of the National Task Force on Information Technology and Software Development, the Government of India approved the policy for advancing the zero import duty target on all IT finished goods from 1-1-2005 to 1-1-2002 and several key parts to January 1, 1999 in line with the originally proposed WTO-ITA-I schedule. With less than 30 months to this target applicable specially to only the IT sector, the Government's revenue earning through import duties need not be a major concern. The protection of the surviving units of the hardware industry can be given as a reason for not advancing the target date even further. With the drive for PC and other IT product penetration ever-increasing and with the past and existing policy paradigm, it is unlikely that many of these surviving hardware units which have achieved higher value addition can survive to see the year 2002. Marginal retuning of the policies would have no salient impact. If the present surviving units are required to survive and grow in future and if the entire hardware industry has to be put on a high growth path, without adversely affecting the growth of the software industry as well as IT services and applications, then a major paradigm shift of the policy regime is essential for the following reasons:

1. Uncertainty discourages an investment - uncertainty has to be minimised by avoiding change of duty regime every year with zero duty as the ultimate goal.

2. Duty on inputs should not be more than that on finished goods, as the negative potential gradient will impede further investments.

3. All factors leading to the grey market, which creates unfair competition, have to be de-emphasised.

4. In an import intensive industry like the hardware industry, with fast changing prices and obsolescence, all procedures for imports, exports, licensing and inspection should be simplified to help increase the velocity of business.

5. The economical scales internationally achieved should also be nationally achieved in the shortest possible time. Until large enough volumes of production can be put in place, the market should combine a large enough export drive with the internal market.

6. Competitive climate for investment and production in comparison with that present in the competing countries should be put in place including customs, foreign exchange regulations, labour laws, banking facilities and support infrastructure.

Making IT hardware manufacture viable in the Indian context, is a major challenge of reconciling highly conflicting parameters cutting across software, IT services and applications, hardware import, hardware manufacture, subsystem and parts import, subsystems and parts manufacture, component import and component manufacture. One exercise is to work out the reconciliation which calls for a minimum sacrifice - be it the loss of Government revenue, attenuated growth of one industry or the other, survival of the more disadvantaged units, slowing down of the IT application drive, etc.

From the vantage of the indirect taxation of the IT hardware manufacturing industry, the scenario is:

• The majority of the bill of materials of the IT hardware industry are sourced locally involving such items like Plastic, Steel, magnetic devices, passive devices, etc.

• Units manufacturing in the DTA buy these items by paying excise duty as well as multiple levels of Sales and Sales Tax and Entry Tax.

• Most of the excise duty gets recovered by offsetting through MODVAT process.

• Cascading effect of sales tax poses considerable disadvantage.

• The level of import duty compensates the disadvantages created by the fiscal system of the country for the local manufacturers. This is especially so for the import duty differential between finished products and the key parts imported.

The problem gets more complicated with the stringent requirements of infrastructure like the following:

• Quality, quantity and regularity of power.

• Quick transportation of goods from the factory to the ports.

• Efficient facilities at Ports for loading/unloading of containers at any time of the day to facilitate timely export shipments.

• The special requirement of fast courier services for import or export of small consignments of goods.

• Production infrastructure in industrial parks to have captive power plants and get competitive fiscal and tax benefits with respect to competing countries.

• Value added telecommunication services

In short, the paradigm shift in the long term strategy to boost hardware production and export will be required to satisfy the following objectives:

• Ensure sustainable survival

• Enlarge viable local manufacturing base

• Dynamically increase productivity and modernisation

• Attract fresh investments from within the country and abroad

• Generate skilled employment opportunities

• Operate at internationally viable economy of scale

• Minimise the Grey market and the misuse of the import policies for dual use items

• Bring about a maximally 'win-win- .......' situation among the various sub-sectors of the IT industry

Integral attainment of the above objectives in India is infeasible, except through the creation of a delicately balanced plicy oasis which essentially requires a high degree of political will to implement, a high level of national ability to take justifiable risks and a change of mind-set for accepting such bold and pragmatic paradigm shift. It is self-evident that the super power status for India cannot be realised without such essential qualifications.

In what follows in this BR-2 report, the concept of 'Soft bonding' is presented in Section-II followed by the outline of the 'Soft Bonded IT Unit' in Section-III, Fiscal & Financial Procedures in Section-IV, Procedural Simplifications in Section-V, the Information Infrastructure in Section -VI, Export Incentives in Section-VII, other banking issues in Section-VIII, Company Law Issues in Section-IX, Conglomerated High Tech Habitats in Section-X and D&D of New IT Products, Processes & Services in Section-XI.