Solar Power Manufacturing – Make In India, But At What Cost?
This is a risky strategy. If it fails, it will come at the cost of slower and more expensive growth of India’s solar power sector.
The Government of India is going all-in on trying to build a domestic solar equipment manufacturing sector. It is not clear if it will succeed. It is even less clear that it will be worth it.
Lots Of Help, Not Much To Show For It
Almost a decade ago, the Government of India concluded that imported Chinese solar equipment was cheaper because of unfair support that Chinese manufacturers got from their government. In response, it imposed anti-dumping duties on Chinese modules and panels. It also included domestic content requirements or DCRs in certain Indian solar tenders and late last year, the central government announced production-linked incentives for domestic solar manufacturing, under which Rs 4,500 crore was allocated for the solar photovoltaics sector. The history of duties and incentives for solar manufacturing is explained in detail here.
Most recently, the government notified the imposition of basic customs duty of 25% on solar cells and 40% on solar modules, effective from April 2022.
Despite these measures, domestically manufactured solar equipment remains more expensive and of poorer quality than imported equipment. And logically, any policy to promote the use of such costlier domestic panels will lead to solar power becoming more expensive.
Renewable Energy And Climate Imperatives
India is currently well behind its target of achieving 175 GW of renewable energy capacity by December 2022, as the Ministry of New and Renewable Energy also accepted recently.
In addition, there are climate concerns. If India is to achieve net-zero greenhouse gas emissions in a reasonable time frame, the share of renewables has to increase significantly, potentially to over 80% of the energy mix by 2050. Achieving this largely through domestically produced modules and cells, at current levels of capacity growth, will be near impossible.
The likelihood of the government’s protectionist policies leading to the cost of solar power going up has been concerning. I was critical of the DCR policy and was pleased when India lost the case brought against us at the WTO by the United States. The PLI scheme brought grounds for cautious optimism, as the strategy seemed to be finally moving from merely making imports more expensive to giving positive incentives to domestic production.
It is therefore disappointing to see higher levels of basic customs duty being introduced.
This combination of (previously failed) higher duties and (as yet untested) PLI present a mishmash of measures, a policy khichadi if you will.
How To Interrogate a Policy Intervention
Let us look at India’s solar manufacturing policy through a slightly more economics-based policy lens. As a template, I turned to ‘In Service of the Republic: The Art and Science of Economic Policy’, the magisterial and accessible policy analysis ‘manual’ by respected economists Vijay Kelkar and Ajay Shah. The authors invite us to ask three questions about a policy:
Question 1: Is there a market failure that the policy is addressing?
Here the market failure is presumably the distortion of solar power equipment prices caused by the Chinese and others dumping cheap products in the Indian market. Let us assume that this is happening.
Question 2: Does the proposed intervention address the market failure?
This is the key question, which requires an analysis of both customs duty and PLIs.
Question 3: Can India implement the proposed intervention?
Higher customs duty and paying out PLIs are top-down measures, theoretically within the capacity of the state. However, how they play out in practice and interact with each other is complicated.
We look primarily look at Question 2, with a brief examination of Question 3.
A Difficult Strategy To Pull Off – In Theory, And In Practice
Trade Policy: Kelkar and Shah remind us of general equilibrium effects: small shifts in policy have effects all over the economy. This is particularly so for taxes and duties. Conventional wisdom in trade theory posits that free or cheap imports are better for an economy in the aggregate through more efficient allocation of labour and capital. In fact, trade liberalisation and reduced customs duties since 1992 have had a positive effect on GDP and tax collection.
Arvind Panagariya, former vice-chairman of NITI Aayog and professor of economics at Columbia University concurs. He makes a powerful case for free trade in his book ‘Free Trade and Prosperity: How Openness Helps Developing Countries Grow Richer and Combat Poverty’ (listen to a podcast of him discussing the book with Shruti Rajagopalan here).
Panagariya cautions the central government from reversing 30 years of trade and tariff liberalisation since 1992. He recently said “The simple fact we must keep in mind is that when we expand imports in the wake of trade liberalisation, we also expand exports to pay for the extra imports. As import and export expansion proceeds, we replace low-paid jobs in small import-competing firms by better-paid jobs in export-oriented firms”.
CII has also called for a graded approach to reducing import tariffs over three years, saying that this will encourage domestic manufacturing.
Implementation: According to Kelkar and Shah, if a large number of transactions are potentially impacted by a policy, the more complex and difficult it will be to implement. Solar modules have many component inputs and manufacturing them involves a matrix of interconnected transactions.
An example: anti-dumping duties on Chinese solar glass imports were put place in August 2017, Malaysia was added to the list in 2019 and countervailing duties were imposed on Malaysian solar glass earlier this year. This is a key component in manufacturing solar panels and there is only one relatively small Indian manufacturer, Borosil Renewables Ltd., who cannot cater to the entire market. Adding manufacturing capacity takes time, and in the meanwhile, costs will go up.
Anti-dumping duties also exist for other inputs and recently, an anti-dumping probe was initiated into another component, fluoro backsheets.
Solar module manufacturers pass on higher input costs in the form of higher module costs to the end consumer, solar power developers, who, in turn, bid higher tariffs, driving up the cost of solar power. Finally, the government will be paying (an inflated amount of) PLI on the revenue that arises from the sale of these (more expensive) modules.
The success of the Indian solar manufacturing industry, therefore, depends on building production capability in the components of solar modules as well as the module itself. The government is hoping to engineer this through a web of duties, with PLI as the cherry on top. It is not clear what data exists to indicate that this is likely to happen, how long it will take, or indeed whether such concerns have formed part of the policy-making process at all.
Cost-Benefit – Is The Price We Are Paying To Build A Domestic Solar Industry Worth It?
Beyond trade barriers, a clear lesson of the recent Indian economic history is that making industrial policy work well is hard. Until liberalisation in 1992, the government was attempting, with limited success, to choose winners instead of allowing the market to select the most efficient manufacturers.
Nevertheless, a targeted subsidy like the PLI is more likely to deliver benefits, as the government will only have to pay out if domestic manufacturers actually produce solar equipment. Small caveat: subsidy schemes like PLIs are more expensive than they look. Government funds have alternative uses and cost money to collect and spend. By some measures, the Rs 4,500 crore earmarked for PLI will potentially cost society three times that amount. This should be part of the cost-benefit analysis.
The argument could be made that the PLI scheme is unlikely to succeed unless manufacturers are given price protection from cheap and potentially even dumped imports. And consequently, PLI-plus-tariffs are both required to provide short and medium-term shelter. However no official data has been offered to give any insight into the likely success of this combination of measures. In other parts of the world such as the U.S. and the EU, similar efforts to build a domestic industry have failed in the face of the sheer scale of China’s domination of the market.
Treat The Disease, Not The Symptom
Given the rhetoric around the issue, one suspects that current policy is aimed at fulfilling aspirational goals such as “replacing the Chinese in the global supply chain” or “self-sufficiency in solar manufacturing” rather than building a coherent strategy to keep the cost of solar power as low as sustainably possible and grow the solar power sector fast, while laying the long-term foundations for domestic manufacturing.
There is no silver bullet. Building domestic solar manufacturing requires a focus on mundane reforms, aimed at reducing friction in the Indian manufacturing eco-system as a whole. This means improving the general ease of doing business - contract enforcement, regulatory stability, reducing avenues for rent-seeking and the cost of long-term finance, and lots more. These are measures all businesses will benefit from. This is not new wisdom. Jagdish Bhagwati and VK Ramaswami famously pointed out in 1963 that it was more effective to address domestic distortions than resort to protectionism.
The Government of India could also spend its money better by fostering research and development.
Chinese manufacturers are more efficient than Indian ones not just because of cheap finance and state support but also because they spend up to 5% of revenue on R&D.
Investing in creating quality R&D facilities, perhaps in conjunction with the solar industry or the International Solar Alliance, could create an eco-system for innovation in solar manufacturing, which should drive down costs in the medium to long term.
The Bigger Picture
The increase in customs duties and the introduction of PLIs are two aspects of a broader three-pronged strategy of self-reliance that the government is attempting to pull off, across a number of sectors. The third aspect of this strategy is opting out of the Regional Comprehensive Economic Partnership, which removes the benefit of duty-free exports. This is a risky strategy, with only a narrow avenue for success that requires many things to work out serendipitously. The danger is that if the strategy fails, it will come at the cost of slower and more expensive growth of India’s solar power sector, with consequences for both our economic development and climate goals.
Akshay Jaitly is President, 262 Advisors; and co-founder of Trilegal.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.