Financials

<p style="text-align: justify;">As most of the readers of this column may be aware, just a couple of days before India went into a prolonged lockdown spanning over 10 weeks, the Government of India had announced the grant of &lsquo;Production Linked Incentives&rsquo; (PLIs) for manufacturers of specified goods in the electronics goods and components industry as well as for producers of specified drugs, drug intermediates and medical devices under separate schemes. Readers would also be aware that back in early November 2019, the World Trade Organization (more commonly known as the WTO), which is the overarching governing body for regulation of discipline in trade and tariff among its member countries, had red flagged India&rsquo;s Merchandise Exports from India Scheme (MEIS), which is very popular amongst goods exporters in the country.</p><p style="text-align: justify;">On a specific complaint lodged by the United States of America (USA) against India, the WTO had categorically ruled that the incentives under MEIS are directly in the nature of prohibited subsidies defined in the WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement).</p><p style="text-align: justify;">The WTO had granted India a time frame of 120 days from the date of adoption of its report (30 th November, 2020) to pull out the MEIS from its Foreign Trade Policy, 2015-2020 (FTP). Incidentally, all the new PLI Schemes are being made effective from 1st April, 2020.</p><p style="text-align: justify;">In the light of this development, it would be worthwhile to ponder whether the latest PLIs that the Government now intends to dole out to manufacturers of specified goods will also be challenged at the WTO in due course of time, given the fierce competition that would now emerge among trading nations, in the aftermath of the coronavirus (Covid-19) pandemic that has afflicted over 180 WTO member nations.</p><p style="text-align: justify;">What exactly was wrong with the incentive granted under the MEIS?</p><p style="text-align: justify;">The panel of the Dispute Settlement Body (DSB) of the WTO examining the US complaint observed that MEIS provisions incorporated in the FTP referred to offsetting infrastructural inefficiencies, which are different and distinct from offsetting of indirect taxes suffered by exported product. The DSB panel concluded that &ldquo;hence, MEIS does not meet the conditions set out in Footnote 1[ii] of the SCM Agreement and hence cannot be permitted.</p><p style="text-align: justify;">The DSB further observed that because MEIS scrips are a financial contribution by the government and confer a benefit on their recipient, they are a subsidy within the meaning of Article 1.1(b) of the SCM Agreement (Financial Contribution by Government as Subsidy)</p><p style="text-align: justify;">How similar or distinct are the recently announced PLIs from the incentive granted under MEIS?</p><p style="text-align: justify;">Similarities It is worthy to note that the PLIs too are direct cash credited to the account of the applicant manufacturer on fulfilment of the prescribed criteria of incremental sales and incremental capital investment as compared to the base year.</p><p style="text-align: justify;">Further, just as in the case of MEIS, even the PLI scheme provisions refer to offsetting infrastructural inefficiencies on manufactured goods, which are different and distinct from offsetting of indirect taxes suffered by any exported product.</p><p style="text-align: justify;">Finally, PLIs too, just like MEIS, are for &ldquo;promoting&rdquo; incremental capital investment and production in India and do not deal in anyway with refunding taxes already paid on the incremental goods sold by the eligible applicant.</p><p style="text-align: justify;">Distinctive Feature</p><p style="text-align: justify;">PLIs are not export linked: The foremost point of difference between the MEIS and the PLIs is that PLI is not an incentive just for encouraging exports from India. Instead, production linked incentives are granted to encourage manufacturers to sell more goods by making more and more capital investments in India and thereby get rewarded for incremental investment linked sales. It is pertinent to note that in respect of the PLI scheme for Electronic goods manufacturers, it is intended to attract capital investments by large manufacturers of mobile phones and specified electronic parts and components.</p><p style="text-align: justify;">Also, as regards the PLI scheme for manufacturers of Drug Intermediates is concerned, it is expected to reduce manufacturing cost of bulk drugs in the country and dependency on other countries for bulk drugs.</p><p style="text-align: justify;">Do the PLIs too have the potential to distort the export trade in the international market? Taking a leaf out of the US &ndash; Upland Cotton Case. It is important to remember that while a reasonable quantum of goods produced by most of the electronic goods manufacturers eligible for the PLI scheme will be consumed in India, a major share of goods produced, however, could also be exported, eventhough the scheme per se is not linked to exports in any way. This is extremely pertinent in the context of subsidies prohibited under the SCM Agreement. Article 3.1(a) of the said Agreement prohibits both, subsidies that are export contingent in law and subsidies that are export contingent in fact. Article 3.2 of the SCM Agreement provides: &ldquo;A Member shall neither grant nor maintain subsidies referred to in Article 3.1.&rdquo;</p><p style="text-align: justify;">The financial contribution in the case of the PLIS is by direct transfer of funds. Again, this direct transfer of funds shares "significant commonalities with grants". Similar to revenue foregone, adjudicators in the DSB have repeatedly found that grants, by their nature, confer a benefit to the recipient: "they place the recipient in a better position than the recipient otherwise would have been in the marketplace" because no entity acting pursuant to commercial considerations would make such unremunerated payments.</p><p style="text-align: justify;">Another important factor in the DSB holding any financial assistance offered by the Government as a &lsquo;prohibited subsidy&rsquo; is that the subsidy should be seen to be causing serious prejudice as laid down in Article 6.1 of the SCM Agreement.</p><p style="text-align: justify;">In the US &ndash; Upland Cotton Case decided by the Appellate Body (AB) of the WTO DSB, it was observed by the AB that for four of the five upland cotton crops between 1999 and 2003, the expected harvest price at the time of making planting decisions was always substantially higher than the actual price realized at the time of harvest of the crop. This suggested that although farmers had expected higher prices in making their planting decisions, they were also aware that if actual prices were ultimately lower, they would be "insulated" by government support, including not only marketing loan program payments but also counter-cyclical payments, which were based on a target upland cotton price of 72.4 cents per pound.</p><p style="text-align: justify;">The AB, in that case, had held that,&ldquo;if the price- contingent subsidies increased United States production and exports or decreased prices for United States upland cotton, then the fact that United States production and exports of upland cotton significantly influenced world market prices would make it more likely that the effect of the price- contingent subsidies is significant price suppression. Accordingly, this fact seems to support the price-contingent subsidies "are directly linked to world prices for upland cotton".</p><p style="text-align: justify;"><br />In other words, whether the effect of the subsidy is significant price suppression under Article 6.3(c) plays an important role in its analysis by the DSB.</p><p style="text-align: justify;"><br />The price-contingent subsidies stimulated United States production and exports of upland cotton and thereby lowered United States upland cotton prices. This fact supported the AB&rsquo;s conclusion that the effect of the price-contingent subsidies is significant price suppression.</p><p style="text-align: justify;"><br />The AB, in US &ndash; Upland Cotton case, in its assessment of whether "price suppression" has taken place in the same "world market", considered the following three factors relevant: "(a) the relative magnitude of the United States' production and exports in the world upland cotton market; (b) general price trends; and (c) the nature of the subsidies at issue, and in particular, whether or not the nature of these subsidies is such as to have discernible price suppressive effects".</p><p style="text-align: justify;"><br />The above analysis of the US Upland Cotton case should offer us adequate guidance that subsidies need not necessarily be exclusively export linked to avoid the WTO&rsquo;s scrutiny. What they should demonstrate is that under no circumstances are they adequate to influence price of the goods in question in the global market or influence the market share of other sellers of those goods in the global market.</p><p style="text-align: justify;"><strong>Where does Covid-19 figure in this discussion?</strong></p><p style="text-align: justify;"><br />Well, given the times that we are currently facing, every country worth its weight in global trade will try to pull all stops and introduce measures to bolster its industry, rattled by the prolonged closure and subsequent slack demand in the first half of this year. The PLIs introduced by India would also perhaps offer the health care and electronic goods manufacturers some motivation to make fresh capital investments.</p><p style="text-align: justify;"><br />Article 6.7 (c) of the SCM Agreement specifies that displacement or impediment resulting in serious prejudice shall not arise where any of the following circumstances exist during the relevant period: natural disasters, strikes, transport disruptions or other force majeure substantially affecting production, qualities, quantities or prices of the product available for export from the complaining Member.</p><p style="text-align: justify;">Perhaps, this clause, which is hitherto untested at the WTO DSB, could come to India&rsquo;s rescue atleast for the initial couple of years of the tenure of these PLI schemes, if not for the entire tenure, given that the nature of the Covid-19 pandemic as a natural disaster is no longer a point of debate anywhere across the world.</p><p style="text-align: justify;"><br /><strong>Yet, the Damocles sword will always hang over incentives&hellip;</strong></p><p style="text-align: justify;"><br />Even if the incentives do not constitute export subsidies or preferential subsidies for domestic products, subsidies with &ldquo;specificity&rdquo; that cause adverse effects to other countries may be required as a result of WTO dispute settlement to be abolished or removed. Therefore, the concept of &ldquo;specificity&rdquo; and what situations constitute &ldquo;adverse effect&rdquo; become issues to consider.</p><p style="text-align: justify;">Article 2.1 of the SCM Agreement stipulates the following &ldquo;principles&rdquo; for determining the existence of specificity -<br />(a) if the granting authority explicitly limits access to a subsidy to certain enterprises, then such subsidy shall be specific;<br />(b) if the grant recipient or its amount is stipulated by an objective criteria/condition, then there is no specificity; and<br />(c) although it is considered that there is no specificity according to (a) or (b), but if subsidies can be deemed to be used in fact by a specific company/industry, then there is specificity.</p><p style="text-align: justify;"><br />It is pertinent to note that subsidies that stipulate certain criteria and conditions as a requirement for the granting of subsidies (i.e. revenue, earnings condition and number of employees) can be granted to any type of business as long as the criteria and conditions of &ldquo;specificity&rdquo; are not met.</p><p style="text-align: justify;"><br />In order to claim that a subsidy has caused &ldquo;serious prejudice&rdquo;, there needs to be a causal link between the effect of subsidies and &ldquo;serious prejudice&rdquo;. Concerning the causal link, the Appellate Body has ruled that conditional relationships that state that &ldquo;but for&rdquo; are not enough; a &ldquo;genuine and substantial relationship&rdquo; is necessary.[xiv] Therefore, in situations where the relationship between the effect and the cause is thin, such as claiming &ldquo;one thing has led to another&rdquo;, even if the subsidy was a factor that caused the result, pursuant to the SCM Agreement, the subsidy cannot be acknowledged to have caused &ldquo;serious injury&rdquo;.</p><p style="text-align: justify;"><strong>Conclusion</strong></p><p style="text-align: justify;"><br />It remains to be seen whether goods manufactured from the facilities in India that will be benefit from the Production Linked Incentives announced by the Indian Government will have any significant impact on global market prices and share of other competing countries in the global market of those goods. Once this is known, the discussion on &lsquo;serious injury&rsquo; will become relevant.</p>