Thirty years later, in spite of conquering the manufacturing sector, China continues with its tax incentives. India's decision to end the tax incentive signals the impending decline of Indian IT.
In 1978, when China was in dire straits, Deng Xiaoping went to the US to plead for more foreign currency. China had depleted all its foreign currency reserves and did not even have enough dollars to buy return tickets for Deng's delegation. The Chinese People's Bank, with just 80 employees at its head office, was the only financial institution in the country with no linkages to the outside world.
But thereafter, China liberalised and announced incentives for manufacturing and SEZs. It reduced tax rates from 55% to 25%. For manufacturing, the policy provided for zero tax for two years and just 12.5% tax for another three years. Thirty years later, China has reserves of almost $3 trillion. Its manufacturing sector at over $2,500 billion is 12 times bigger than India's . In spite of this stupendous achievement , China continues with all its tax incentives till date.
With the world recognising Chinese supremacy in the manufacturing sector, we find the "Made in China" label on almost everything we see. Indians have even found it cost-effective to worship Ganesh idols manufactured in China. Today, China is in a position to charge higher prices for their products without affecting their business, because no country will be able to respond in the short run.
Building infrastructure and manufacturing plants and training industrial workers take decades. In the next decade, the Chinese can happily extract exorbitant monopoly prices for manufactured products.
Just like China, India too ran out of foreign currency reserves in 1991 and had to pledge its gold in London to borrow foreign currency for day-to-day payments. It followed a similar path in the IT sector (IT, BPO and KPO). The sector was liberalised by the then IT secretary with an innovative scheme, STPI, which provided IT companies with a single window agency for all business as well as a tax holiday for 10 years.
This incentive and STPI's support nurtured the IT industry, resulting in a tremendous surge: from 13 firms in 1991, to over 5,000 companies now in Bangalore alone.
In 1992, the government invested just Rs 2.75 crore in STPI, resulting in a Rs 3,00,000 crore industry, without taking a single extra rupee from the government budget. The STPI created a vibrant IT small and medium enterprises (SME) sector that currently employs more than a million professionals.
India now has 58% of world market share in this sector. After nurturing these companies and making them world-class , this year's budget abruptly buried the innovative STPI scheme. Given the scheme's success, why did the government scrap STPI?
First, the government succumbed to the SEZ lobby. Real estate wanted tax incentives for only SEZs. Most SMEs have no voice or lobby with the government. Ministers are happier to meet large real estate players and pay lip service to SMEs. Second, large IT companies found it convenient to have their own SEZ and save taxes. Some Indian IT companies have turned out to be real estate players.
As such, large companies with access to ministers encouraged SEZs and did not credit the STPI scheme with their initial growth.
Third, NASSCOM works primarily in the interest of larger companies. So they were not too concerned about looking after the interests of smaller IT players. They did not take up the cause of SMEs as Dewang Mehta did by lobbying in the initial STPI days. Fourth, IT industry captains declared that IT should pay normal taxes and implied STPI should be scrapped. Their companies simultaneously acquired large tracts of SEZ land to save taxes.
What does the future hold for IT? India will grow rapidly in the next few years, primarily due to the present growth momentum. However, itwill soon begin to lose business to neighbouring countries . Currently India has a market share of 58% while China holds 33% share. But by next year, China is expected to increase its market share to 40%. By 2014, it will emerge as the world's IT superpower.
Meanwhile, a small country like Philippines has already overtaken India and holds the maximum market share in the BPO sector. East European countries with a 6.5% market share will consolidate. With the incentives taken away, a large number of India's small IT companies will be forced to fold up. Consequently, India will face job losses running into millions.
Had the tax concessions continued, India would have grown faster and created at least a million additional jobs. Every IT job creates five indirect employment opportunities in real estate, commercial space, malls, entertainment etc. That is one of the main factors contributing to India's vibrant economy.
Japan, South Korea and China became rich via manufacturing . The IT sector was India's chance to become rich. But Budget 2011-12 has killed the golden goose.
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