The ongoing story of electric vehicle manufacturers gaming the conditions of the Government of India's Faster Adoption and Manufacturing of Electric Vehicles (FAME) scheme to knock off subsidies is a teachable occasion.
The FAME II guidelines stipulate that all manufacturers must source 50% of components locally, including 18 critical components, and have a price ceiling on the vehicles to be able to avail of the subsidy. The five-year scheme which started in April 2019 and is set to expire by March 2024, with an Rs 10000 Cr outlay has provided a big boost to EV manufacturing in India. Its biggest beneficiary has been the two-wheeler segment, where the price is capped at Rs 1.5 lakh and the subsidy is about Rs 50000 which has to be passed on to the customer.
Following an unknown whistleblower's complaint, the government initiated an investigation. It appears to have revealed that certain companies (Hero Electric and Okinawa) have manipulated the local sourcing condition by importing key components from China and passing them off as being locally manufactured, and certain others (Ather and Ola) have been selling components like portable chargers and proprietary software to overcome the Rs 1.5 lakh price cap. The government has withheld the release of subsidies and directed the companies to refund the customers.
It would not be surprising if the content localisation problem is the underlying issue, feeding into the price cap. Right now only two of them may have been caught. Let's wait and see.
This scandal highlights several issues - corporate governance problems among Indian startups, lack of vision and dynamism among corporates, the weakness in the state's capability to enforce its own regulations, problems with outsourcing core activities etc.
Some observations on the issue:
1. The implementation of the FAME II scheme is a repeated game. The scheme appears well-designed in theory. In the first instance, the government in good faith restrained from micro-managing the assessment of localisation requirements and released the subsidy based on third-party certification and self-disclosure of localisation and pricing. Now that trust has been breached, it's sure to invite greater oversight from the government on the certification process. This, in turn, could add a few layers of bureaucracy to the certification process. The net result could be difficulties, delays, and corruption in accessing the subsidy. And if that happens, the industry has nobody but itself to blame.
This is a constant feature of regulations in India. In good faith, the government decides to deregulate and liberalise, only for the industry to game the process, and the government to be forced to respond with tightening regulations. The Insolvency and Bankruptcy Code is a very good example.
As we are seeing with companies in Edtech and elsewhere among the startups, corporate governance remains a serious problem even in the new age businesses.
2. The certification was done by ARAI and ICAT which are autonomous institutions affiliated by the government as testing and certification agencies. But this is what the whistle-blower wrote about the certification,
The eligibility certification from ARAI and ICAT, subsidy claims and the disbursement process in the FAME-II scheme, is severely compromised. It is a complete mockery of the phased manufacturing plan norms laid out by the department of heavy industries that a simple undertaking submitted by an electric vehicle manufacturer to ARAI/ICAT is considered genuinely Made-in-India.
Apart from poor corporate governance by the EV companies, this is also a serious enough indictment of these two certification agencies. The episode exposes serious weaknesses in their certification processes, poor administrative oversight within these organisations, or regulatory capture of the certifiers by the industry, or a combination of all. In any case, it highlights capability weaknesses within the certification agencies.
To be fair to them, the certification requirements appear to have been beyond their competencies,
It is not so straightforward. It is going to be very difficult for us to understand which part goes into a scooter that is high-speed (and claims subsidies) and which one goes into a vehicle which doesn’t enlist for subsidies. The nomenclature of parts is also very similar. We are not trained for this sort of analysis, and it is not even expected out of an agency like ours
It's also most likely that the companies showed samples that had localised components to get certification and then went on to cheat in their regular customer deliveries. This is a standard modus operandi. This could be addressed by periodic randomly sampled testing of the EVs, a process that's now followed in third-party quality assessments of public procurements.
3. The problems go beyond corporate governance and point to the lack of corporate vision and dynamism. The FAME II mandated that critical components like battery pack, traction motor and controller, vehicle control unit, on-board charger, instrument panel should be locally manufactured. Given the need for a supply chain to develop, the government announced generous subsidies and gave five years to the industry to develop the ecosystem. But the industry representatives are now lobbying that the supply chain has not yet developed and therefore want dilution of the localisation norms!
Given that all manufacturers have access to more or less the same supply chain ecosystem and have to procure components from them, and if the supply chain is still inadequate, it's not clear how others have met their localisation requirements. One more reason to suspect that the localisation problems may be greater than what has come to light.
This highlights the general lack of long-term thinking and dynamism within corporate India, and the startups seem no less culpable. Businesses want instant gratification and don't want to put the hard yards and hunker down to nurture supply chain for the emerging industry. Companies like Hero Electric should have utilised the FAME II opportunity and taken the lead to bring all manufacturers together and facilitate the development of a supply chain of component makers. Instead all of them opted for the short-term gain of piggy backing on the subsidies to maximise sales without any concern for what would happen when the subsidies expire. Obviously they would have believed that they could lobby to continue the subsidies.
In this context, it's worth noting that such failures and weakness among certification agencies is pervasive. It's all fine in theory to argue that the activity of certification can help governments outsource the verification of critical outcomes. But it holds only as long as the certification process is rigorous, which in turn depends on the capabilities of the certification agencies. The example of the Quality Council of India's numerous misadventures in certifications in areas like open defecation free, cleanliness of cities, skilling centres etc should be cause for caution. Deep-rooted problems and persistent weaknesses cannot be overcome by quick-fixes like outsourced certifications.
Given India's poor corporate governance standards, the capabilities have to be not only technically proficient but also administratively strong. The certification agencies will have to be technically proficient enough to detect attempts to technically get around the certification process and also have the administrative integrity to deter efforts to corrupt its bureaucracy. Higher the stakes, the greater the efforts by the industry to indulge in such practices.
5. The FAME II subsidy has boosted EV sales in India by more than seven-fold growth in the 36 months from March 2020. The monthly sales have crossed 100,000 in no time. With the government withholding subsidies, the spectacular growth rate has now started to decline. The government should not be concerned about this. Sales growth is purely a matter of the economy's absorption capacity, and as I have blogged several times India's consumption class is too small to support such rapid growth rates for sustained periods without significant subsidies. If the subsidies are bigger the sales growth will be bigger still.
6. This episode should alert the government to the possibility of such gaming in the much bigger production-linked incentive (PLI) scheme. There too third-party certification would be playing a major part. And given the much higher stakes involved, it's almost certain that firms will seek to game the process and over-invoice their local content.
The Department for Promotion of Industry and Internal Trade (DPIIT) should strengthen internal capabilities to eliminate such gaming. And that does not mean hiring consultants.
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