Can India decouple itself from Chinese manufacturing?

India faces challenges linked to infrastructure and skill sets; and its policies are unpredictable

The border clashes with China and the COVID-19 pandemic have reignited questions about India’s dependence on Chinese manufacturing. India’s imports from China in 2019-2020 reached $65 billion, out of $81 billion two-way trade. Is the pandemic, as Union Minister Nitin Gadkari said last month, a “blessing in disguise” for Indian manufacturing? Will companies be able to move deeply integrated supply chains out of China? And if so, will they choose India? In a discussion moderated by Ananth Krishnan, Biswajit Dhar, and Amitendu Palit, discuss India’s options and the challenges ahead in India’s efforts to boost manufacturing at home. Edited excerpts:

It has been more than five years since India launched the Make in India initiative. If we look at India’s dependencies on China as one barometer, how would you assess where we are now?

Biswajit Dhar: I think that the Make in India initiative was a good opportunity for us to get our manufacturing sector back on track. I don’t think that we have taken advantage of what we had actually planned. In the past five years, what we have seen is that the dependency on China has actually gone up. It’s a very strange situation that we have today, that India is exporting a lot of raw materials and intermediate products, and importing finished products from China. And, of course, certain key intermediates such as active pharmaceutical ingredients. So I don’t think we are really on a strong footing because our dependence on China is huge. This needs to change significantly, if we are to think in terms of this whole discussion that is going on if there is to be relocation of industries here in India.

Amitendu Palit: What we are seeing in terms of India’s trade engagement is the fact that for a variety of reasons, India’s dependence on imports is getting to be localised, in the sense that there is not a wide diversification of countries from which India is sourcing its imports. For example, if you look at critical medical supplies which India has been importing for frontline healthcare workers in the COVID-19 battle, most of these come from China. China is one of the top sources but on the other hand, there isn’t a very widely diversified source of countries from which India can actually import these. This essentially means that aside from China, there are probably three or four countries of the world on which India's dependence is increasing. China is by and large widespread across different concentrations. To that extent, it’s going to be a difficult choice for India to get out of this dependence and search for alternative partners.

What are some of the concentrations and key sectors where the dependency is acute?

Amitendu Palit: Firstly, regarding capital goods, Indian manufacturing is dependent on supplies from China. This includes a wide variety of machineries, including electrical machinery, semiconductor driven machinery etc. We import fertilizers from China. If you look at limited value consumer goods which to a very large extent has flooded the Indian market — whether these are actually required to be imported or not in the first place is not clear — but nonetheless they have flooded the market. Where the criticality actually comes in is when there are a number of imports which are not really a matter of choice but which are essential. For example, if you look at humidifiers, which are being utilised in the COVID-19 battle, China is again the main source. For medical masks, China is the main source. Even for something like liquid soap, which is very much highly required across the country today, China again happens to be the main source of the supplies. We need to look at the whole situation very clearly and probably prioritise in terms of what are the areas where India can relatively more easily move back away from the dependency it has on China, and what are the areas where it will take much longer. Our approach has to go much deeper and has to develop sector specific strategies.

The conventional wisdom is we should aim to replicate what China did in the 1990s. But how different is the global environment — and global value chains — from 30 years ago when China was opening up?

Biswajit Dhar: Global value chains today are looking quite different. What the data suggests is global value chains are in fact becoming more local. Countries are depending more on their own economies rather than on global markets. This is an impact of the great recession of 2008. There was a fear at that time also that globalisation will take a hit, and value chains, which were doing fairly well at that time, will become less important. What we have seen over the past decade is that there is a general tendency for countries to become more local. So I don’t think that the strategy that China followed, when a large part of the demand came from global markets, can work. It was a global market-driven industrialisation strategy, an export-driven strategy, but that is not going to be a reality anymore. Policymakers keep making these statements, that we are going to become more open and we are going to be relying more on the global markets. Unfortunately, that possibility has now passed.

 

Amitendu Palit: Let me come into this with a slightly different perspective. If one looks at why China is so central to a very large number of global and regional supply chains, there are two elements to it. The first is the fact that China does offer the capacity to businesses to develop the supply chains by considerable lengths within itself. This is not just because of the geography that it has, but also because of the fairly wide broad-basing that it has developed over different sectors, and by and large in most products. China’s biggest value comes as a final stage assembler. That’s where China’s proficiency in value chains happens. It’s important to note along with being an exporter of assembled final products, China has also over the years become a major consumer for final products. So when we look at value chains today, let’s say in a post COVID-19 situation, the emphasis on the part of businesses is to make these chains shorter, more resilient, more durable, and locate them closer to the final demand markets. Now, this is where I think we often overlook the importance of China. China continues to remain a major source of the final demand market. As a result of which, shifting physically supply chains out of the Chinese geography and it’s connected arms — I refer to Hong Kong and Taiwan — is going to be pretty difficult because the geography offers a tremendous amount of what in economics we call agglomeration advantages, moving back and forth across borders and offering integrated facilities. So I am a bit doubtful as to whether we will actually see substantive supply chain relocations out of China. Whatever relocation had to happen has actually happened after the onset of the U.S-China trade war driven by tariffs, but now, we might not get to see that kind of relocation anymore — or at least not in a very substantive fashion.

We have seen companies moving out, although mainly to South-East Asia. Even assuming there is limited relocation that we can absorb, what should be our policy priorities to attract this?

Biswajit Dhar: We need to carefully look at ourselves and ask why is it that there was there’s always been a huge gulf between FDI inflows into China and into India, and why is it that we have been attracting so little despite being one of the most open economies, and despite being a country, which offers very attractive terms to foreign investors. The claim the government has often made that we are one of the most open regimes is actually true. But why is it that FDI is still not interested in coming here and we are not getting investment in the sectors that we're looking for? The Make in India strategy talked about FDI into manufacturing, but if you look at the data and see which sectors have been preferred by the foreign investors, you’ll see it’s all about service sectors. And many of these sectors are those where India does not need any investment, for instance IT services. I think the reason is clear, and that is there are skill set problems in India. Foreign investors get into the sectors where there are acknowledged skills, for instance in IT. But we don’t have similar skill sets in manufacturing. The second issue is infrastructure. We will keep talking about it till the cows come home. It’s not just about having a good policy, but you need to have the infrastructure in place so that the foreign investor can make profits. We should not see foreign investors as someone who comes to develop India. That could happen as a part of the process. Foreign investors will have to be given the opportunity to make money. The advantages that China has locationally, we don’t have any of these. We have outdated ports, and all kinds of other problems. There is a view that since the wage rates are low, investment is going to come here. That’s not true. We all know that it’s actually productivity-linked wages that matter, and productivity in India is pretty awful. We can talk about offering land, but I don’t think that land is an issue because from 2005, after we announced our special economic zones policy, the Government of India has gone and acquired land all over the place. The government is sitting on a huge land bank, so that’s not an issue. There is also the red tape. It’s not enough to say that we are going up the ease of doing business rankings. We know what the situation is on the ground. These three issues are extremely important for us.

We often hear industries calling for labour reforms, and complaints that in India labour unions are too powerful and it should be easier to hire and fire workers. Is that the issue, or is it a skills issue?

Biswajit Dhar: It is actually easy for industries to hire and fire. If one lesson COVID-19 has taught everyone, it is that there’s virtually no labour laws in this country. Labour was retrenched at the drop of a hat. The reverse migration we are seeing is because of this problem. This is a false kind of a narrative that has been parroted time and time again, that we need more flexibility. Labour couldn’t be more flexible than we have in India. My point is you have to put the finger on the right issues that are restricting or rather making ourselves a less attractive destination, as compared to the other countries.

Amitendu Palit: If you look at the kind of FDI that India has been getting over the last three to four years, and the big ticket FDI, whether it is Walmart’s acquisition of a large stake in Flipkart, or that of Facebook in Reliance Jio, all of these are essentially intending to acquire existing assets. None of these are in the nature of building a boat from scratch in terms of the typical greenfield investment, which is capable of creating substantial jobs and other additional capacities within the economy. One needs to also accept the fact that India is unique as a country which has a huge domestic market when one looks at other economies. Let me come back to the question of relocation. When one looks to other economies like Vietnam, Malaysia, Thailand, Cambodia or Bangladesh that are all competing for a slice of the pie of the relocated supply chains, they don’t have that kind of a market. But what they have is the ability to provide access to other markets in a far more effective fashion. For example, we now see Vietnam concluding a free trade agreement with the European Union, which will offer them two advantages. First, some businesses from China can move out and get relocated in Vietnam, which they already have been doing. They can take the advantage of the European market and they can also export back to China. Along with that, they have the advantage of the greater ASEAN and Asia-Pacific region, which is basically following a strategy of scaling up markets if one’s domestic market is relatively small. If you look at the question of labour in this context, we have been talking about wage rates in China going up. We have been talking about skilled labour becoming pricey. We do see that happening even in Vietnam. But the point is that at some level people also need to look at what kind of labour is wanted for what kind of operations. There is a situation in India and across the region where skilled labour continues to be at a premium. There will be a choice between countries and locations in terms of access to new labour. One other factor which we often overlook is there is a cultural commonness in business practices across region that you can find in China, Japan, Korea, and large parts of South-East Asia, the emphasis on settling disputes through dialogues, the emphasis on informal consultations, as opposed to what we are familiar in terms of a more structured fashion, not just in India, but in the West. I think there is also a cultural element to this entire question of supply chains and investment and relocation, which we often overlook.

One thing India can probably offer that other countries in South-East Asia cannot to the same degree, is the market. Can we leverage that better?

Biswajit Dhar: In the context of the great recession of 2008, there was a very serious discussion about decoupling because the global markets don’t provide those kinds of certainties. So, countries need to actually rely on their own domestic markets. The unfortunate reality is we have not cared to harness the dominant domestic market adequately. And this is linked to our overall strategy of increasing the manufacturing sector, allowing the sector to absorb more labour, especially from agriculture, and so easing the burden of agriculture, and then having a more resilient manufacturing sector, and reducing the dependence on countries like China which is now becoming a thorn in one's neck. What we are finding is that since none of these things have actually fallen in place, we find that the unemployment rate has actually gone up. And the direct implication of this increase in unemployment rate is that the domestic market has shrunk. There's less demand in the domestic market. And we’ve been seeing that growth was tapering off even before COVID-19. At the end of the day, if you have to create your own market, you got to have enough demand on the ground. And if you don't ensure that, this is a problem that you’re creating both for foreign investors as well as domestic investors.

Is there a contradiction between India aspiring to become a linchpin in global supply chains while being wary about trading agreements?

Amitendu Palit: First, we can all agree upon the fact that the WTO actually is the best set of rules for global trade as well as regional trade. Unfortunately, there have been issues with the functioning of the WTO and various groups of countries have not been happy with it. So they have moved on to pursue regional agreements and bilateral agreements. The Asia Pacific has been a very active region in this regard. We are looking at the RCEP getting concluded without India. Even if we go by what India's stated objective is, that is reduce dependency on China and work towards relocation of supply chains with like minded partners, countries like Japan, Korea, Vietnam, those are all members of RCEP as well. And they’re all going to work on the same rules of origin, which this agreement is going to give them. Now, what I’m trying to reconcile, and I’m unfortunately failing to, are these contradictory sets of objectives, with India looking to position itself as a hub and working to relocate supply chains along with a group of countries, but with countries which are part of a completely different sub-regional trade understanding. The question India needs to answer upfront is, is it going to stay engaged with the trade agreements or not? There could be two elements to this — reduce dependency on China, and reduce dependency on the rest of the world. Just reducing dependency on China has one set of implications, but reducing dependency on the rest of the world is an approach that will drive you up the road of economic nationalism.

Biswajit Dhar: I think we are going to go more towards the road of economic nationalism. There have been very clear signals in the last few years. India has gone more protectionist, and the average tariffs have actually gone up. We don’t need to guess what the tariff policy is going to be. I think it is going to be even more protectionist. There have been statements which have been made by most of the major ministers saying that we need to promote domestic goods, we need to shun imported goods, and even products made by foreign companies. That is very, very disturbing. If for everything from air conditioners to furniture to leather products, we start talking about indigenisation, that means we are trying to go down the path of import substitution. In this day and age, you can’t really do that. There are practical problems, because in order to go down that path, you have to garner huge resources which India doesn't have. And surely India is not talking about autarky. Going forward, I think policymakers are not going to make life easy for any of the investors or those who want to do business in India, because there will be these conflicting signals. On the one hand, there are some people who say that we should go and do an FTA with the U.S. On the other hand, you find these strong voices of economic nationalism which are coming in. One thing which is very important for any country today in the world that we live in is that policies must be predictable and transparent. Unfortunately, we seem to have neither. I wouldn’t want to be in the shoes of foreign investors or foreign companies. I have been talking to some of them, and they really don't know what’s going on here. This kind of muddling through is going to be the new normal.

Amitendu Palit, is Professor at the Institute of South Asian Studies, National University of Singapore; Biswajit Dhar is Professor at the Centre for Economic Studies and Planning, Jawaharlal Nehru University