Five Investments India is Making to Become China's "Plus One" in Manufacturing

Apple is in the news today for announcing that they will create manufacturing capacity in India to produce 25% of the world’s iPhones from there.  Apple is acting on a trend with other multinationals to reduce reliance on China as their primary manufacturing source.  The COVID-19 pandemic and geopolitical events such as the Russia-Ukraine war have vividly illustrated the fragility of the world’s supply chain.

India is one country that’s been working hard to become China’s Plus One and improve its attractiveness as a manufacturing hub.  Currently, manufacturing contributes 17% of the GDP.  The government’s goal is to expand manufacturing to 25% of GDP by 2025.  Below are five investments India is making to attract foreign investment and build domestic manufacturing capacity.

Investment #1: Production Linked Incentives (PLI)

The PLI schemes provide economic incentives to foreign companies, like Apple, to set up manufacturing facilities in India.  It also provides incentives to domestic Indian companies to set up or expand manufacturing capacity to increase employment and reduce reliance on imports to meet domestic demand.  These schemes are targeted at 14 key sectors including electronics, pharmaceutical drugs, and medical devices.  In exchange for investing in plants, machinery, and R&D, the government is providing various incentives for up to five years.

Investment #2: Special Economic Zones

India has approximately 270 Special Economic Zones (SEZ) to attract Foreign Direct Investment (FDI).  These SEZs give favorable tax treatment to companies setting up manufacturing sites.  Often, these zones are targeted at specific industries to develop manufacturing clusters.  As an example, Pune attracts about 20% of India’s FDI with a concentration in automobiles and durable goods.  Pune also serves as an engineering R&D hub for companies such as Tata Motors, Volkswagen, and Visteon.

Investment #3:  Road Infrastructure

India is focused on improving road infrastructure with agencies such as the Ministry of Road Transport and Highways (MoRTH) and the National Highways Authority of India (NHAI).  India’s roads support over 60% of freight transportation in the country.  In FY22, India completed over 6,200 miles (10,000 kilometers) of roads, up significantly from previous years.  Much of that has been built under the Toll-Operate-Transfer model where India builds the highways and then monetizes them by selling the right to operate the roads and collect tolls.  Companies like Canada’s Brookfield Asset Management are providing the capital for this monetization process.  The Indian government has even gone digital with the deployment of a Project Management and Data Lake cloud-based software used to manage the bid and execution process of all contracts.

Investment #4: Shipping Port Infrastructure

The Indian maritime sector accounts for 95% of export-import trade by volume.  Like roads, India has been actively working to build port capacity through the use of Foreign Direct Investment.  The Maritime Vision 2030 initiatives seeks to attract foreign investment to build and operate ports under long-term contracts.  A central component of the Maritime Vision 2030 is the creation of four mega-port clusters.  These will come in the states of Gujarat, Maharashtra, Tamil Nadu, and West Bengal-Odisha.  Key features will include port automation, seamless movement of cargo, and paperless transactions to create standard processes and provide access to real-time information for port management.

Investment #5: Human Capital Development

According to a 2020 World Bank study, India’s Human Capital Index places it 116th out of 174 countries.  The index measures a variety of factors including projected life expectancy and quality of education.  India’s population skews younger, with 65% of the population under 35.  As part of the challenge to develop skills to compete, India has a partnership with the World Bank to improve education quality.  Additionally, private companies run programs to further improve skills after completion of education at the university level.

Conclusion

India is not alone in its desire to take manufacturing from China.  Other Asian countries like Vietnam, Thailand, and Malaysia are also ramping up to compete.  However, India is making serious commitments to increase its global competitiveness and become a central part of the world’s manufacturing sector.

The Impact of Rising Trade Restrictions

Rising trade restrictions between countries can have significant economic and geopolitical implications, leading to a range of key issues that affect various stakeholders. The International Monetary Fund (IMF) has an interesting article out this month in Foreign Affairs in which they argue that the world is moving in the wrong direction by increasing the number of trade barriers.

According to the latest International Monetary Fund projections, annual global GDP growth in 2028 will be only three percent—the IMF’s lowest five-year-ahead forecast in the past three decades, which spells trouble for poverty reduction and for creating jobs among burgeoning populations of young people in developing countries. - International Monetary Fund

Since the Global Financial Crisis in 2008, growth in world trade has more or less leveled out, what some have described as “slobalization”. While the growth in trade has been slowing, the nature of trade is also morphing. In light of the Covid pandemic and the Russia-Ukraine war, countries are reevaluating which trading partners can be counted on in difficult times. This “friendshoring” movement will reduce supply chain risks, but also impact the cost of goods and services, with developing countries much more likely to feel the brunt of reduced trade and global growth.

Countries perceive trade restrictions as working in their best interests, but this is a short-term view. I’ve written elsewhere that India would do well to rethink its trade restrictions, including taxes on imported sub-components for the assembly of mobile phones. This is just one example where lessening trade restrictions would eventually lead to longer-term economic growth, with millions of Indians benefiting from a broad and efficient manufacturing economy.

Countries should be thinking about the following issues before they erect even more trade barriers:

• Economic Impact: Trade restrictions, such as tariffs, quotas, and import/export bans, can hinder the flow of goods and services across borders. This can lead to reduced economic growth and lower consumer welfare. Industries that rely heavily on international trade might face challenges in accessing foreign markets or sourcing necessary inputs, which can disrupt supply chains and lead to higher production costs.

• Price Increases: Tariffs and other trade barriers often result in higher prices for imported goods, as the cost of complying with these barriers is passed onto consumers. This can lead to inflationary pressures, particularly if the affected goods are essential or inputs for other industries. For Western countries, moving supply chains to “friendly” countries will almost surely have the impact of rising prices from both labor and materials.

• Reduced Competition: Trade restrictions can limit the level of competition in domestic markets, as they protect domestic industries from foreign competitors. While this might offer short-term advantages to domestic producers, it can lead to complacency, decreased innovation, and reduced efficiency in the long run.

• Global Value Chains Disruption: Modern production processes often involve components and materials sourced from different countries. Trade restrictions can disrupt global value chains, causing delays in production and increased costs as companies search for alternative suppliers. In an example like rare earth metals, there are relatively few countries that have these materials. Countries, and companies that need these materials for production will have to find a way to deal with these countries, even if they are deemed “unfriendly”.

• Retaliation and Trade Wars: When one country imposes trade restrictions, its trading partners might retaliate with their own restrictions. This tit-for-tat escalation can result in a trade war, where both sides suffer economic losses, reduced trade volumes, and increased uncertainty.

• Impact on Developing Countries: Developing countries often rely heavily on exports to drive economic growth. Trade restrictions can limit their access to global markets, reducing their ability to generate income, create jobs, and improve living standards.

• Global Economic Uncertainty: Rising trade tensions and protectionist policies can create uncertainty in global markets. Businesses might delay investment decisions due to the unpredictability of trade relations, leading to reduced economic activity. Already, many companies including Apple are looking at a China Plus One manufacturing strategy, given the geopolitical risks of dealing with China.

• Inefficiency and Resource Misallocation: Trade restrictions can lead to inefficient resource allocation as countries are forced to produce goods domestically that could be produced more efficiently elsewhere. This can result in a waste of resources and reduced overall economic output. It may also result in the misallocation of human resources, where domestic resources could be involved in higher-value activities if low value activities where outsourced to other nations.

• Neglect of Multilateral Agreements: Increasing trade restrictions can undermine multilateral agreements like the World Trade Organization (WTO), which aim to promote global trade cooperation, reduce barriers, and resolve trade disputes. A disregard for these agreements can weaken the international trade framework.

• Geopolitical Tensions: Trade restrictions can exacerbate geopolitical tensions between countries. Economic conflicts can spill over into political and security issues, making it more challenging to resolve international disputes.

According to the IMF, over the long term, trade fragmentation—that is, increasing restrictions on the trade in goods and services across countries—could reduce global GDP by up to seven percent, or $7.4 trillion in today’s dollars, the equivalent of the combined GDPs of France and Germany and more than three times the size of the entire sub-Saharan African economy.

Rising trade restrictions for goods and services between countries can create a range of negative consequences, affecting economic growth, consumer welfare, global cooperation, and geopolitical stability. It's important for countries to carefully consider the potential drawbacks of protectionist policies and to seek avenues for constructive dialogue and negotiation to address trade-related issues.

Questions:

• What do you see as the primary negative consequences of increasing trade restrictions?

• Do you think there are positive benefits that outweigh the negative consequences outlined above?

• How do you think companies should balance Foreign Direct Investment (FDI) against national interests?

Let us know your thoughts in the comment section.

Ernst & Young survey on India Foreign Direct Investment (FDI) shows investor optimism

A recently released survey by Ernst & Young shows that executives of multinational corporations still see India as an attractive place to invest.  The survey included approximately 500 executives and indicated that India is seen as a "global leader in education, R&D, innovation, and as a producer of high value-added goods and services".

The study was led by Rajiv Memani, Country Managing Partner at Ernst & Young India.  For the details, Ernst & Young encourages people to contact them (Hey, they've got to have a reason to fund the research!).

You can read more at Reaching towards its true potential - Ernst & Young's 2011 India attractiveness survey.

India Leads the World in Wage Hikes

An article from Industry Week discusses the double-digit wage hikes employers can expect to hand out.  According to the article, wages are set to rise almost 13%.

An excerpt:

At the fastest pace in the world, Indian corporate salaries are set to grow by 12.9% this year and will keep rising at this level for up to five years, a consultancy forecast on March 8.

Indian wage growth slipped to an average 6.6% in 2009, the survey said, but quickly moved up the following year to 11.7% as India shed the effects of the global economic downturn.

"We expect Indian salaries to grow by 12% to 15% over the next four to five years for sure," Sethi said.

Continue reading India Sets World Record for Double-digit Wage Hikes.

India and ASEAN seek to liberalize trade

The Hindu is reporting on an upcoming economic summit between India and ASEAN (Association of Southeastern Nations).  At the top of the agenda for is a liberalized trade agreement that will create greater access to ASEAN member nations for Indian professionals.  However, no all member nations are on-board as they are concerned about dominating their markets.

An excerpt from the article:

After signing a free trade pact in goods last August, India and ASEAN are engaged in talks to widen the agreement to include services and investments at the earliest. Indian officials had earlier indicated that the negotiations would be wrapped up by end of this month.

The official, however, admitted the pace of talks is slow as there are some differences.

“ASEAN members are not ready to liberalise services where India has interest,” he said, adding that some of them are apprehensive that India, which is the world’s second fastest growing economy, would end up dominating their markets.

During the meeting, Commerce and Industry Minister Anand Sharma is likely to press for more access for Indian professionals in the ASEAN market.

India, which has expertise in areas like finance, IT and education is eager to enter the vast services market of the south-east Asia. Similarly, the ASEAN members are eyeing India’s growing contract services area and tourism.

ASEAN consists of of Malaysia, Singapore, Vietnam, Myanmar, Thailand, Bruni, Cambodia, Indonesia, Laos and Philippines.

Here the link to the full article: India, ASEAN trade ministers to meet in Vietnam on Aug 26