US-China trade war: Has India missed the bus?

• The US-China trade war has been painted as a golden period for a lot of emerging markets as a plethora of US-based companies are looking for alternate production sources.
• However, countries like Vietnam and Thailand have taken the lead in capturing these opportunities, while India has lagged so far despite being an ideal counterweight to China in terms of scale. 
• The government has taken a number of measures to improve manufacturing attractiveness, but FDI in India has historically been dominated by the services sector. 
• In order to attract foreign investment, India must enact favourable legislation, create a facilitating environment, select relevant sectors that synergise with its ecosystem and understand the specific nuances of the businesses that it seeks to attract.

The world has been overwhelmed by the hot and cold trade war between US & China that has been playing on in the battlefields of geopolitics and global trade since the beginning of 2018. The latest moves by the two countries include the US imposed 25% duties covering US$ 50 billion worth of Chinese-made goods in July, and a second round of 10% tariffs covering another US$ 200 billion of Chinese goods. US is also likely to impose a third round of tariffs on US$ 267 billion of goods, which will bring all of China’s exports to the US into the tariff regime. The repertoire of tariffs seriously damage China’s competitive edge of being a low-cost production base. At the same time, the rising labour costs in China, a slowing economy and the plethora of environmental regulations are giving producers a tough time in China.

This grim Chinese scenario has been painted as a golden period for a lot of emerging markets as a plethora of US-based companies are looking for alternate production sources. Over the last few months, numerous companies from various countries have shut shop in China and moved to other production sites. For instance, Denmark’s Danfoss has relocated some production of heating and air conditioning equipment from China to the US in order to avoid tariffs, reduce transport costs and limit shipping-related emissions of gases that cause global warming. Similarly, Samsung Electronics Co Ltd has ended mobile telephone production in China. Sony, the electronics giant, also resonated this sentiment and said that it is moving its production base to Thailand.

What is particularly interesting is that while countries like Thailand and Vietnam have been successful in enticing these companies to invest in them, India significantly lags behind in this amazing relocation race! This is indeed surprising when India would otherwise be seen as the ideal counterweight in this scenario, with the highest potential among competing economies to replicate China’s scale.

Top host economies for FDI inflows

Source: UNCTAD, World Investment Report’19

One obvious factor that seems to be impacting FDI, could be investor apprehensions on India’s slowing economy. The World Bank estimates that the Indian economy will slow down to a GDP growth rate of 6% in FY 2019, outpaced by Bangladesh (8.1%) and Nepal (6.5%). The Index of Industrial Production (IIP) numbers indicate a decline in August 2019 by 1.1% YoY, the lowest in 7 years. It was led by the capital goods segment (-21%) and the manufacturing sector (-1.2%). Consumer durables declined by 9.1% and infrastructure/construction fell by 4.5%.

Credit growth of Indian banks has hit a near two-year low in September of 8.79%, owing to growing risk aversion among lenders and poor demand among borrowers. The consumption cycle is weak across sectors, and that certainly affects overseas investor sentiment, since the availability of a strong captive market is a major element of India’s investment attractiveness.

Even traditionally, India’s cumulative FDI inflows between April 2000 and June 2019 (according to DPIIT)  have been dominated by the services sector (US$ 76.95 billion), computer software and hardware (US$ 39.48 billion), telecom (US$ 37 billion) and construction development (US$ 25.12 billion). This shows that manufacturing hasn’t exactly been a magnet for FDI in the relative sense, as far as India is concerned, part of the larger trajectory that India has followed to become a services-led economy. Manufacturing FDI is in fact a miniscule 0.6% of India’s GDP at present.

But past analysis shows there is a welcome shift. A survey by UBS Evidence Lab of CFOs in China and North Asia indicates that India’s attractiveness as a manufacturing destination has improved over the past few years. Some of the factors driving this shift are the absence of tensions of a potential trade war, less onerous environmental governance, and a relatively higher skilled workforce. But in practice, out of 56 companies that relocated production from China between April 2018 and August 2019, only 3 came to India. Vietnam took the lead with 26 firms, followed by Taiwan (11) and Thailand (8).

If we look at other countries, like Thailand, for instance, the government has designed a string of investor-friendly packages to entice foreign firms to come to Thailand. Some of the measures taken under the relocation package called ‘Thailand Plus’ include enhanced investment incentives, tax incentives, special economic zones, fiscal measures, manpower development, and deregulation. Now investment projects worth at least 1 billion baht (around US$ 32.26 million) in the identified activities submitted to the Thailand’s Board of Investment (BOI) by the end of 2020 will be permitted to avail of 50% corporate tax reduction for an additional 5 years, provided at least 1 billion baht of actual investment is put in place by December 2021. In order to accelerate reskilling and upskilling of the workforce, employers will be eligible to special deduction of training expenses related to advanced technology. The package also says that investments in automation systems will be entitled to double deduction. An investment steering committee, chaired by the Prime Minister, will also be set up to advance investments.  Vietnam, on the other hand, has proved to be an inspirational investment-led export success story in the past few years, to the extent that it now faces a major labour shortage in the manufacturing sector.

In order to attract foreign investment, India must take a cue from its international competitors. While the cut in corporate tax is a welcome step, it needs to be followed up with further action on key focus areas. Albeit the Indian government too has initiated favourable legislation like greater flexibility and ease of operation for single-brand retail and contract manufacturing; FDI in India still comes primarily in services, telecommunication and construction; not in manufacturing.

As the government is high on giving impetus to its manufacturing sector with initiatives like Make in India, it should analyze which manufacturing sub-sectors the country is best suited for. It should then meet the requirements those manufacturers have in order to set up shop, and target the regions where their investments can generate the most sustainable returns. Creation of SEZs, for instance, along with creating a facilitating environment like 24*7 power supply, connectivity to ports, appropriate skilling of workforce, etc. will help in doing the same. Necessary incentives need to be offered to investors in specific sectors. Accelerated infrastructure construction, reform of land and labour laws, reduction in logistics costs and greater policy certainty will play a major role, if India expects to capture the investment opportunities moving out of China in the coming years.