India’s Best Chance To Become A Global Manufacturing Hub

India is making it easier to do business. It has been taking concrete measures to improve the business climate, that would take India from the current $2.8 trillion to the targeted $5 trillion economy, albeit a little delayed.

Hitherto, India has significantly lagged in increasing its manufacturing ability unlike its prowess in capturing service outsourcing.

Manufacturing capability and scale can only be improved if there is a considerable ease of doing business in India which would in turn spur confidence and attract foreign and domestic investments to set up and expand businesses in India.

India’s high import dependence in manufacturing has continued over the years. India’s merchandise imports currently account for 19 per cent of gross domestic product (GDP).

China accounted for 25 per cent of India’s imports, excluding energy and jewellery, in 2019 (70 per cent in API, 57 per cent in categories like furniture/lighting, 40 per cent in electronics and 28 per cent in appliances/machinery).

India’s GDP share of manufacturing has remained constant around 17 per cent, over the last 10-12 years. Comparatively, Bangladesh and Vietnam have both increased their GDP share of manufacturing by 5-6 per cent in the past 10-12 years.

India has a growing labour force because of its young population as also people are leaving farms and turning to urban areas for jobs.

India must create enough jobs for the one million addition to workforce monthly, for which it needs a massive expansion in small enterprises in the private sector over the next decade to absorb its growing labour force. The recent labour reforms are part of India’s serious attempt to boost manufacturing.

From the current 12 per cent of India's workforce in manufacturing, even if India did not reach the 28-35 per cent level that major economies have had at their peaks, and only reached 18 per cent, that would mean 30-50 million more jobs.

Improving Ease Of Doing Business

Procedural reforms by the government has already seen India's ‘Ease of Doing Business’ (EoDB) rank improve from 134 in 2014 to 63 in 2020, ie, up 14 places from 77th position last year, among 190 nations in the World Bank’s EoDB ranking on the back of multiple economic reforms by the Narendra Modi government.

India ranked among the top 10 improvers for the third consecutive time. However, it failed to achieve government's target of being at the 50th place in 2020 that it set in 2015.

While India has been consistently improving its global EoDB ranking, one needs to adopt a cautious approach before we start celebrating, as to whether there has been a genuine improvement in the business climate at the ground level or has India managed to capitalise on some of the low hanging fruits in the ranking methodology.

This is perhaps evident from the fact that though India (Rank 63) enjoys a higher EoDB ranking than Vietnam (Rank 70), many companies migrating from China have preferred Vietnam over India.

Malaysia (Rank 12) with strengths of macroeconomic stability, financial system and health of human capital and Thailand (Rank 21) with a strong financial system and flexible labour policies, have also been an attractive investment destination.

Migration Out Of China

India's current manufacturing push under ‘Atmanirbhar Bharat’ initiative is coming in at a time when many global manufacturing companies are exploring a China plus one strategy in a post-Covid world, in order to diversify supply chains, beyond China.

Earlier itself, many US companies had also been moving out of China in response to the US-China trade war with 25 per cent tariffs placed on $500 billion of Chinese goods.

Geopolitical tensions, increasing labour costs in China and supply disruptions are expected to accelerate the migration of manufacturing out of China, as concerns about the risk of production concentrated in one country increase.

In April 2020, amidst the coronavirus pandemic, outgoing Japanese Prime Minister Shinzo Abe proposed building an economy that is less dependent on one country — China, so that the nation can avoid supply chain disruptions.

Japan has announced a $2 billion ‘China exit’ subsidy for Japanese companies to shift their base out of China to stabilise and diversify Japanese production bases.

One may assume that India's large domestic market and low corporate taxation makes the Indian economy highly competitive and potentially attract higher investment.

While a migration/diversification out of China has been happening for about two years now, India hadn't been a beneficiary.

As per a study by Nomura Group between April 2018 and August 2019, on 56 companies primarily engaged in three sectors of electronics, apparel, shoes and bags and electrical equipment shifting production out of China, only three of these relocated to India while 26 went to Vietnam, 11 to Taiwan, eight to Thailand and six to Mexico.

However, after the announcement of ‘Make in India’ measures by the Indian government such as production-linked scheme (PLI), there has been a marked change in perception of India as an attractive investment destination.

Why Has India Lagged Vietnam So Far?

Vietnam has geographical and cultural proximity with China, and even the political system is similar — a single-party communist state.

Vietnam, with a population of around 10 crore and its proximity to China, is a preferred destination as the companies moving to Vietnam know that they will find a conducive environment like China in the country, given the nature of its political system.

The companies prefer Vietnam as there is no bureaucratic lethargy and democratic red tape.

In Vietnam, the court and the executive are not equal but under the legislature, which is filled with only single party members. Therefore, once the legislature clears a project, there are no additional hurdles.

Moreover, Vietnam has free trade agreements (FTAs) with China, which helps Vietnam become a manufacturing hub for labour-intensive industries such as textiles and electronics.

Regional Comprehensive Economic Partnership (RCEP)

The Regional Comprehensive Economic Partnership (RCEP) is made up of 10 Southeast Asian countries, as well as South Korea, China, Japan, Australia and New Zealand.

The pact is seen as an extension of China's influence in the region. The deal excludes the US, which withdrew from a rival Asia-Pacific trade pact in 2017.

India was also part of the negotiations, but it pulled out in 2019, over concerns that lower tariffs could hurt local producers. Signatories of the deal said the door remained open for India to join in the future.

China has been using the South Asian route to dump its goods, circumventing the country of origin (COO) issue. India’s trade deficit with China peaked at $73 billion in 2016-17. This was a key concern why India did not sign the RCEP.

India’s strength currently lies in the services sector. RCEP privileges merchandise trade over services. Moreover, currently India is not competitive in manufacturing and therefore not on a level footing with other countries.

India has had FTAs (free trade agreements) with the ASEAN countries (2009), South Korea (2009) and Japan (2010) for more than a decade.

Not only has these FTAs not helped export competitiveness in a great way, India has actually yielded ground to several South East Asian countries in terms of trade balance.

While India eliminated tariffs on 74 per cent of its market to ASEAN countries, the reciprocity has been less generous.

Indonesia eliminated tariffs only on 50 per cent of its market for India while Vietnam on 69 per cent of the trade market.

In 2009, India’s exports to South Korea was $3.4 billion, which barely increased to $4.7 billion in 2018-19 after a decade of signing FTA.

WTO Risk

A World Trade Organization (WTO) panel ruled against India in a trade dispute over its subsidies to exporters under various schemes in 2019.

These subsidies were worth over $7 billion annually and benefitted producers of steel products, pharmaceuticals, chemicals, information technology products, textiles and apparels.

While there will be no retrospective impact, India would have to stop providing subsidies in this form under the five sets of schemes viz export-oriented units, electronics hardware technology park and bio-technology park (EOU/EHTP/BTP) schemes; export promotion capital goods (EPCG) scheme; special economic zones (SEZ) schemes; duty-free imports for exporters scheme (DFIS); and merchandise exports from India scheme (MEIS).

According to WTO’s Subsidies and Countervailing Measures (SCM) Agreement, India was only exempt from this provision until its gross national product per capita per annum reached $1,000.

However, India can tweak the schemes to support exports while making them more WTO compliant by providing tax concessions (like concessions on goods and services tax or GST) on parts and components used in the production of the exported product.

Production Linked Schemes (PLI) — Make In India Initiative Under Atmanirbhar Bharat

By linking incentive to production rather than exports, PLI schemes are WTO compliant.

In order to boost domestic manufacturing, cut down on import bills, increase exports and create new jobs, the central government has introduced PLI scheme in certain sectors.

The PLI programme provides incentives to companies against their incremental sales from products manufactured in domestic units, capital expenditure or investments after the programme is notified.

The PLI scheme will make Indian manufacturers globally competitive, attract investment in the areas of core competency and cutting-edge technology, ensure efficiencies and create economies of scale.

It is a kind of subsidy to the sector, based on disadvantage/disability faced by a sector. It is a direct payment from the budget to goods made in India and the amount of subsidy varies from sector to sector.

Apart from inviting foreign companies to set up shop in India, the scheme also aims to encourage local companies to set up or expand existing manufacturing units.

he idea of the PLI programme is to get large manufacturers to India, whether integrating India as part of the supply chains or encouraging them to set up new base.

It is estimated that the PLI scheme will help create an ecosystem that will add 20 lakh crore worth of manufacturing ecosystem and 30 million well-paying jobs.

The PLI scheme provides benefits to companies who make ‘commitments’ to incremental revenues over the base year, rather than doling out benefits to all entities.

This would lead to capacity building in the long term. The GST that the government will collect on domestic sales on the back of higher production could cover the value of the incentive being offered.

By linking incentive to production rather than exports, the government has tried to keep it WTO compliant too.

Earlier in the year 2020, the government launched PLI scheme for bulk drugs & medical devices and mobile phones and electronics with a total incentive of over Rs 500 billion.

The response has been very encouraging.

In November 2020, the government approved PLI scheme for additional 10 sectors, with a total five-year outlay of Rs 1,460 billion.

These 10 sectors include the traditional export intensive warhorses like textile, pharmaceuticals, automotive, steel and white goods, but also the sectors of the future like solar panels, telecommunications gear, advanced cell batteries, food processing and electronics products.

India is taking constructive measures to position itself as an attractive investment destination, in the light of migration out of China.

The government’s vision is not to turn inwards or protectionist but the idea is that India engages with the world from a position of strength, on fair and reciprocal terms.

The nationwide roll-out of GST system in 2017, implementation of an effective Insolvency & Bankruptcy Code from 2018 and a large 8-15 ppt cut to corporate taxes in 2019 have helped businesses.

While the government has launched various structural reforms such as PLI, labour reforms, agriculture reforms, the next hurdle to overcome in improving the business climate is addressing pendency, delays and backlogs in the appellate and judicial arenas, complex compliance burden and improving the efficiency of logistics.

This is arguably the best opportunity for India to grow its manufacturing capability and become a global economic force to reckon with.