The first Economic Survey of Modi 3.0 dropped a bombshell when it made a case for getting Foreign Direct Investment (FDI) from China to help India improve its participation in global supply chains through exports. Even as Union commerce & industry minister Piyush Goyal quickly scotched speculations about easing Chinese capital inflows, the economic survey—tabled a day before the Union budget to provide an overview of the Indian economy’s performance—has set off a debate.
China is India’s largest trade partner, with export/ import volumes exceeding $118 billion (Rs 9.9 lakh crore, at the current exchange rate) in 2023-24. But India’s trade deficit with China is also the highest at $85 billion (Rs 7.14 lakh crore), not including Chinese products reaching its shores through free trade agreements (FTAs) with ASEAN countries. This gap was less than a billion dollars at the turn of the century when China joined the World Trade Organization (WTO). Since then, China has transformed itself into a bustling “factory of the world”, capitalising on lower environmental compliances, surplus and cheaper labour, as well as economies of scale. It was producing enough to flood global markets with much cheaper products, especially when other emerging economies like India and Brazil continued to struggle with their own reforms to open up to foreign capital.
In fact, the share of manufacturing in India’s GDP declined from 15.93 per cent in 2001 to 13.35 per cent in 2022, despite the economy expanding by about a 6 per cent compound annual growth rate (CAGR). Many economists argue that India needs to continue blocking Chinese finished goods through both tariff and non-tariff barriers while incentivising domestic industry and opening up FDI to set up cutting-edge factories that manufacture intermediaries as well as final products. In 2020, when the pandemic forced the world to devise the ‘China-plus-one’ strategy to diversify investments into other emerging economies, India too saw an opportunity to boost its manufacturing. Around the same time, Chinese aggression in Galwan and Beijing’s opportunistic takeovers of Indian companies led to New Delhi shuttering Chinese FDI by amending rules, which mandated that India’s neighbours could invest here only after securing prior government approval. Subsequently, the government also raised tariff and non-tariff barriers to block Chinese goods, similar to the US’s ‘small yard, high fence’ strategy.
But this poses another challenge. Prime Minister Narendra Modi aims for India to become a $10 trillion (Rs 839.5 lakh crore) economy by 2031-32 from the existing $3.94 trillion (Rs 331 lakh crore), requiring more than a 12 per cent CAGR. This can’t be achieved unless the manufacturing sector starts firing on all cylinders and contributes at least a third of GDP. The Economic Survey indicates that consumption is growing at 4 per cent, roughly half the rate of GDP growth, and capacity utilisation of existing factories remains at 74-76 per cent. A World Bank report, on the other hand, forecasts global growth to stay steady at 2.6 per cent in the current fiscal. The report notes that the major growth engines are not the developed economies of the West, but India and China. This means Indian manufacturers will have to rely more on domestic consumption than on any surge in export demands.
Accelerating manufacturing
With India’s expanding workforce availability, factories remain big work churners. The Reserve Bank of India’s KLEMS (capital, labour, energy, materials, services) database shows 46.6 million added to the organised workforce in the previous fiscal. To accelerate manufacturing, India requires a multipronged strategy: strengthening the ecosystem for intermediary product manufacturing, turning MSMEs from just auxiliary manufacturers for the mother industry to also the makers of new products, and integrating them into the global value chain. In the past four years, India has taken steps in this direction—for instance, the production-linked incentive (PLI) schemes in 14 sectors that incentivise manufacturing of products to substitute imports and capitalise on opportunities that are emerging from the ‘China-plus-one’ policy, especially in the manufacturing of advanced electronic items and components. Among them is the PLI scheme for automobile and auto components launched in September 2021 to boost the manufacturing of Advanced Automotive Technology (AAT) products, facilitate deep localisation for AAT products and enable the creation of a domestic as well as a global supply chain. The sector continues to be a key driver of the Indian economy, contributing 7.1 per cent to India’s GDP and about half of the manufacturing GDP.
India is also focusing on new-age products like electric vehicles (EVs), cleaner hydrogen-based cars, electronics and white goods, active pharmaceutical ingredients (APIs), telecom and networking products, and drones and their components. But despite attracting investments through PLI and tax breaks, India remains short of becoming an immediate beneficiary of manufacturing diversification by the West. For, even for these products, there’s dependency on the imports of Chinese equipment. It was perhaps faced with this Hobson’s choice that the economic survey made a case for FDI inflow from China, having learnt from the experience of other economies such as South Korea, Vietnam, Thailand and Malaysia that have benefitted from it.
Safeguarding national interests
However, this comes at a time when the Modi regime is repairing its relationship with its ideological parent, the Rashtriya Swayamsevak Sangh (RSS), which sees China as an ideological opponent and does not want New Delhi’s interests to become subservient to Beijing’s. The RSS and its affiliates working in this arena have been pushing the government to look for alternatives and bring in reforms such as easing out the inverted duty structures that have hit labour-intensive sectors such as textiles and leather. In a research paper written for the New Delhi-based think tank Council for International Economic Understanding, economist Ashwani Mahajan noted that the textile industry in India faces a 9 per cent cost disadvantage on account of levies like the cess on fuel, logistical inefficiencies and cheaper inputs flooding the market through FTAs, especially with the ASEAN countries. Talking to India Today, he identified 70 products ranging from chemicals and metals to textiles and electrical and electronic goods that are facing cost disadvantages. “The PLI is a good start,” he says, “but to lay the foundations for the factories of tomorrow, India will have to bring the next level of reforms quickly.”
India is investing heavily in railway and highway networks to facilitate the transportation of raw material and goods. The introduction of the Goods & Services Tax (GST) has added to the ease of doing business. But “the availability of land to set up factories and the availability of robust supply lines are still a big challenge”, says an industrialist, speaking on condition of anonymity. Access to cheaper and easy capital is also an uphill task, he adds. In April this year, a report by consulting group EY highlighted that preferential duty structures in FTAs with countries having strong manufacturing capacities, like ASEAN, South Korea and Japan, have created an uneven playing field for Indian manufacturing. The report identified several factors, including taxes outside GST, higher input costs, expensive capital, and high energy and logistics expenses, as contributing to the disadvantage of India’s manufacturing sector. This gives vital pointers to the government to recalibrate India’s multilateral and bilateral trade agreements for achieving a level playing field between imports and domestic manufacturing.
But a change is visible. In fact, the EY report noted that since 2010-11, when FTAs were implemented, India has eliminated 75 per cent of its tariffs, covering nearly 90 per cent of tariff lines. In 2019, India pulled out of the Regional Comprehensive Economic Partnership (RCEP), conceived at the 2011 ASEAN Summit, and has never given heed to the Belt and Road Initiative (BRI) pushed by China. Instead, India has decided to go for bilateral agreements with the UAE and Australia and has entered into a Trade and Economic Partnership Agreement (TEPA) with EFTA countries (Switzerland, Iceland, Norway and Liechtenstein) besides negotiating trade deals with the US, UK and EU. This reflects a change in strategy, as these new geographies may not supply cheaper inputs but open up markets for Indian products. Another industrialist, speaking anonymously, suggests that while the focus is on strengthening manufacturing, it should be done in a “synergised way”. “Look at the final product,” he adds, “and do backward integration, cleaning up the inverted duty structures which make the products uncompetitive and ineffective.” If done right, it could very well help India achieve its ambitious growth targets and become a global manufacturing hub.
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