India comes for China’s manufacturing crown as supply chains slowly shift

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Two decades ago, China and India’s economies were neck and neck, and would famously often be compared as the Dragon and Elephant at investors’ meetings, where attendees would dwell on their relative merits. Over the years, the Dragon beat the Elephant hands down to emerge as the world’s factory.

But India now looks set to make a pivot, analysts say, and could soon challenge China’s manufacturing pre-eminence amid a changed world order.

‘Historic moment’: Modi ramps up push to position India as alternative to China

Tamil Nadu is one of the country’s success stories. Home to more than 130 Fortune Global 500 companies, India’s southernmost state recently outlined an incentive programme aimed at encouraging investors to go beyond assembling low-value products, and manufacture high-value goods.

“What we have seen over the last two years is very, very strong interest in establishing advanced manufacturing facilities. Companies are also very keen to establish global capability centres here in India,” said Vishnu Venugopalan, managing director and CEO of Guidance Tamil Nadu, the state government’s investment promotion agency.

Global interest in India has grown since Prime Minister Narendra Modi’s government launched production-linked incentives for sectors such as electronics and renewable-energy equipment to boost the economy four years ago amid the pandemic.

These were recently expanded in an attempt to usher in investments in sophisticated technologies like making satellites and space-launch vehicles.

Is India like China, 15 years ago? … The answer is yes

Kevin Carter, emerging-markets investor

A raft of reforms has also been introduced to cut red tape, such as a simplified tax code that has sped up logistics, and revamped infrastructure including arterial highways, brand new airports and a modernisation programme for the country’s antiquated railways.

Further changes are expected, sending the stocks of many Indian companies soaring in anticipation – as Modi and his government seek a third consecutive five-year mandate in national polls between April and June.

“Is India like China [was] 15 years ago?” asked Kevin Carter, founder of the Emerging Markets Internet and ECommerce ETF, which has a specialised India-focused fund called INQQ. “The answer is yes.”

More than half of the country’s population is under 30, he pointed out. India, which surpassed China as the most populous country last year, is also the world’s fastest-growing major economy.

Customers visit India’s second Apple retail store, named ‘Apple Saket’, at a shopping centre in New Delhi last year. Investors expect India to surpass China in terms of number of consumers. Photo: Hindustan Times via Getty Images

“When you combine demographics and growth, India will surpass China in terms of number of consumers,” Carter told an investment webinar this month titled “The Rise of India: Investing in the Perfect Emerging Market”.

One of the cornerstones for optimism about India, he added, is its world-beating public digital infrastructure that has enabled millions to open bank accounts and transfer money instantly, swelling the nation’s base of middle-class consumers.

This digital infrastructure is soon expected to bring e-commerce into the fold – allowing consumers to get deliveries such as groceries from family-run shops within minutes, likely bringing more opportunities, Carter said.

Reforms and opportunities

“Without question, there is an opportunity for India. It is coming not only from the US-China rivalry and global firms’ ‘China plus one’ strategy, but from two other sources,” said Naushad Forbes, a former president of the Confederation of Indian Industry.

“China’s internal policies are really deterring foreign investors and making them seek other locations. Rising wages in China are also making it more economical to start simple assembly operations in places like Vietnam, Bangladesh, the Philippines and India.”

US officials have pointed to fines, raids and other actions against foreign companies that have made it risky to do business in China, despite efforts to reassure investors. But India’s ability to make the most of rising diversification varies from sector to sector, Forbes said.

“Medium-technology sectors are the ones where India is showing the greatest promise,” he said, adding that industries like speciality chemicals, engineering products and ready-to-eat foods are among the biggest areas of strength.

Workers make clothing for Ralph Lauren Corp. at a factory in Gurugram earlier this month. Observers say some of India’s neighbours have better positioned themselves for garment production. Photo: Bloomberg

But Forbes rued the fact that India was not grabbing opportunities in labour-intensive sectors such as garments. “India should worry about [this] because of the potential for employment creation,” he said, pointing out that neighbouring countries like Bangladesh had better positioned themselves.

Delhi is also missing a trick, Forbes said, by not joining trading blocs such as the Regional Comprehensive Economic Partnership – a free-trade agreement that includes China, Japan, South Korea, Australia, New Zealand and the 10 member states of Asean.

Despite strong ties with Western nations, he said “India is not being a part of key free trade where a lot of products exist”.

Experts say India’s reluctance to join the trade bloc stems mainly from China’s presence since a border clash in 2020 frayed diplomatic ties. But Chinese components are still needed for many of the products, such as iPhones and electric vehicles, in which India wants to ramp up production.

Technicians and engineers work at a mobile-phone manufacturing factory in Noida, India’s Uttar Pradesh state. Chinese components are still needed for many of the products that India manufactures. Photo: Shutterstock

Southeast Asia, a growth bright spot, could also help amplify India’s manufacturing, Forbes said.

“I hope we have a more moderate approach to how we define our self interest. China is a huge market and it’s not just a large exporter but also the second largest importer,” he said.

Delhi, which recently signed several new free-trade deals and is negotiating others with Britain and the European Union, should also look to lower import duties across the board, observers said.

“India’s import tariffs are among the highest across emerging markets, which acts as one of the deterrents to improving India’s market integration,” said Upasana Chachra, chief India economist at multinational investment bank Morgan Stanley.

Geopolitical tensions and the China-plus strategy provides India with a unique opportunity to become an integral part of global value chains

Pushan Dutt, INSEAD economics professor

High import tariffs fuel concerns about Delhi being too protectionist of its domestic industries, analysts say – even though isolated sectors may have benefited. The government did recently signal it would readjust some taxes to boost manufacturing, however.

Earlier this month, Delhi said it would lower import taxes on electric vehicles, committing to at least US$500 million in investment and a manufacturing plant within three years, potentially allowing Tesla to enter the market.

“India has not been very open to trade. Exports, for instance, are slightly more than 20 per cent of Chinese exports,” said Pushan Dutt, an economics and political-science professor at INSEAD business school.

“The geopolitical tensions and the China-plus strategy provides India with a unique opportunity to become an integral part of global value chains and use exports as an engine of growth.”

Simultaneously, India should look to boost jobs in labour-intensive sectors like tourism to cater to its young and growing population, experts said.

Job seekers visit stalls at “Mega Udyoga Mela” (Mega Job Fair) in Bangalore last month, organised by the Karnataka state government. Providing enough jobs is India’s single biggest economic challenge, observers say. Photo: EPA-EFE

Employment challenge

Providing enough jobs is the country’s single biggest economic challenge, according to Forbes, who said: “We are providing a lot of employment but mostly in informal services, not in good-quality formal jobs.”

India’s elite engineering colleges are tougher to enrol in than Harvard, boasting illustrious graduates from Microsoft CEO Satya Nadella to Google CEO Sundar Pichai, while the country’s scientific and technical manpower services the world.

“India’s vast pool of highly skilled talent, particularly in the fields of engineering and information technology, provides us with the resources needed for innovative technological advancements,” said Subramani Ramakrishnan, vice-president of the UPS Technology Centres in India, explaining the American logistics firm’s decision to establish a technology hub there.

Yet millions of young people in smaller towns and rural areas still struggle to master foundational skills – though the government did recently launch a new National Education Policy in a bid to improve matters.

Students and visitors conduct science experiments at Raman Research Institute in Bangalore during a recent open day. India boasts world-class institutions for tertiary education, but needs to invest more in other areas. Photo: EPA-EFE

“Where India lags behind is investment in education. While boasting world standard institutions like the IITs [Indian Institutes of Technology], India needs to invest in basic and secondary education,” said Pushan Dutt, an economics and political science professor at INSEAD.

“The quality of schools and teachers is poor and variable; teacher absenteeism is common and the quantity of colleges has not kept pace with the rapid increase in the number of young people entering the labour force.”

Nearly a quarter of India’s young people, or 23.22 per cent of those aged between 15 and 24, were unemployed in 2022, according to the latest available figures from the World Bank.

Yet labour laws are still cumbersome, remaining one of the biggest obstacles from the country’s bureaucratic legacy of red tape, Dutt said, adding that a backed-up courts system hardly helped matters.

Indian Prime Minister Narendra Modi addresses a public meeting in Chennai earlier this month. He is set to make labour reforms a priority if re-elected this year, his party says. Photo: AFP

Modi is set to make labour reforms, already passed by parliament in 2020, a priority if he wins the coming general elections as widely expected, a spokesman for his ruling party was quoted as saying by Reuters last month.

Despite being approved by parliament, the new labour code has yet to be implemented following resistance from labour unions who oppose easier hiring-and-firing provisions and restrictions on their activities.

Budding manufacturing growth

The promise of more reforms and growth has spawned a new generation of businesses who aim to usher in fresh manufacturing paradigms.

Bharath Krishna Rao Potluri, co-founder and CEO of Emobi Manufactury, is looking to pioneer low-cost two-wheelers for India in a strategic partnership with Japan’s Honda and Musashi Seimitsu Industry Co., catering to businesses making last-mile deliveries.

“We are moving away from the concept of mega-factories, and we believe more in micro-factories, which would be more regionally distributed, and closer to the points of consumption,” said Potluri, who hails from a business family.

Emobi’s first micro-factory in Bengaluru, capital of Karnataka state, is set to start production in July this year.

India’s long-term prospects are upbeat. Domestic demand will remain an important growth driver

Aditi Raman, Moody’s Analytics economist

Potluri concedes that Chinese firms, the global leaders in electric vehicles, have had a 10-15 year head start, but he hopes to bridge the gap with new technologies, frugal engineering and integrating software development into vehicles.

Industry executives say Indian industry could chart a new growth path by marrying its traditional strengths in software development with manufacturing. In some sectors, such as speciality chemicals, products are already being sold that combine these specialisations.

“India’s long-term prospects are upbeat. Domestic demand will remain an important growth driver, with strong investment and government spending as critical inputs,” said Aditi Raman, an associate economist at Moody’s Analytics.

She added that while more production bases were likely to emerge, India still needed to address glaring gaps between urban and rural infrastructure that had resulted in disparities, such as the varying cost of fuel across the country.

An Indian woman operates a fertiliser-spraying drone in Manesar, outside Delhi, as part of government-backed training initiative. India still needs to address glaring gaps between rural and urban infrastructure. Photo: AFP

An uneven investment landscape will hamper the country’s manufacturing ambitions, analysts say, as robust physical infrastructure and minimal bureaucracy are crucial for global companies looking to shift operations away from China.

It’s clear India still has some way to go to catch up with its giant neighbour to the north.

“One indicator is the size of factories. In India, they tend to be small relative to those in China, but they are growing in size as infrastructure becomes better,” said Srividya Jandhyala, an associate professor of management at the ESSEC Business School, Asia-Pacific in Singapore.

Analysts say most global companies looking to move out of China are currently testing the waters by shifting some production capacity, but they’re not moving everything all at once.

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“Many companies globally will remain significantly embedded with China, [even though] they may have the odd facility here and there,” said Subhabrata Sengupta, a partner at Asia-focused strategy consultancy Avalon Consulting.

One of the main reasons for this, he said, is that China accounts for nearly one-third of global demand in some product categories, while the country has also built entire manufacturing ecosystems.

“So, even in some cases where maybe the final assembly has moved from China to Vietnam or India, you may find that the components are still being sourced from China,” Sengupta said. “The nerve centres of these supply chains still remain in China.”

Indian companies, meanwhile, are only in the early stages of developing such supply chains.

An Indian man works at an electronic waste recycling shop in Gauhati, Assam state, in 2017. Analysts say the “nerve centres” of many supply chains still remain in China. Photo: AP

“A lot of companies in India assemble circuit boards, but very few actually manufacture circuit boards. So, in that sense, I will say that the movement has been only partial here, though there has been a fair bit of progress,” Sengupta said.

India’s manufacturing sector accounts for only 17 per cent of its gross domestic product, compared with 28 per cent in China, said Bernard Aw, chief APAC economist at Coface, a global credit insurer.

“But there is no doubt India’s manufacturing activity is growing and the product mix evolving to include higher-value activities such as electronics,” he said.

US-India tech deal could further detach China from global supply chain

Global companies like Apple are expected to shift significant amounts of phone-and-components manufacturing to India within two to three years to diversify their supply chains out of China and build more resilience against possible disruptions.

But the move seems “to be driven more by political considerations” and such a “shift may help India towards a quicker industrialisation process”, Aw said.

“So clearly, this is an opportunity for India to seize, by having not just policies that directly promote the manufacturing sector but also policies to invest in public health, education and physical infrastructure.”

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