The Future of the Sino-Indian Rivalry
This article was originally published in French, Italian and Spanish by the Le Grand Continent. Below is the unedited English version of the article.
Introduction
The "China + 1" is a diversification strategy adopted by countries and businesses to reduce dependency on China as a sole manufacturing or sourcing hub. This approach involves exploring alternative locations beyond China (the "+1" country) to spread out supply chains and minimise risks associated with over-reliance on one supplier. It reflects a broader effort by countries and businesses to counterbalance China's economic dominance and navigate global power shifts. Trade and investment data analyses over the last three years indicate that the EU, Mexico, Taiwan, Malaysia and Vietnam have emerged as clear beneficiaries of the China+1 strategy across sectors such as machinery, automobiles, and transport and electrical equipment.
India is also seeking to capitalise on the anxiety created by China's supply chain dominance by reforming its economic and regulatory landscape to make it an attractive business alternative. India’s strategy includes reducing its dependence on China, attracting investments from those looking to diversify from China, and adopting a protectionist policy stance by introducing import tariffs.
India’s View of Economic Relationship With China
In the early 2000s, there was optimism and hope in India that developing trade and economic complementarity with China would help strengthen the relationship. China was growing as a manufacturing powerhouse, and India as a sizeable services-based economy, so this expectation seemed plausible. In 2012, the then Indian Ambassador to China and current Indian Foreign Minister, S. Jaishankar, even remarked that India-China economic ties were the game changer in the bilateral relationship. When the current Indian Prime Minister, Narendra Modi, came to office in 2014, there was a renewed expectation that strengthening the economic relationship with China was in India’s interest and China would also reciprocate. However, things did not turn out as expected.
China has deployed various tools, including non-tariff barriers, to limit imports from India in sectors where India is competitive, such as pharmaceuticals and certain types of food and dairy products. As an IT services exporter, one of the biggest non-tariff barriers against India is China’s Great Firewall, which regulates its domestic internet. All this while, India has become more dependent on China for manufactured goods ranging from electronics, mobile phones, and computers to cheap toys and frying pans. China has also disproportionately benefitted from the Free Trade Agreements (FTAs) India signed with Southeast Asian countries by exploiting loopholes in the rules-of-origin (ROO) regulations and dumping Chinese goods in the Indian market. The ballooning trade deficit with China, which crossed the $100 billion mark last year, is now considered a vulnerability in India.
India also refused to sign the Regional Comprehensive Economic Partnership (RCEP), the world’s largest trading bloc, primarily because its core concerns, such as circumvention of rules of origin (especially by China) due to tariff differential, inclusion of fair agreement to address the issues of trade deficits and opening of services were not being addressed. Apart from non-reciprocity in trade access by China, the strategic dimension of the India-China bilateral relationship has also undergone a significant shift.
The experience of concentrated supply chains across sectors during COVID-19 and dependence on China for even basic medical supplies and key Active Pharmaceutical ingredients (APIs) for pharmaceutical manufacturing raised significant concerns in India, similar to what many other countries globally realised. Additionally, an attempt by China to change the status quo at the border with India along the Himalayas significantly damaged the bilateral relationship between the two countries and increased distrust and suspicion. The fact that these clashes resulted in the death of 20 Indian soldiers even soured the public mood regarding the relationship with China. It is worth noting that both countries remain on high alert along the border, with enhanced military deployment by both sides. So, it seems unlikely that there will be any breakthrough in the near future.
Instead of seeing economic ties with China as an opportunity, India increasingly sees it as a vulnerability, especially in sensitive sectors. India’s Foreign Minister, S. Jaishankar, has remarked that globalisation and technology are not just economic issues anymore; they’re strategic issues. For example, in resilient supply chains and trusted technologies domains, economic price and cost imperatives are no longer the only things that count. They have become part of national security architecture.
India has imposed several measures restricting or imposing extra scrutiny on Chinese investments in various sectors, including but not limited to the economy, emerging technologies, telecommunications, civil society, and media domains. These restrictions have become necessary as it becomes increasingly difficult to differentiate a Chinese private player from the Chinese state, especially in strategic sectors and emerging technologies. Instead of economic ties facilitating political bonhomie, political friction has further exacerbated economic concerns.
Over the last decade, India has undertaken several direct and indirect measures to improve its business environment. This includes repealing thousands of redundant laws from the statute books, streamlining its bankruptcy laws, increasing capital expenditure to expand its logistics (rail, sea and road) infrastructure, digitising government processes, and decriminalising minor, technical or procedural defaults. India is looking to increase its share of global manufacturing exports to 25% of GDP by 2025 from the current 17.7% share. The geoeconomic opportunity provided by the global move towards the China+1 strategy has provided a much-needed shot in the arm for these efforts.
Changing Approach to Free Trade Agreements
India has sought to change its traditional outlook on Free Trade Agreements (FTAs). India had been reticent to sign FTAs, especially with countries outside its region. Until 2021, it had signed only 11 FTAs, limited to its South Asian neighbours, ASEAN countries, Japan, and South Korea.
India’s experience with FTAs has been a mixed bag at best. Between 2017 and 2022, India’s exports to its FTA partners increased by 31 per cent, whereas its imports increased by 82 per cent. While agreements with Japan and Korea can be termed balanced overall, the one with ASEAN is quite imbalanced. For example, India’s global imports during the 2010-21 period rose by 63%, but imports from ASEAN alone grew by about 120%. India’s FTA utilisation, which indicates how much a country’s exporters benefit from an FTA, remains very low at below 25 per cent. In contrast, it is usually between 70–80 per cent for developed countries.
India's Free Trade Agreements (FTAs) have faced considerable challenges in advancing India’s trade due to India’s inefficiencies and structural problems. The performance gap between India's manufacturing sector and those of FTA partner economies, like South Korea, Malaysia, Vietnam, and Thailand, has also impeded the utilisation of FTAs. These countries have emphasised research, innovation, and value chain enhancement to bolster global competitiveness. This makes importing directly from these nations more cost-effective for Indian manufacturers than domestic production due to inherent challenges in India's manufacturing landscape. Furthermore, complex certification requirements and rules of origin further compounded challenges for Indian exporters. Cumbersome procedures and high costs associated with certificates of origin increased compliance expenses, hindering streamlined export processes. However, even when India has reduced tariffs, persistent non-tariff barriers such as stringent standards and technical trade obstacles restrict Indian exporters' access to partner markets.
Another key issue has been the lack of comprehensive industry and stakeholder involvement during the negotiation phase, leading to market access being granted to FTA partners without addressing crucial concerns of domestic industries. Moreover, post-implementation efforts by the government to popularise FTAs among industry stakeholders have been inadequate. Limited outreach activities and insufficient marketing efforts fail to create awareness among exporters about the benefits of these agreements. Recognising the ineffectiveness of these FTAs, India began reviewing them in 2019.
However, there has been a shift in how India sees FTAs and their purpose in recent years. While the earlier FTAs focused on India’s eastern neighbourhood under the ‘Look East’ policy, the current focus has shifted to Western geographies such as the US, the UK, the EU, and Eurasia. The main reason for this shift is the recognition that there is a need to look for credible supply chain partners. Besides lowering tariffs, India’s priorities now include building resilient supply chains, becoming part of global value chains, production integration, digital trade and environmental protection.
India has also decided to be part of the Indo-Pacific Economic Framework (IPEF), which was launched in Tokyo in 2022 as an initiative to strengthen economic partnerships among participating countries to enhance resilience, sustainability, inclusiveness, economic growth, fairness, and competitiveness in the Indo-Pacific region. India has agreed to discuss three out of four pillars, which are Supply Chains, Tax and anti-corruption and Clean Energy. Although not an FTA, the IPEF is important for developing a shared understanding between participants along the identified pillars. India recently signed the Indo-Pacific Economic Framework for Prosperity (IPEF) Supply Chain Agreement.
Since 2021, it has concluded FTAs with UAE, Australia and Mauritius. Discussions with similar agreements with the European Union and Canada are ongoing, while that with the United Kingdom is in advanced stages. In an encouraging sign, the FTA utilisation of the India-UAE agreement is over 50% and, in the first nine months, is around 77% for the India-Australia agreement. However, India must accelerate efforts to sign FTAs with as many partners as possible to increase its export potential and become deeply integrated with the global value chains. In contrast to seeking out FTAs, India has also actively encouraged import substitution through import tariffs and providing domestic manufacturing subsidies.
Industrial Policy to Encourage Manufacturing
In March 2020, India announced the ‘Production Linked Incentive (PLI)’ scheme to incentivise companies in identified sectors on incremental sales from products manufactured in India for a fixed period. As India seeks to encourage foreign direct investment and push domestic enterprises to expand their production capacity, both domestic and foreign companies can avail of incentives under this scheme. The scheme initially targeted three industries: mobile and allied component manufacturing, electrical component manufacturing, and medical devices.
The scope of the PLI scheme has gradually expanded to include several other sectors such as automobiles and auto components, pharmaceuticals, drugs, speciality steel, telecom & networking products, electronic products, white goods (ACs and LEDs), food products, textile products, solar PV modules, advanced chemistry cell (ACC) battery, and drones and drone components. The government expects that the minimum production in India within five years due to the PLI schemes will be over $500 billion and has committed to spending over $26 billion to provide these incentives. Till March 2023, 733 applications were approved by the government in 14 sectors with an expected investment of INR 3.65 lakh crore ($43 billion). The realised investment value was about INR 62,500 crore ($7.5 billion), resulting in incremental production of over INR 6.75 lakh crore ($81 billion) and employment generation of around 3,25,000.
A critical component of this strategy is to invite flagship foreign companies in some of these sectors to set up manufacturing capacity in India, which can bring in capital, global best practices and their research and development ecosystems to serve as a lightning rod for the broader domestic industry. A closer examination of India's mobile phone manufacturing sector illustrates how India is seizing the opportunity provided by the China+1 strategy and how this strategy is being implemented.
India is expected to export mobile phones worth $11 billion this year, up from $5.5 billion exported last year and just $1.7 billion in 2021. A significant share of these exports are iPhones, which constitute about 50% of all mobile phones shipped from India. Apple has also quickly scaled up its operations in India and is expected to shift at least 18% of its global iPhone production to India by 2025, up from the current 7% and just 1% share in 2021.
Since at least 2017, the Indian government and Apple have been negotiating concessions for Apple to start making iPhones in India. Although the government ultimately ruled out giving preferential treatment to a single company, these discussions helped formulate the PLI scheme for the entire sector, which was launched later in 2020. The geopolitical tussle between China and the United States has also necessitated that Apple diversifies its supply chains to prevent disruptions.
While iPhone manufacturing in India seems to be a runaway success, geopolitical tensions between India and China have also affected Apple’s expansion plans in India. In April 2020, India made prior approval mandatory for foreign investments from India’s neighbouring countries—a move likely aimed at China. Although there are legitimate national security concerns for such a decision, this has negatively impacted the growth of India’s electronics manufacturing sector as Chinese companies are crucial players in the ecosystem, especially as suppliers of intermediate components. For instance, of the 188 companies in Apple’s supplier list, 151 are Chinese or have a substantial manufacturing presence in China.
Apple has to get its Chinese suppliers to invest in India to shift a part of its supply chain to India. However, the FDI restrictions have made this process extremely difficult and unpredictable. In 2021, Apple's attempt to get its largest vendor, the Chinese manufacturing conglomerate BYD, to assemble iPads in India failed because of New Delhi’s restrictions on Chinese investment. Recently, a major China-based Apple supplier, Luxshare, moved a planned investment of $330 million from India to Vietnam after requisite approvals from India were experiencing inordinate delays.
However, India has realised that it needs to be flexible. Earlier this year, New Delhi gave several of Apple’s Chinese suppliers preliminary clearance to set up facilities in India, but only as a joint venture with Indian companies. Furthermore, Apple’s suppliers located outside of China, such as Corning from the US and Pegatron and Foxconn from Taiwan, find it relatively more straightforward to get approvals for starting or expanding operations in India.
Indian provinces are also competing against each other to attract these new investments. It was reported that Apple and its manufacturing partner, Foxconn, successfully lobbied for a significant liberalisation of labour laws in the South Indian state of Karnataka. The revised law now allows for 12-hour shifts and night-time work for women, similar to the companies’ practices in China.
It is still too early to comment on the overall success of PLI schemes as many of the sectors covered are capital-intensive and would take some time before production starts. However, sectors such as mobile manufacturing and active pharmaceutical ingredients have shown significant progress where either Indian exports have increased, or dependence on China has declined, albeit slowly. For these successes to be replicated in other sectors, India must promptly address industry-specific bottlenecks for each scheme.
As competition for China+1 destinations intensifies, India is competing against time to get a slice of the economic pie.
Imposing Import Tariffs
India has also sought to encourage import substitution through policies such as import tariffs to incentivise domestic manufacturing. According to a study, Between 1991 and 2014, average most favoured nation (MFN) tariffs declined from 125% to 13%. However, since 2014, there have been about 3,200 tariff increases at the HS-6 digit level (on most-favoured-nation imports), increasing the average tariff from 13% to nearly 18%. Some economists see such a drastic increase in import tariffs as moving away from the economic liberalisation that India embarked on in 1991, while others see it as a necessity (if done surgically) to aid India’s PLI schemes further.
India’s electronics manufacturing industry provides an illustrative example here as well. India has imposed tariffs on electronic inputs that significantly surpass those of its key competitors like Vietnam, Mexico, Thailand, and China. Despite some specific reductions in import duties for smartphone components in 2022, India's overall tariff trajectory contrasts sharply with the declining trend observed in competing economies. Therefore, the industry is urging the government to reconsider this approach, arguing that high tariffs, initially beneficial during phases focused on import substitution, have outlived their utility.
The industry has come a long way from 2014, when 78% of all smartphones sold in India were imported, to 2023, where 99.2% of all phones sold in India are manufactured domestically. With over $11 billion in exports annually and increasing, import tariffs are now inhibiting the progress of sectors such as electronics. This is an important distinction, given the nature of electronics manufacturing in India. The mobile phone manufacturing in India primarily involves assembling the device from constituent components imported from other countries, especially China. Although the value addition in India has seen an uptick recently, high import tariffs on electronic components significantly impact the process downstream.
Indian Cellular and Electronics Association, an industry body representing electronics manufacturers, has urged the government to address this disparity. They suggest moving away from the current convoluted import tariff structure comprising six tiers ranging from 0% to 20% to a more streamlined three-tier system of 0%, 5%, and 10%. This simplification would help mitigate misinterpretations in tariff classifications, thereby reducing disputes between importers and customs authorities.
Conclusion
Given the dominance of China in both trade with India and its status as an economic powerhouse, a sense of realism is needed while evaluating the opportunity provided by the China+1 strategy. Among its three major approaches, protectionist tariffs and becoming a crucial component of global supply chains are simply irreconcilable. India must reduce restrictions on imports, especially intermediate goods, to take full advantage of the opportunity accorded by the global move towards the China+1 strategy.
India should keep working with its domestic industry, foreign investors and global partners to ensure that it decreases strategic trade vulnerabilities with China, especially in sectors such as semiconductors, pharmaceuticals, and advanced electronics, while allowing non-strategic trade to grow apace.
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