[Analytics] Why manufacturers are not rushing from China to India

Prime Minister Narendra Modi gave an exclusive interview to Economic Times, an Indian English-language business daily, last Thursday in which he claimed that India will be a manufacturing hub on its own strength in the future. Bhim Bhurtel specially for the Asia Times.

“We saw how a new world order was formed after World War II. Something similar will happen post-Covid-19,” Modi said, adding: “This time, India will ride the bus of manufacturing and integrating into global supply chains. We have specific advantages in the form of democracy, demography, and demand.”

Earlier, Indian media were full of pomp and noise in April and May about 1,000 US manufacturing companies that would be relocating from China to India amid the pandemic. But contrary to the media hype, a very small number of companies have actually entered India to date.

Similarly, because of the US-China trade war that started in March 2018, it was expected that many US companies would leave China and come to India. However, only three of the 56 companies that exited China had entered India as of October 2019. Of those 56 firms, 26 relocated to Vietnam, 11 went to Taiwan, and eight to Thailand.

Modi also claimed in the interview that foreign companies would come to India because of its “3D’s” – democracy, demography, and demand.

However, the case for the latter two is weak.

First, not as many American companies moved their plants out of China as both American and Indian strategists had estimated.

Second, those companies that did leave China did not relocate to India.

The main reasons for not relocating manufacturing plants to India, analysts now believe, include certain non-economic and governance-related factors prevalent in India. The non-economic elements are a long list.

First, doing business in India is much more cumbersome because of lengthy legal formalities than in China. The World Bank suggests it takes 18 days to register a company in India, whereas it takes nine days in China. This process takes about a week longer than the average in the OECD (Organization for Economic Co-operation and Development) countries.

Besides, the process of registering a business must pass through 12 steps, and every step involves a lot of red tape.

Similarly, a construction permit takes 34 steps and 110 days to process. Approval must be obtained from both central and state governments.

There is no fixed limit on how long it takes to get permission from relevant government departments.

Second, acquiring basic amenities like land, water and electricity required for manufacturing is not as easy as in other destinations. For example, it takes eight days to three weeks to get an electricity connection.

Land acquisition is a more tedious task in India.

Third, India has weaker and less efficient infrastructure than China, such as highway and rail networks. The seaports and airports are also less efficient at handling freight than in China.

The less efficient infrastructure means more additional logistical costs for production and transportation. The extra costs make it harder for companies to be competitive.

Fourth, India’s political and policy stability matters, although it is true that periodic elections are held and transfers of power are made smoothly after a general election.

India’s tax regime keeps changing, ant the tax rate is also significantly higher than in China. Recently, the corporate tax was reduced from 40% to 25%. However, surcharges of various rates have been imposed on it. In contrast, China has a 25% fixed corporate tax rate, but multiple exemptions can reduce it to as low as 15%.

Fifth, it is more complicated for a business to exit India than to enter the country. India has tried to improve this situation, but its reform measures have been insufficient, and the process is still complex. The bankruptcy code is also tedious in India.

Foreign or domestic companies do not enter a market unless doing so is reasonably simple, and exiting same if necessary is also easy. This is an axiomatic law of microeconomics. As long as there are barriers to companies’ entry and exit, not only will new foreign companies stay away, but domestic companies too will not enter the market.

Many business analysts believe that these non-economic and governance-related factors mentioned above determine why American companies do not come to India.

But these are secondary factors. The primary determining factors are more economic in nature.

First, India is one of the emerging-market economies that have relatively low currency swings. However, India’s currency swings are far greater than China’s.

For example, according to the US network CNBC, in January 2000, the Chinese exchange rate was 8.27 to the US dollar. By October 2020, it had strengthened to 6.69 yuan to the dollar. Meanwhile the Indian exchange rate was 43.55 rupees to the dollar in January 2000, and had weakened to 74.54 by October this year.

Thus the Chinese yuan strengthened by 19% in 20 years, while the Indian rupee weakened by 71% in the same period. This shows that the yuan is more stable than the rupee.

Currency volatility dramatically increases business risk. In contrast, a stable currency reduces risk and increases a company’s investment, sales, profits, and brand value.

Currency volatility means less foreign investment because it is not easy for companies and risk managers to navigate.

Profits cannot increase, even if sales revenue increases through market expansion: The effect of an increase in sales revenue is outweighed by the impact of the currency swings. More important, investments made by US companies in India also decrease in value as the Indian currency weakens in US dollar terms.

Indian policymakers seem to have overlooked the issue of currency volatility. When the rupee weakens, imports decline, and exports increase. Consequently, the balance of payments improves.

Because of the higher prices of imported goods, government tax revenue rises commensurately. Indian policymakers may see this as an advantage. However, it makes the economic environment less attractive for foreign companies’ entry to India.

The second factor is market demand. Modi claimed in the Economic Times interview that his government had seen unparalleled success in distributing rice and lentils to 800 million Indians during the Covid-19-triggered lockdown. He underscored that “free food grain and pulses to 800 million people for eight months is a program without parallel in human history.”

The figure he mentioned matters hugely for foreign firms looking to enter India.

Of India’s 1.3 billion population, 800 million are poor, low, or lower-middle-income people who receive food grants from the government. Such people will not be consumers of American companies’ pricey goods and services.

Foreign companies do not enter a country just because it has a large population. The population needs to have sufficient purchasing power to consume their products.

China is both a producing and a consuming country. It has about 800 million middle- and high-income people. For instance, China was Apple’s third-largest market in 2019 globally, and it is the largest market in Asia.

India is estimated to have only 20% of the purchasing power of China because India’s per capita income is just US$2,104, whereas China’s was $10,261 in 2019.

So it would be idiocy to expect an American company to leave the Chinese market and come to India. In India, no market demand can be found as Modi claimed in his interview.

The departure of General Motors from India three years ago of Harley-Davidson more recently indicate that Indians cannot afford US companies’ goods. As there is little consumer demand for American companies’ products, they don’t see enough sales prospects to justify relocating to India.

Many Indians may consider that the kind of personal bonhomie they witnessed between Modi and US President Donald Trump, if it continues after this week’s American election, can bring US investment to India. However, it takes more than hugs and handshakes at PR stunts like the “Howdy Modi” event in Austin, Texas, or the “Namaste Trump” gimmick in Gujarat, to bring in investment.

Businesses look at whether or not they can maximize sales, revenue, profits, and brand value after investing in India. An investment decision is a rational undertaking; there is no room for emotion.

Modi may be able to fool the Indian electorate with such incidents. However, he cannot deceive American companies into relocating from China to India. American companies don’t base their investment decisions on melodramas like Howdy Modi and Namaste Trump.

Whoever is chosen to preside over the US administration, whether Donald Trump or Joe Biden, at Tuesday’s election can after he assumes office in January urge US companies to relocate from China to India, but he cannot force them to do so. US companies themselves decide whether to leave or remain in China.

Therefore, the relocation decisions of US companies are based on purely economic factors.

Minimum risk attracts maximum investment. The companies exiting China are not relocating to India because of the higher economic risks involved. Therefore US companies, if indeed they do depart China, will look for other destinations than India.

As former US assistant secretary of state Nisha Biswal has pointed out, India needs to provide more incentives to US companies such as tax exemptions, ease of doing business, stabilizing the currency, and expanding consumer demand by rapid economic growth to become a global manufacturing hub. Without such incentives, US companies won’t come to India as Modi claimed in the interview.