Managing the Dragon
Decoupling from China requires a deep strategic vision where defending digital territory is as vital as physical territory.
Joined by deep civilizational bonds, the political equation between India and China post-independence and the Chinese revolution has been contentious and conflict-prone. When Chairman Mao consolidated Chinese power by taking over Tibet, India sheltered the Dalai Lama; bound by a centuries-old relationship, independent of China or anyone else. PM Nehru patronized China in Bandung (1955) and the United Nations, reportedly forsaking a permanent seat at the Security Council in China’s favour. With no hint of reciprocation, China has instead adopted a hegemonic attitude and repeatedly provoked conflict starting with 1962. Indian strategic thinkers have historically failed to understand China’s hegemonic outlook to be able to build our resilience and self-reliance accordingly.
By 1978, both India and China had closed their economies for three decades, with low growth, and a similar GDP of approximately USD 150Bn. Post the ping-pong-diplomacy of Kissinger and Mao, China opened up in 1978 under Deng Xiaoping - paving the way for unprecedented growth with a sequential strategy:
1. Liberalized agriculture sector—farmers could grow crops of their choice. They abolished restrictions on selling produce and agricultural land use. Farmer income multiplied, creating surpluses for rural growth.
2. Coastal Special Economic Zones—entire coastal provinces like Guangdong and Fujian were converted into SEZS. Granted flexibility for free market operations, they attracted overseas investment for rapid industrial growth. SEZ provinces were decentralized and empowered to make investment deals.
3. Labour-intensive industries—china also had a large population that needed employment at scales agriculture couldn’t provide. Focus on sectors that could absorb surplus labour like garments and fabrication succeeded in routing China’s workforce toward higher economic growth in the SEZS.
4. Infrastructure development and urbanization— Excess labour and savings were routed toward infrastructure development, making it a significant economic driver. Construction grew at 16.6% YOY for nearly four decades, with feedforward effects for supply chains, labour utilization and socio-economic development. China urbanized from 26% in 1990 to 59% today, while India remains at 34%.
5. Human capital and knowledge economy—rapid economic growth was complemented by investment in higher education, R&D, startups, and hi-tech industries. China is now close to the United States in many frontier fields like AI, ML, and quantum computing. It recently announced a USD 150Bn investment in these sectors.
China’s economy is now at USD 15.5Tn, from USD 150Bn in 1978; a feat unparalleled in human history. Meanwhile, India was brought to its knees with ineffective socialist policies and was finally forced to open up in 1991. Liberalization is the most significant event in independent India’s economic history, enabling 8.6% YOY growth (in dollar terms) from USD 275Bn in 1991 to USD 2.97Tn in 2020. We missed out on a decade’s worth of growth (1978-1991) and the race for Asian dominance due to the disastrous socio-economic policies of Nehru and Indira Gandhi. With rapidly changing geopolitical events today, India must pursue an extensive strategy for self-reliance and export-oriented economic growth.
STATUS QUO
China can influence the global economy due to its sheer size. It is the largest exporter, second-largest importer, and holds the highest foreign currency reserves. China also leads in manufacturing with 24% of the global share. They flex their industrial influence to dominate trade with India. Over the last ten years, India has built up a trade deficit of USD 500Bn. In 201920, with imports of USD 65.2Bn and exports of USD 16.6Bn, annual trade deficit reduced to USD 48.7Bn from USD 63Bn in 2017-18.
India has repeatedly asked China to increase imports but has been mostly unsuccessful. It is only in the last year that PM Modi has been able to insist that China import more, particularly our excess agriculture products. 70% of our pharmaceutical APIS come from China. Chinadependent supply chains dominate many sectors in India, like electronics and telecom equipment. Their production is cheaper, of good quality, and delivered at scale with attractive credit terms.
China developed its industry on contract manufacturing by building capacity and extending favourable terms. Many international brands have endto-end production there. Even the ones that don’t, get their tooling and moulds made exclusively in China. Indian industrialists frequently look to China to fill supply chain gaps and scale when demand rises, for lack of viable alternatives.
Chinese companies have also invested around USD 8Bn in Indian startups since 2014, out of a total investment of USD 60Bn. Chinese investors have stakes in 15 of India’s 32 unicorns. Domestic capital only accounts for 10% of the USD 60Bn. We have invariably made it easier for overseas investors to direct large pools of capital in our startup ecosystem while discriminating against and over-regulating Indian investors.
The economic fallout of COVID-19 was worldwide and simultaneous. The world now understands how intrinsically interlinked manufacturing and supply chains are with China. US, Korean and Japanese companies want to diversify. In India, too, we had to react to dependencies on China quickly. We ramped up PPE and N95 mask production from almost nil to near-export-surplus volumes in three months, because of the surge in global demand combined with defective goods sent from China as humanitarian aid.
Apart from the Covidfallout, the Galwan valley incident has demonstrated the imperative to move away from the economic iron grip of China. Many are calling for a boycott of Chinese goods, and the government too seems determined to reduce dependence. It is also evident that across the world only the Us—as the first mover—and China—by design—fully own their digital realms while other nations are dominated by the two. Over the last decade, China has acquired vast digital territory in India. The ban on 59 apps is a first step toward ensuring India’s digital security which is as vital to our sovereignty as securing our physical borders.
We must understand that it is difficult for India to support an outright ban on the import of Chinese goods and services or implement a rapid import substitution policy. Global supply chains are intimately integrated. Also, our domestic economy cannot suddenly take on the load.
Instead, we need an indepth strategy with the long-term goal to create high-quality products in India, cater to the massive domestic market and then export globally to capture market share.
SECTOR-SPECIFIC STRATEGY
India needs a studied policy to decouple strategically by
1. Identifying large-scale imports in every sector
2. Analyzing reasons for these imports
3. Creating incentives accordingly for Indian manufacturing to ramp up and cater to domestic demand which will automatically reduce export dependence
We have already proven this value proposition with our mobile manufacturing strategy; India became a significant exporter last year to the tune of USD 4.5Bn. The new INR 45,000 crore program for electronic manufacturing will increase value-add and make India an electronics export house. These are strong signals for electronics behemoths in the US, Korea and Japan to consider setting up in India.
In the wake of COVID-19, the government has already instituted strategies to set up API manufacturing. Every sector and sub-sector needs a specific plan, especially critical ones like medical devices, telecom equipment, ACS, etc.
POLICIES AND INVESTMENTS FOR COMPETITIVENESS
Policy overhaul and reforms in labour and land are vital for the China-decoupling strategy. India has excellent manufacturing capabilities as seen during the COVID-19 crisis where within 3 months, India has become a dominant producer of PPE, respiratory aids, and diagnostic kits. Sadly we haven’t invested enough in developing manufacturing as a dominant economic sector.
Once large import items are identified for domestic manufacturing, India can ensure industries become competitive by further improving supply chains, developing infrastructure, providing tax holidays and incentives, reforming labour laws, further reducing overhead costs like power and water, and arranging long-term credit.
India must also reduce the immense compliance and regulatory overload on our companies. Failed socialist policies which over-regulate private enterprise combined with archaic colonial systems to suppress domestic production, unfortunately, are still part of our policy frameworks. As a result, we find it hard to scale and compete with companies in countries where taxation and compliance regimes are friendly to wealth- and job-creators. Large-scale reforms at the state government level are crucial. Tax terrorism at the centre also continues to be one of the biggest threats to foreign and domestic investments.
LABOUR-INTENSIVE MANUFACTURING
India needs a policy that unlocks labour-intensive manufacturing as a means of export dominance. It is the only way our large 1.38 billion population can access sustainable employment; 70 years of history has shown us agriculture cannot support a massive workforce. Garments, fabrication, electronics, are all great industries for labour utilization and skills development, especially in the heartland states.
Additionally, China is moving to automated and hi-tech manufacturing and is slowly vacating labour-intensive manufacturing. Living and labour costs there are skyrocketing, and it is becoming unviable to produce goods as cheaply as before. These industries are moving elsewhere, especially to Vietnam (with a 1,200km Chinese border), Indonesia and Bangladesh.
These countries actively pursue investor-friendly policies and send frequent delegations to the US, EU and Japan. They have marketed and built their brand better than India.
India has not taken adequate advantage, but COVID-19 presents unique opportunities. We must actively pursue trade treaties with the EU, US and Japan along with large-scale reform policies in labour, land and SEZS. Indian states can lead here as state governments are responsible for industrial development.
Contract manufacturing is the optimum way to quickly attract international customers without the need for extensive foreign investment. Investors can enter with a capital-light strategy, and set up their plants once the trust relationship builds. India can scale up quicker this way.
QUALITY AND DESIGN FOCUS
Innovative design and world-class quality are crucial to capturing both the domestic and global markets. Here, our two-wheeler industry stands out for having repeatedly beaten China because of the farsighted focus on design, quality, scale, marketing and brand building. There is no reason why we cannot build the same capacity and quality in other industries too.
Automation and robotics can complement labour to assure repeatability and predictability. For example, Havells has set up an INR 400 crore AC plant near Delhi – fully automated, whose quality and cost structure beats China. We can selectively apply this value proposition to edge out Chinese competition while pursuing high labour-utilization strategies elsewhere.
LIBERALIZE DOMESTIC CAPITAL
In the startup space, India recently announced that investment by China and other neighbouring countries require approval. While this is necessary for national security, it has cut off a major source of growth capital. To replace it, we need friendly domestic funding via insurance companies like LIC that have large pools of investable capital. They need to understand the substantial ROI from tech companies that will dominate future growth.
Indian pension funds must also do the same. Pension funds from Canada, Europe, the US and Australia are already investing in Indian startups because they recognize the unique growth proposition and high reward-risk ratio.
Reducing regulatory hurdles and improving asset allocation avenues into tech startups will liberalize domestic capital and increase investment. The Indian ecosystem severely needs local funding to counter predatory overseas capital like China’s. Without incentivizing domestic capital, we risk becoming a captive digital colony; a fate no Indian citizen wants to repeat.
CONCLUSION
There are more aspects to improve India’s self-reliance. We need substantial investment in intellectual property creation and R&D, quadrupling of supply chain efficiencies, and opening up more sectors to private players like we just did with defence and space. The Atma Nirbhar reforms are the first significant step. Decoupling from China will not be simple, but the decisions and investments to execute it this decade have to start now in a focused manner.
T.V. Mohandas Pai is Chairman, Aarin Capital Partners, and Nisha Holla is Technology Fellow, C-CAMP.