Kevin Wang (Macro Strategist, Clocktower Group)
Given domestic reform efforts and ongoing supply chain restructuring, India is increasingly becoming a popular destination for foreign investors. According to the United Nations Organization for Trade and Development (UNCTAD), india's foreign direct investment (FDI) attracted increased from $38.7 billion to $52.5 billion from 2018 to 2020, making it the world's fifth-largest capital inflow. Despite a decline in 2021, it still ranks seventh. Driven by foreign capital and the policies of the Indian government, India's exports have also achieved record growth, with total exports reaching more than $400 billion by 2021.
Many investors expect India to become the next global manufacturing hub and gradually transform into an export-oriented economy, which will provide more adequate employment opportunities for its large young population. In addition, India's rapidly rising tech industry may accelerate the transformation of its stock market into another "Nasdaq Asia", which will meet the needs of Western investors eager for growth.
Given the accelerated digital transformation under the pandemic, Indian technology companies have also grown rapidly over the past two years. According to the latest ASK Private Wealth Hurun India Future Unicorn Index 2022 released in early July, India already has 84 unicorn companies; Just half a year earlier, another report by Hurun (Global Unicorn Index 2021) said that the number of unicorn companies in India was 54, second only to the United States and China.
Due to the Chinese government's strategic shift to hard technology, the prospects for the development of India's Internet industry are sufficiently attractive to Western investors. A leading U.S. asset manager told us that India could build a deeply liquid stock market dominated by technology companies in the next three to five years, which would lay the groundwork for a large inflow of foreign portfolio investment.
Thanks to strong inflows from domestic and foreign investors, The Indian stock market not only escaped the downward pressure brought about by the soaring commodity prices, but even beat the US stock market to become the best performing market in the world since the epidemic in 2020.
Foreign capital inflows and soaring exports have prompted a growing number of investors to believe that India today is the China of the early 2000s. The next "world factory" and "growth miracle" are coming to us.
However, under the fame, it is actually difficult to match.
While the performance of India's financial markets and a number of economic indicators suggest that this time may really be different, in-depth research has found that there are still many concerns behind the Indian economy, which is shrouded in high optimism. Global investors may have overestimated India's economic and political readiness to become the next world manufacturing hub, while underestimating the resilience of the world's existing supply chain structure and China's ability to defend its trading position.
Supply chain shifts are still in the "storytelling" phase
After the Sino-US trade war and the outbreak of the new crown pneumonia epidemic, the restructuring of global supply chains has become a hot topic. Given that more multinationals plan to move their production facilities out of China, South and Southeast Asian economies are widely seen as potential biggest beneficiaries. While countries such as Malaysia and Thailand may be more competitive in terms of cost, regulation and logistics, India may be the only country that can undertake supply chain transfers on a large scale. Given the deteriorating situation in India's manufacturing sector over the past decade, the Modi government sees the ongoing global supply chain restructuring as a strategic opportunity to reinvigorate its manufacturing sector.
While investors are optimistic about production-linked incentive schemes and FDI inflows to India are increasing, there is overwhelming evidence that supply chain migration to India is still in the "storytelling" phase so far. First, China has further expanded its share of exports to the de-global market over the past three years, once again strengthening its trade dominance. Although India's exports surged to an all-time high of $400 billion, its market share of global exports has not risen significantly, which fully indicates that the main reason for the growth of its exports is the beta opportunity brought about by the surge in global demand, rather than the alpha benefits of supply chain migration. In addition, India's industrial production activity has lagged behind that of other competitors over the past two years, which has forced us to question reports of a massive influx of multinationals into India.
Second, surveys have shown that the number of multinationals interested in moving out of China is far more limited than many expected. According to 2021 data from the U.S. Chamber of Commerce, only 8.8 percent of companies surveyed plan to move more than 20 percent of their production activities outside of China over the next three years. The percentage of companies committed to maintaining planned investments in China increased from 74 percent in 2019 to 81 percent in 2021. Among foreign alternative bases that can replace China, India also lags behind Southeast Asia and Mexico in popularity. India's lack of competitiveness is also reflected in a study by Nomura Securities: Of the 56 companies that moved their production lines out of China between April 2018 and August 2019, 26 went to Vietnam, 11 went to Taiwan, and only three went to India.
Third, although FDI inflows to India have surged over the past few years, they have not contributed proportionally to the country's capital formation. Since 2015, most of the direct investment flowing into India has been concentrated in services represented by computers and the Internet, with only a small portion going to manufacturing. With limited FDI in manufacturing, India may struggle to take over the shift in China's supply chain and establish itself as the next world factory.
Underinvestment remains the number one flaw
In our 2019 Net Assessment of India, we believe that underinvestment is a fundamental problem facing the Indian economy. Without enough investment-led growth, India could fall into premature deindustrialization and miss out on the most efficient development path towards a middle- and higher-income country.
To be sure, the Modi government has introduced a series of policies to promote domestic investment since 2019. For example, the Indian government has reduced the corporate tax rate for existing companies from 30% to 22% and the corporate tax rate for new manufacturing companies from 25% to 15%. In addition, insolvency laws and financial sector reforms have effectively reduced the non-performing loan ratio, thereby restoring the lending capacity of the banking system.
However, this series of reforms has not prevented a sharp decline in India's investment rate. Since 2018, Investment in Infrastructure, Manufacturing and Construction in India has collapsed across the board. Local investors generally believe that the main source of weak investment is the debt crisis of infrastructure leasing and financial services companies (IL&FS).
Founded in 1987, IL&FS is an Indian state-owned investment company that started out as funding commercially viable long-term infrastructure projects. But over the past few decades, the company has gradually moved beyond its original mission to become a major infrastructure player. The company operates through more than 250 subsidiaries, develops and finances projects worth more than $23.4 billion, and has a portfolio of 14,000 kilometers of roads. IL&FS announced its default on investment Grade A commercial paper in September 2018 due to mismanagement, rising borrowing costs, and delays in approval of land acquisitions, which had a huge impact on the entire Indian financial system and led to a severe credit crunch.
Given the insolvency law reforms of 2016 and the escalating non-performing loan ratio, the IL&FS debt crisis further exacerbated deleveraging tendencies in the corporate and banking sectors. As a result, even before the COVID-19 outbreak, demand and supply of credit in India had fallen sharply. While many investors are optimistic that the clean-up of the banking system and low private sector debt levels will help India usher in a new credit cycle, a sharp recovery in credit may be difficult to happen in the short term, given that industrial capacity utilization remains low and household consumption is weak.
In addition to the low credit, the Indian government has also failed to improve its own fiscal position, which has greatly limited the resources it can invest in infrastructure. Over the past few years, the government's divestment plan from state-owned enterprises has failed to meet expectations. Although the Modi government has long been interested in cutting subsidies, this part of government spending has more than doubled from 8.5% of the total in 2018 to 20.1% in 2020. The good news is that India's fiscal 2022-23 budget decided to cut subsidies to 8 percent while raising capital expenditure on infrastructure by 35.4 percent to nearly $100 billion. Given the strong dissatisfaction of low-income groups such as farmers with subsidy cuts, investors should be concerned about whether the Indian government's budget shift to capital expenditures will be sustainable in the coming years.
Reforming government is increasingly constrained
Under the leadership of the Modi government, India has embarked on the most transformative supply-side market-oriented reforms in recent years. But as reforms move into deep waters, political resistance grows.
The withdrawal of agrarian reforms and the delay in the implementation of the Labour Code have shown that popular opposition could disrupt the reform process. Previously, a series of reforms, such as the deforestation order, the Goods and Services Tax and the Citizenship Amendment Act, have all shown Modi's image as a tough, decisive leader: he can insist on structural reforms that he believes are good for the country, despite popular opposition. And recent setbacks in agricultural and labor reforms are significant because they reveal a less confident Modi. The regressive pace of reforms suggests that Modi may be increasingly worried about his political capital and re-election odds in 2024.
While the results of the recently concluded local state elections show that Modi and BJP still have a solid popular base, the number of BJP members in the Legislative Assembly (MLA) in the four winning states has dropped from 406 to 357. Moreover, it is unclear to what extent Modi's decision to reverse agrarian reforms helped the BJP to victory in the state elections. With the election looming two years later, the likelihood that the Modi government will continue to push for other controversial reforms has diminished considerably. While Modi could choose to take advantage of the state election victory to move forward in the deep-waters of reform, continuing to push forward could once again spark massive protests as the economy has slowed, oil prices have soared and food prices have risen in an extremely dangerous way. Given that the BJP has already demonstrated its willingness to stop reforming in exchange for votes in this year's state elections, this strategy is unlikely to change radically in the next two years.
In addition, the Indian government's willingness to expand manufacturing and exports is also being constrained by the rise of domestic protectionism. While New Delhi has worked to liberalize trade and investment policies in recent years, import substitution remains the preferred development strategy for India's big businesses. Since 2014, the Indian government has imposed tariffs on 3,200 of its 5,300 products. The average tariff rate increased from 13% in 2014 to nearly 18% in 2019. Protectionism within India peaked in November 2019, when india abruptly announced its withdrawal from regional Comprehensive Economic Partnership (RCEP) negotiations, citing concerns about the trade agreement's negative impact on vulnerable sectors. According to a 2020 study by the Peterson Institute for International Economics, "India's revenue would increase by $60 billion a year if it joined the agreement, and a $6 billion reduction would be reduced by exiting the agreement." However, growing protectionism has forced New Delhi to choose the latter.
In summary, there is no definitive evidence that TNCs are accelerating their supply chain shift to India, and most of the FDI flowing into India is concentrated in the services sector rather than manufacturing. Given the IL&FS debt crisis, credit crunch and deteriorating fiscal position, India's underinvestment has not been effectively addressed; Given the election two years later, the Modi government is unlikely to continue pushing for controversial market-oriented reforms for fears of another massive protest, so investors should not overestimate the likelihood that India will become the world's next manufacturing hub for the foreseeable future.
(The article represents the views of the author only.) Editor-in-charge email: [email protected]. ）