China's zero Covid policy & India's opportunity

India must suitably reorient its trade policy to take advantage of China's persistence with lockdowns

Barely a week after reopening following a two-month complete lockdown, Shanghai imposed a fresh, partial Covid-19 lockdown again earlier this month (Business Standard, June 9, 2022). Such persistence by China with a zero-tolerance strategy has lent an element of urgency to global value chain (GVC) restructuring and relocation, a process that has been in progress, though haltingly, over the last decade. India, which has thus far not been able to attract relocating supply chains, now gets another chance and should not let it slip by this time.

The process of GVC restructuring began in the wake of the global financial crisis of 2008-09 followed by a series of natural disasters like the Tohoku earthquake in Japan, Tsunami and the Thai floods in 2011. While the earthquake impacted semi-conductor production, the Thai floods disrupted the automotive value chains followed by electronics and electrical appliances. As large corporations undertook risk rebalancing, regionalisation of GVCs or shorter length supply chains by “near shoring” to neighbouring countries emerged as preferred options. Proximate production facilities provided a degree of flexibility in terms of responding to sudden events and/or demand shifts. Towards the end of the last decade when US-China trade tensions were at their peak, “China plus one” emerged as the alternative strategy for MNCs to relocate their subsidiary operations. Clear winners in this process were the EU, Mexico, Taiwan and Vietnam, in sectors like automobiles, machinery, transport equipment and electrical equipment. Except for marginal gains in the machinery sector, India did not benefit from this trade diversion away from China.

The pandemic-led border closures, followed by the Ukraine war, have further added to supply chain woes by disrupting the flow of critical minerals, elements and components. Availability of easily substitutable inputs from alternative trading partners is now being considered as a means to making GVCs more resilient. The significant question in this context is: How to find suitable trade partners for substitute inputs? Should they be within the region, that is, in close proximity “friendly” nations, or should the substitute inputs be sought from within country, domestic suppliers? Globally, two alternatives, localisation and regionalisation are therefore being debated for GVC resilience.
 

Illustration: Binay Sinha

While in both, regionalisation and localisation, efficiency may be compromised for reduced geopolitical risks, regionalisation remains a superior choice. Under localisation, use of domestically produced inputs is encouraged through protectionist instruments such as tariff increases and restrictions on imported inputs. Building complete supply chains domestically is also a more time-consuming process. Most importantly, relying solely on domestic inputs will make localised supply chains rigid and actually less capable of adjusting to exogenous shocks. This is most pertinent in the case of India which seems to be veering towards increased localisation and building complete supply chains domestically. India’s trade policy has been more protectionist in the last few years and this is one of the reasons for India’s inability to take advantage of the earlier waves of GVC restructuring and shifts.

Over the last two decades, global trade has been increasingly dominated by GVC-led trade in intermediate goods. Several countries directed their trade policies, in response, to facilitate the movement of intermediates across multiple borders. China and Asean economies, for example, adopted a differential and favourable tariff structure for imports of parts and components/ intermediates, in particular, in sectors like automobiles and electronics. This has been a major contributory factor in these countries’ ability to attract export-oriented foreign direct investment (FDI) in these sectors. India, in contrast, maintains much higher levels of tariffs and relatively fewer duty-free lines in these GVC-intensive sectors. In addition, customs compliance has been made more cumbersome in India for importers utilising free-trade agreement (FTA) preferences. Furthermore, there are now reports of possible import licensing being introduced for some commodities (Business Standard, June 10, 2022 “India considers curbing fridge imports for local boost”).

In the context, it may help to know that China’s policy reorientation in the last few years towards reduced imports and self-reliance follows a period of very high levels of GVC participation and technological diffusion made possible by the trade-FDI nexus underlying GVCs. China’s increased domestic value added in exports in the last few years follows a period of significantly higher foreign value added component in its exports in the first decade of the 2000s. India, on the other hand, has had low levels of GVC integration throughout the last two decades with a further fall registered since 2012. Unlike other emerging market economies like China, Malaysia, Vietnam, Thailand and Mexico, India’s trade policy was not designed in recognition of the importance of integration with GVCs for enhancing its trade participation as well as manufacturing competitiveness. In the last two decades, therefore, when trade in manufactures remained the dominant global trend, India’s presence in global trade remained peripheral (For a more comprehensive analysis see my recent book India’s Trade Policy in the 21st Century, 2022, Routledge, London.).

In addition to low and favourable tariff structures, trade and investment agreements play a significant role in integrating with GVC/regional value chain networks. India has recently accelerated its pace of negotiating FTAs/comprehensive trade agreements. However, while these recently concluded FTAs may lead to enhanced exports for India, it is doubtful if they will result in diversification of India’s export basket towards a higher share of manufactured goods or to greater competitiveness of Indian manufacturing. While pursuing trade agreements with the Gulf Cooperation Council nations, which are not at the core of GVCs/ RVCs, India should not ignore the Asean or East Asian economies. Notably, there are indications of a regional reorganisation of value chains in East Asia as intermediate exports from Japan and Korea are observed to be going directly to the US rather than through China. So, even while India mulls over its possible participation in the Regional Comprehensive Economic Partnership, it may be wise to work on early conclusion of the review processes of its existing FTAs/Comprehensive Economic Cooperation Agreement and Comprehensive Economic Partnership Agreement. with Asean, Korea and Japan, as also to follow up the India-Australia early harvest scheme with necessary investment liberalisation provisions towards achieving a full-fledged comprehensive agreement soon.

Recognising that integration with GVCs is an important means to achieving long-sought manufacturing competitiveness, India must suitably reorient its trade policy to take advantage of China’s zero-Covid strategy.

The writer is Professor of Economics, School of International Studies, JNU. The views are personal