Chinese investments will not benefit India

High cost of doing business and geopolitics limit opportunities

The Economic Survey 2024 suggested that India should welcome Chinese foreign direct investment (FDI) to boost manufacturing, increase exports, reduce imports from China, and strengthen our role in global value chains (GVC). Suppose India allows such investments — will the promised gains to manufacturing, exports, imports, and GVC actually happen?

Manufacturing: Let's understand the impact of Chinese investment on manufacturing with the example of Mr Yang (an imagined name), the CEO of a large Chinese firm making solar modules.

Mr Yang wants to manufacture solar modules in India and compares the costs at each production stage in China and India. The production process starts with obtaining quartz minerals and processing them into high-purity polysilicon ingots, which are then converted into polysilicon wafers. The wafers undergo chemical and laser treatments and silver etching to create solar cells, which are finally assembled into solar modules.

Mr Yang’s analysis shows that starting production in India from raw materials, such as quartz minerals, would be at least 40 per cent more expensive than in China. This cost difference reduces to 25 per cent if he uses imported polysilicon wafers and decreases to 3 per cent if he uses solar cells imported from China.

Despite his interest in India, Mr Yang finds that producing solar modules from raw materials is too costly. He might consider starting from the wafer stage if India offers additional support, like land and capital at concessional rates. Otherwise, he would likely use imported solar cells to produce solar modules, as many Indian firms currently do. This is similar to India’s smartphone sector, which relies on imported subassemblies, and the electric vehicle (EV) battery industry, which depends on imported lithium cells. Most manufacturing happens abroad in both cases, and more than 85 per cent of the components are imported.

The high-cost difference between India and China is partly due to India’s higher cost of production inputs and China’s subsidies for its firms. For example, in India, the capital cost for businesses is 9-10 per cent, compared to 4-5 per cent in China. Industrial electricity in India costs $0.08 to $0.10 per kWh, while in China, it’s $0.06 to $0.08.

India has traditionally been strong in textiles, garments, leather, and footwear, mainly using local raw materials. However, the country is losing competitiveness to Bangladesh and Vietnam due to rising production costs and complex regulations. Producing goods in India from raw materials has also become unviable in many sectors because the Chinese government heavily supports local production. For example, Chinese solar companies get free land, electricity, interest-free loans, and subsidies covering 35-65 per cent of product costs. In comparison, firms making in India don’t receive similar support, making it more expensive to produce goods from raw materials.

Without lowering production costs and simplifying regulations, foreign investment, including from China, can only result in superficial manufacturing that relies heavily on imports.

Exports: The Economic Survey 2024 mentioned Chinese FDI would strengthen the manufacturing sector and boost exports to the US and Europe, following the strategies of countries like Mexico, Vietnam, Taiwan, and Korea. However, this may not be easy.

In June this year, the US imposed import tariffs of up to 250 per cent on solar panels produced by Chinese companies in Cambodia, Malaysia, Thailand, and Vietnam. Then, in March, Donald Trump indicated he might escalate the trade war by targeting the Chinese auto industry, which is considering using Mexico as a gateway for car exports to America. Why would India’s situation be any different?

Imports: The idea is if China manufactures products in India, our imports from China will decrease. However, this is unlikely because 30 per cent of India’s industrial imports, including electronics, telecom, machinery, chemicals, plastics, and automobiles, come from China. Despite increasing domestic production in areas like mobile/smartphones, India’s imports from China have also increased, particularly in electronics components, solar panels and EV batteries, exacerbating dependency. While imports may decrease in some sectors where China starts production in India, they will likely continue to rise in thousands of other products. Even for products made in India by Chinese firms, imports may still increase, as these firms would prefer sourcing inputs from their parent companies in China to cut costs.

India’s GVC integration struggles: Despite free trade agreements with Asean, Japan, and South Korea, facilitating zero-tariff trade across the region in over 90 per cent of industrial products for over a decade, India could not become a significant part of GVCs. To improve, India needs to reduce business costs and speed up port and Customs clearances.

Experience of neighbours: Many Asean countries are experiencing increased imports from China and adverse effects from the local presence of Chinese manufacturing firms. For instance, when Chinese EV firms began production in Thailand, orders for local auto parts fell by 40 per cent, forcing many local manufacturers to reduce their operations. The situation in India will be no different as it has similar EV policies.

Geopolitical strategy changes: India’s participation in the Indo-Pacific Economic Framework and the Supply Chain Resilience Initiative with the US and other partners aims to reduce reliance on Chinese supply chains. Encouraging Chinese FDI would counteract these efforts to diversify away from China.

FDI has not helped manufacturing: In FY24, new FDI inflows were just $41 billion, less than 1 per cent of gross domestic product. Since March 2000, less than 20 per cent of FDI has gone into manufacturing, with most going into simple assembly work. This shows that foreign investments have never been strongly attracted to India’s manufacturing sector due to high costs and complex regulations. Allowing FDI from China won’t change this situation even after we ignore the security aspect, the most important parameter in deciding investments in strategic sectors.

We need to reduce business costs at every step, from start to port, and improve infrastructure and the ease of doing business. Without these changes, foreign investments will be limited and focus on basic assembly rather than deep manufacturing, increasing our dependence on China for critical supplies. Worse yet, investments may come to promote trading of Chinese goods or expanding presence of Chinese brands in India.

Above all, India needs a clear and stable China policy that outlines our medium- to long-term strategy on security, economic, and trade issues with China.

The writer is founder, Global Trade Research Initiative