India among Asia's new flying geese

It is placed well, both economically and geopolitically, to benefit from the China plus one strategy

The term “wild-geese-flying pattern” of economic growth is a translation of the Japanese term, Gankō Keitai, which was coined by economist Kaname Akamatsu to describe the pattern of economic development he observed in Japan.

Post-war Japan, as the lead goose, started out producing low-value products like garments. As its costs rose in the 1960s, it relocated production to the next flock of geese, the newly industrialising economies (NIEs) of Hong Kong, South Korea, Singapore and Taiwan. As the NIEs caught up with Japan in the early 1990s, they helped launch the next flock of geese in the Asean-4 and China.

Viewed through Akamatsu’s lens, the shift in supply chains from China is a natural progression of economic development, although US-China tensions and the pandemic have clearly accelerated this trend by forcing multinational firms to look for alternatives and diversify supply-chain risk.

How much can India benefit from China plus one?

Concurrent data is mixed, but leading signals suggest significant benefits are accruing.

Greenfield foreign direct investment (FDI) involves the establishment of new facilities abroad and is a good gauge of the ongoing shifts in global supply chains. According to fDi Markets, India took the first spot within Asia Pacific and the second position globally in 2023, attracting 1,006 greenfield FDI projects worth $83.7 billion. Almost $30 billion was pledged to manufacturing FDI projects outside the energy industry, down from the record of $34.7 billion in 2022 but higher than any other previous year since the database started tracking FDI in 2003.

Our bottom-up survey suggests similar benefits. We collected a sample of around 130 companies that are either planning to relocate their production out of China or are looking to invest in new production facilities in Asia or elsewhere.

Our results show that India has received the most interest from firms (28 out of 129 firms), followed by Vietnam (23), Mexico (19), Thailand (16) and Malaysia (14). These results differ from our 2019 survey, when Vietnam was the biggest beneficiary and India was not even in the top five.

Benefits to India are also broad-based across sectors, with firms looking to invest in smartphones, automobile & components, capital goods, semiconductor assembly and testing, and apparel.

While de-risking from China is an important push factor, firms setting up shop in India are also attracted by the captive domestic consumer market, its large and skilled workforce and progressive policies.

The source of investing countries also puts India in a sweet spot. Our survey shows that China is the lead investor across a preponderance of new investments, but mostly concentrated in the Asean economies. By contrast, a majority of investments into India are from US-based companies and the developed Asian economies of Japan, South Korea and Taiwan.

Chinese firms’ investment in Asean is partly intended to bypass trade tariffs, but as the West looks to plug loopholes that allow Chinese companies to redirect their trade via third countries, we believe the more diversified source of investment into India will be an advantage.

Pushback against our views

We have heard three main objections to our view.

First, India’s trade balance is not improving, so where is the benefit? Our answer is that global value chain or GVC integration is a process, and India is still in its early stages, where it is more dependent on imported inputs as there are limited domestic options. However, as the domestic ecosystem develops, domestic production will substitute for imports, and exports will rise, leading to a more visible improvement in the trade balance over time.

Second, how can Indian exports be globally competitive when they need import protection? There is nothing unusual about India’s policy. Looking back at the industrial policies of Japan and South Korea, such inward protectionism was common in early stages. However, this has to be temporary and government subsidies will need to be phased out at the right time.

Third, is an export-led growth strategy feasible in a de-globalising world? This is indeed a challenge, as India is taking off against a more hostile global backdrop. However, since firms today are looking to diversify risk and build resilience in supply chains, rather than just reduce costs, there will still be ample opportunities as the China plus one strategy gains traction. There is no reason why India should not maximise its gains.

The China challenge

Even as India integrates with GVCs, it remains heavily reliant on China for imported intermediate inputs of industrial goods, electronic components, solar panels, etc. This is leading to a widening trade deficit with China, but more importantly, it limits the development of the domestic ecosystem, led by the micro, small and medium-sized enterprises. For India to benefit from the trickle down effects of GVC integration, there has to be a policy focus on increasing the domestic value added.

Government policies have to be dynamic

India’s initial objective should be to gain export market share in low-tech manufactured goods that are more cost sensitive. This requires lower tariffs on intermediate goods, entering into new free trade agreements, easier labour market regulations, good infrastructure, lower logistics costs, and a favourable investment climate. Subsidies to protect local manufacturers should have a sunset clause and focus should be on making domestic products more competitive.

The next stage involves moving up the value chain (i.e., from basic to more advanced products). This needs improved quality of human capital and a focus on innovation, for which the government can offer incentives to firms that engage in more research and development (R&D) spending. It will also require the development of an innovative intellectual property rights framework.

Countries that rank high on high-tech manufacturing, such as South Korea, have transformed the quality of their exports through innovation and have succeeded in moving from low-tech to high-tech manufacturing over time. That should also be India’s medium-term goal.

Overall, India is placed well, both economically and geopolitically, to benefit from the China plus one strategy. Government policies will need to constantly evolve to ensure higher domestic value addition and to move up the value chain, such that this remains a multi-decade growth driver.

For India as one of Asia’s new flying geese, this is only the beginning.

The writer is the chief economist (India and Asia ex-Japan) at Nomura