By nearly every economic measure, including GDP, FDI and trade, India is dwarfed by China. But after more than 10 years of increasing economic reform, India seems to be making headway as never before, revealing its potential to viably compete with China for both markets and capital.
India's economic growth exceeded expectations in the first quarter, racking up 7% year-on-year gains. Its industrial output in May grew nearly 11% from a year ago, the highest rate in nine years, helped by a robust manufacturing sector that saw strong domestic and overseas demand. These rates are still less than China's 9.4% first quarter GDP growth and 16.6% industrial output growth in May – but onne impressive. In June, India landed its largest single foreign direct investment ever, as South Korea's POSCO, the world's fifth-largest steelmaker, signed a memorandum of understanding for a US$12bn steel project to be established in India's eastern state of Orissa.
Japanese businesses are also warming to India as they hedge their China bets at a time of unresolved Sino-Japanese tension, while MNCs such as like Barclays and Wal-Mart are making India the centerpiece of their Asian strategies.
For some, the recent swing in attention to India portends a paradigm shift, which comes as China's FDI growth plateaus and higher labor and raw material costs weigh on profits. Meanwhile, India is steadily opening up its industries, overhauling its infrastructure and paving the way for increased foreign capital inflows and trade.
What we're seeing is probably a trend of significance because India's been up and down," said Kenneth DeWoskin, a retired PricewaterhouseCoopers partner who over-saw the firm's China strategy for 42 years and who continues to consult on China. "There's a certain amount of push from China where some manufacturing sectors are losing their luster, meanwhile you have a pull from India with a focused economic development strategy and a serious commitment by the government to open its economy."
While China has done wonders marketing itself, extolling its low-cost labor and rising consumer class, India "has had a PR problem because of the unpredictability that a democratic society creates," DeWoskin said. The evolving policies that come with the changes in India's political guard involve considerable risk to businesses that plan five or 10 years ahead. Then there are India's famous bureaucratic red tape, inadequate infrastructure and scarce government incentives – all less significant problems in China – which India is now addressing in earnest.
With a legacy of a sheltered economy, India has gone through fits and starts since beginning the process of liberalizing its markets in 1991. One factor that could make a difference this time around is Indian Prime Minister Manmohan Singh, an economist by training and the architect of the country's initial market reforms when he was finance minister in the early 90s.
"He's a man of purpose and is more of a bureaucratic professional than a politician," said Rakesh Sharma, chief of China operations at the State Bank of India.
On a macro-level, India's structural story seems to be panning out too. The country's large consumer market is reaching critical mass with its growing appetite for soft goods and durables, creating cyclical upswings in the past two years for steel, copper and other commodities. Add to this India's growing per capita income (see table), the millions of young and educated workers driving the booming service sectors, the opening of its economy to private and foreign capital, and you have the makings of a solid growth story.
As India steadily opens its industries, among them insurance, banking, real estate and telecommunications, foreign interests are queuing up to make their play. For an example of pent-up demand, look no further than the ensuing deal rush in India's media sector after the government relaxed the industry's foreign investment rules. The UK-based Henderson Global Investors started it all when its Asia fund invested US$26m in HT Media, publisher of the Hindustan Times in early 2004. Since then, Pearson Plc's Financial Times, Dow Jones, Reuters, Standard Chartered Private Equity and others have jumped on the bandwagon, hoping to cash in on India's growing media advertising market. Most recently, Ireland's Independent News and Media Plc, put down US$34m
for a 26% stake in Jagran Prakashan, a diversified media company.
Other sectors such as banking, with its more "level playing field and easier access to potential customers [than China's]" will see deepening foreign investments, according to Sharma of the State Bank of India. Foreign banks will find in India a more established retail banking market where credit and debit cards are widely used and banks are one-stop shops, unlike the case in China where banks are barred from providing certain types of loans. India also has fewer restrictions on bank branch office expansions; foreign banks can open up to 12 branch offices annually compared with China's one per year. So it comes as little surprise that UK-based Barclays said in June that it would first focus on India rather than on China, in its bid to expand in Asia, or that Citigroup has made India a focus market.
In trade, India has been on a parallel campaign to engage the outside, partly out of frustration with WTO, whereby industrialized nations have refused to eliminate their farm subsidies. To date, India has signed framework free trade accords with ASEAN and the Mercosur bloc of Argentina, Brazil, Uruguay and Paraguay, while pursuing FTA discussions with China. And like China, India has globe-trotted through Africa and Europe to drum up more bilateral trade.
With India's signing of the Comprehensive Economic Cooperation Agreement (CECA) with Singapore in June, and with Sri Lanka and Thailand FTAs in its back pocket, the focus on China as a trade partner is likely to shift "slowly but steadily" toward India, according to Christopher Seeley, an Australia-based trade consultant.
India's FDI rising
While India has lagged in the FDI boom that China has ridden to enviable success, it is in for an "investment revival" said Abheek Barua, a Mumbai-based ABN AMRO economist. As sectors such as autos, housing, pharmaceuticals and infrastructure gain steam, some estimates have India's FDI in-flow rising to US$6-7bn for the next three to four years, up from the historic average of US$3.8bn in the last five years. (This, however, still pales in comparison to China's US$60.6bn worth FDI in 2004.)
That India increasingly is seen as an emerging destination for global expansion, much in the way China was and still is, is borne out by South Korea POSCO's decision to build a new steel project in India. That country's steel consumption is expected to more than triple to 100m tons by 2020, spurred by rising infrastructure investment and demand for housing and durable goods. POSCO's move also serves as a buffer against China's slowing steel demand, as the sector has been a targeted for a cool-down due to over-supply and efforts by Beijing to moderate the economy's fast growth.
Other sectors will also reap increasing investments by MNCs. One of them is telecom, as India is now the world's fastest growing cellular phone market. French telecom major Alcatel recently said it would invest US$600m in India over the next three to four years and more than double its Indian staff from the current 750 to 2,000 by early next year.
Another area that has MNCs queuing up at the gates is India's US$330bn retail market, as the government has yet to decide how much FDI should be allowed in the industry. But already, global retailers are anxious to crack the market: Wal-Mart has begun setting up offices in Mumbai and said in June it is ready to enter India, even if it means striking partnerships with domestic retailers. The lucrative Indian retail market is underscored in AT Kearney's 2005 annual ranking of 30 emerging retail markets: in it, India ranked number one as the "most compelling" opportunity, given its underserved market whose growth is projected to average 10% annually over the next five years.
India will also get a boost in FDI from Japanese businesses seeking to reduce exposure in China over strained Sino-Japanese relations. According to recent surveys by the Japan External Trade Organization, the percentage of Japanese companies planning to expand in China declined following the anti-Japanese demonstrations in China to about 55% in late May, down significantly from 86% last December.
In July alone, both Toyota and Yamaha Motors announced plans to build new plants in India. Their interest in India may have less to do with minimizing political risks and more to do with capitalizing on India's emergence both as an auto market and also a global hub for small-vehicle manufacturing and auto components sourcing.
Business consultancy KPMG said in a recent report that India could join China to become the next major auto production center. "The emergence of major manufacturing centers in places like India…means that addressing the Asian market is no longer simply a consideration of how much capacity you pump into China,? according to David Gelb, KPMG's partner for the automotive industry.
In a bid to boost FDI, New Delhi has taken some cues from China. In May, for instance, a law was passed to create special economic zones where the processes to set up foreign operations (previously a three-month bureaucratic nightmare) are streamlined; foreign businesses operating in the Indian SEZs will also enjoy tax holidays and export tariff exemptions.
How much the government's initiatives will impact India's FDI is hard to say, but MIT's Yasheng Huang, who in 2003 co-authored with Harvard Business School's Tarun Khanna a Foreign Policy article predicting that India would eventually eclipse China, is clear about one thing: ?Mark my words: Manufacturing FDI into India is set to increase," Huang told CHINA ECONOMIC REVIEW. "It will not surpass China's FDI in scale but it will in quality – in terms of technological content of the investments."
Word on the street
With India's new calling cards being its rising exports, consumption demand and capital investments, a new crop of foreign investors are tuning in. They are no longer just American, Hong Kong or British mutual fund managers who long have favored India as an emerging market play; the new investors are pension fund managers, private equity players and they hail from Holland, Germany, Canada, and beyond. Last year, more than 630 of these foreign institutional investors (FIIs) registered in India, up more than 50% from about 400 in 2003. FII in-flows this year could top 2004's US$8.5bn record if the first-half pace of US$4.5bn keeps up. Japan, in particular, India's newest and arguably most valuable fan, has invested US$1.5bn during the first half this year.
Japan has reasons to be bullish: India's stock market, known to be one of the most efficient and transparent among emerging markets, has had a respectable run as the Bombay Stock Exchange's benchmark index, Sensex, has gained more than 10% this year, touching an all-time high in July, rendering meaningless any comparisons with China's opaque and troubled equity market, with its near eight-year-lows.
Private equity players are also warming to India, which has seen a number of highly profitable investment exits, particularly the US$1.1bn killing made by the private equity firm Warburg Pincus, since selling off two-thirds of its stake in Bharti Tele-Ventures, India's top cellular provider in which it invested US$300m between 1999-2001. Warburg now has US$1bn in accumulated investments in India, compared with US$400m in China.
At the Carlyle Group, China and India are about equally weighted in the firm's US$250m Asia growth capital portfolio, as Wayne Tsou, managing director of the Carlyle Group and Head of the Carlyle Asia Growth Capital Group, calls their opportunities "equally compelling."
"India and China have different opportunity sets," Tsou says. "In India, there is a significant export component and a significant service component, which is not limited to IT anymore. India has a vibrant pharmaceutical and biotech/healthcare industry that's also serving the Western world."
Besides Warburg, the Carlyle Group and Henderson, other private equity investors like Actis, 3i and General Atlantic Partners have come to play. One of the more recent entrants, the Blackstone Group, with US$1bn earmarked for India, opened its first Asian office in Mumbai this May, bypassing Hong Kong along the way.
None of this surprises MIT's Huang. "For the past five years, the portfolio investments into India have surpassed substantially similar investments in China, he told CHINA ECONOMIC REVIEW. "One difference is that fund and MNC managers are now more explicit about their investment preferences for India to (over) China."
While India chalks up the headlines and capital, China, some say, may soon be hitting a brick wall, or what DeWoskin calls "China fatigue."
For some investors, China has simply not delivered. "There have been some companies involved in long-cycle projects in China that have yet to resolve their problems," DeWoskin said, referring to MNCs that have committed over hundreds of millions in large-scale infrastructure projects such as water treatment and power. Having entered China almost 10 years ago, US-based Alliant Energy is now seeking an exit. In July, the company sought to divest its mainland power-generating investments whose value has been worn thin by China's rising coal and transportation costs.
The patina is wearing off on China's storied southern coastal area – the genesis of the country's economic boom – where shortages in energy and labor, rising wages and tighter labor and environmental regulations are driving manufacturers to look elsewhere. By some estimates, for example, Guangdong province is now short around 2m workers.
Even Chinese businesses are losing heart, as Xinhua Finance's June quarterly business survey showed a prevailing weakening sentiment, as the index measuring overall business conditions fell to 67.83 from 78.03 in the preceding quarter.
On the private equity front, China's investment climate is getting dicey as an over-supply of capital is driving up target company valuations. "Some investors have seen cases of stakes in companies valued at two- or three times what their underlying assets and sector benchmarks would dictate," said Paul Mackintosh, managing editor of Asian Venture Capital Journal. This trend has McKinsey and Co issuing warnings of disappointing results and advising investors to play China via equity stakes in private overseas companies with a mainland strategy, rather than entering deals with overvalued Chinese companies.
China's political trials with the US and Japan, its top trade partners and FDI sources, also bear consideration. India will get a powerful boost from US and Japan, which have recently cozied up to India, whose rise is seen by the two countries as a way to shift the balance of power away from China. In April, Japanese Prime Minister Junichiro Koizumi visited Indian Prime Minister Manmohan Singh, pledging among other things, increased trade and investment with India. As for US-Indian relations, Singh recently paid a visit to the White House at the invitation of US President George W. Bush. Beijing also can?t be too happy about the 10-year agreement between Washington and New Delhi to increase military ties, including joint weapons production, cooperation on missile defense as well as increased high-tech cooperation, greater economic ties, and energy cooperation.
MIT's Huang and Harvard's Khanna have argued that the indicators for long-term success aren't entirely resident in top-line stats like FDI. China has grown largely on the back of FDI and state incentives favoring the state-owned enterprises (SOEs) at the expense of the entrepreneurs. In contrast, India encourages organic growth in the private sector, which has spawned a handful of world-class multinationals, among them Infosys and Reliance Group. China has no home-grown brands that rank comparably with these companies.
China's development model, despite having accelerated the country's economic progress, has also been criticized for leaning too heavily on fixed investment and exports. Without developing its domestic consumption, China will have trouble sustaining its growth (India's private consumption accounts for 64% of its GDP, compared to 46% in China). Moreover, India appears to be more productive in its use of capital than China. Though China has been growing more than 50% faster than India, the latter has maintained a GDP growth of 6+%, with 18 times less cumulative investment.
For some, however, the India-China discussion is best couched in coexistence rather than competitive terms, since they have complementary economies, one excelling in service and the other in low-cost manufacturing.
But at some point, the two countries will converge – if they have not already done so via the Sino-Indian agreements signed earlier this year binding them to greater economic exchanges. Further convergence will take hold when China competes on India's turf. Although value-added manufacturing FDI is entering India, "China is fast developing on that route too, so it may be only a matter of time before China can offer similar products or services, but at lower cost, than India," according to Venkat Subramanian, an international business and strategy professor at Hong Kong University. China also wants to increase its presence in software and services, as China's Ministry of Information announced in June that it aims to best India's lead in software out-sourcing in the next five years. Its weapon? Tax breaks to companies that sell outsourcing services overseas.
That might not be enough to upset the current order. India's demographics will be a tough hurdle to overcome – its educated, young professionals are and will remain the economy's backbone for the foreseeable future, as the working age population is expected to comprise 47% of India's population by 2020. The growing supply of workers will keep India's wages low, compared with China, where a one-child population control policy has produced an aging populace.
Lest anyone thinks India will threaten China, however, the evidence is inconclusive. India, for all its ambitions, still has to contend with liabilities like a budget deficit that could limit growth, a caste system that wastes human resources of those at the bottom, limiting their upward mobility, and political factions that could stall essential changes (witness the long debate over the retail FDI cap). "The inefficient side of India remains – democracy needs consensus and bureaucracy slows things down – those things won't change," said Harvard's Khanna.
As for China, whose centrally directed economy can sometimes mobilize forces at the snap of the fingers, there are those who believe the world's fastest-growing economy has yet to see its best days and that the recent excitement over India may be over-played. "China is the hottest happening," according to US-based strategic analyst Ehsan Ahrari who has written extensively on Sino-Indian strategic competition. "When we talk about India's economy, we talk about emulating China."
But if the recent progress by Asia's third-largest economy is any guide and if the chips continue to fall into place, it could soon be India's time to shine.