More than 2000 years later, the Modi-led government in India finds itself at similar cross-roads. With supply chains disrupted worldwide and anti-China sentiment on the rise in the wake of COVID-19, companies are actively evaluating alternatives to sourcing from China. India has sensed an opportunity and is keen to make inroads to a space it hopes China will vacate sooner rather than later.
China has been the world’s factory over the past two decades, contributing 13% to world exports. However, the COVID-19 pandemic and sweeping measures to contain it have disrupted global supply chains, bringing factories to a screeching halt and leaving supermarkets with rows of empty shelves. Companies like Fiat Chrysler and Hyundai were forced to halt production as they could not get parts from China. The current outbreak is prompting companies to make their supply chain more resilient by increasing inventories, empaneling alternative suppliers and accelerating technology adoption.
Similar observations were also made after previous disruptive events such as the 2011 Japan tsunami, the 2002 SARS outbreak and the 2008 global financial crisis, but not many companies bothered to adopt those risk-mitigating measures. Most companies, which are constantly looking to cut costs, were deterred by the substantial investment costs. A few months after the crisis was over, most discussions were put on the backburner. But the severity of the current crisis might finally force companies to act. David Farr, CEO of Emerson Electric Co., recently mentioned in an interview “For the first time we are seeing not just one or two countries closing down, we have three countries closing down. So what we are going to have to do here is evaluate this from an economic standpoint and enterprise-risk standpoint”. For decades, industry leaders have focused on making their supply chains lean. But the current pandemic has highlighted the need to look beyond just costs and to ensure supply chain security and diversification.
However, in contrast to some global narratives, packing up and leaving China for good is not something that we believe most companies will consider. The country today accounts for almost 20% of global GDP. China also appears ahead of the global curve when it comes to restarting the economy following months of COVID-19 induced lockdowns, and many of the reasons why companies are in China in the first place still hold true today. China’s role as a major source of manufacturing is therefore likely to be diminished but unlikely to be eliminated.
A more likely outcome is the emergence of a ‘China + 1’ model. The current disruption is prompting companies to diversify away from China to countries such as India, Vietnam, Malaysia and the Philippines as they look to minimize risks and localize their supply chains. To be clear, companies have been relocating their operations out of China for a few years now, prompted mainly by increasing labor costs in the country. This shift gained momentum during the peak of the US-China trade spat in 2018, when companies looking to avoid higher tariffs and rising tensions between the world’s largest economies relocated some of their operations to other countries. In July 2019, Cummins Inc. said it avoided $50 million in tariff expenses by moving some production to India and other countries. Others such as HP and Dell were reported to be planning a relocation of up to 30% of their notebook production out of China even before COVID-19 struck. The current pandemic is only likely to accelerate such plans. In May 2020, Keith Krach, the US Undersecretary of State for Economic Growth, Energy and Environment said in an interview that the Trump Administration is ‘turbocharging’ an initiative to remove global industrial supply chains from China as it examines various ways to ‘punish’ Beijing for its mishandling of the COVID-19 pandemic. Japan has already announced an initiative to set up a fund of $2.2 billion to encourage companies to move out of China.
India is well positioned to capitalize on this opportunity. This is perhaps best exemplified by the recent shift in America’s sentiments towards India and China. In April 2020, a Pew Center survey found that two-thirds of Americans say they have an “unfavorable” view of China, making it “the most negative rating for the country since the Center began asking the question in 2005.” As US-China relations grapple with the growing trust deficit, India it seems is filling the void. Over the last few months, Apple’s assembly partners – Foxconn, Wistron and Pegatron – have started moving their production lines to India that would enable Apple to export around $5 billion worth of iPhones from India apart from catering to the domestic market. Other global firms that have shown interest in India include US-based makers of medical electronics products Teledyne and Amphenol, and medical equipment makers such as Johnson and Johnson. The Indian Communications and IT minister, Ravi Shankar Prasad, recently announced that 22 domestic and global players applied under the government’s production-linked incentive scheme for electronics manufacturers, that will result in production to the tune of $150 billion over the next 5 years, with exports estimated at $100 billion. India has also extended similar incentives to pharmaceutical businesses, and plans to cover more sectors, which may include automobiles, textiles, and food processing under the program.
In 2019, the United States’ imports from China totaled a staggering $452 billion. Only five low-cost countries have GDPs larger than that: India, Mexico, Indonesia, Brazil, and Thailand. India is the biggest economy among these candidates and has the largest untapped potential for filling part of the supply chain vacuum that is created by exodus from China. India’s English-speaking workforce, large pool of low-cost, yet highly skilled talent, and growing market of 1.3 billion people with increasing disposable incomes makes it a natural destination for US companies looking for alternatives to China.
Traditionally American executives have thought of India as a source of IT services, spices, textiles, apparel, jewelry and handicrafts. While India does export billions of dollars of these products to the United States, India has moved much further up in the value chain. The cabin of Marine One, the presidential helicopter is fabricated for Lockheed Martin’s Sikorsky unit in India. Ford manufactures its EcoSport model in India for the U.S market. NASA’s Jet Propulsion Laboratory is collaborating with the Indian Space Research Organization on the most expensive imaging satellite ever to be launched, NISAR. Most of the leading Indian manufacturing companies have adopted world class manufacturing or manufacturing excellence practices using methodologies like TPM, TQM, Six-Sigma and Lean. Since 2003, India companies have won 401 JIPM TPM awards which are highest for any country outside Japan. Indian companies have won 38 Deming Prizes – the highest global recognition for TQM implementation. India has the most US FDA approved pharma plants outside US. The Harvard Business Review calls this phenomenon “India Inside,” where much of what is imported from India goes unnoticed by both American consumers and the media, but is nonetheless crucial to the fabric of the U.S economy.
The Indian government has moved with intent to seize the opportunity. The government has announced that it is readying a pool of land twice the size of Luxembourg to offer companies that want to move manufacturing out of China, and has reached out to 1,000 American multinationals. Local governments, such as the state government in the northern state of Uttar Pradesh, which has a population the size of Brazil, are forming economic task forces to attract firms keen to move out of China. Several states have also begun making moves to address some concerns around the ease of doing business – prime among them being making contentious changes to India’s archaic labour laws, put in place to reduce exploitation. Uttar Pradesh and Madhya Pradesh states, for instance, have suspended significant labour protections exempting factories from even maintaining basic requirements like cleanliness, ventilation, lighting and toilets. The intention is to improve the investment climate and attract global capital. Initiatives such as ‘Make in India’ & ‘Skill in India’ have been given a renewed push to create a large pool of skilled human resources. Reports have indicated that a large number of companies have already initiated talks with Indian authorities seeking to pursue production plans in this country in sectors such as electronics, medical devices and textiles, among others
At SeaLink Capital Partners, we have been actively exploring the twin themes of supply chain diversification and import substitution by global companies. Unlike export-driven China, India’s companies grew rapidly by serving pent-up domestic demand since the economy liberalized in 1991. In the process, Indian managers and entrepreneurs acquired the management skills and quality standards to expand globally, but they first turned to emerging markets in the Middle East, South East Asia and Africa. Today, Indian companies export billions of dollars each in categories as diverse as: furniture, pharmaceuticals, surgical instruments, electrical machinery, vehicles, boilers, parts made of plastic, steel and aluminum, organic and inorganic chemicals and more. We believe that many of these Indian suppliers are ready for first-world markets, given their existing client relationships, familiarity with international markets, ability to meet global quality thresholds and existing distribution networks. A recent report from Bain & Co. has pegged this manufacturing opportunity at $1 trillion over the next 5 years.
To be fair, there is still plenty of work to be done to ensure that India builds upon the prospects offered by the current environment to emerge as an enduring sourcing partner for global firms. India needs to work on fixing its lower labour productivity, higher land and industrial electricity costs, higher capital costs, higher logistics and compliance costs, sudden policy changes, delays in achieving government plans and overloaded legal system, which are visible bottlenecks for attracting investment. For instance, India lacks world-class infrastructure, which is necessary for efficient movement of goods in and out of India and a necessary condition for international production networks. Logistics costs in India account for 13-15% of the product costs, compared to a global average of 6%. The government has so far displayed an intent to attract foreign companies moving out of China. However, sustained measures and effective implementations, which have often been the bane in the past, are needed to help India emerge as a serious destination for supply chains relocating from China and burnish Prime Minister Modi’s ‘modern-day Chanakya’ credentials.