US-China trade deal: Time running out to woo FDI exiting China

Rajeev Kher and Harsha Vardhana Singh,
Financial Express, 20 December 2019.
https://www.financialexpress.com/opinion/us-china-trade-deal-time-running-out-to-woo-fdi-exiting-china/1799233/

The recent bilateral trade deal between the US and China has important implications for India. It hastens the need to conclude India’s ongoing efforts to provide a policy framework for attracting foreign direct investment seeking locations other than China. The trade deal covers important areas of concern for the US, ranging across Intellectual Property Rights, technology transfer, currency-related issues, greater market access for US products (goods and financial services), and dispute settlement for effective implementation.

Under the trade deal, the US will maintain its 25% tariff on imports worth $250 billion, reduce its 15% tariff to 7.5% on $120 billion worth of imports, and not implement the planned tariff increase on the so-called List 4B products, which include mobile phones, laptop computers, apparel, and toys.

For List 4B products, the window of commercial opportunity is now open for a longer period because the planned US tariff increase is not being implemented. The US-China deal provides a framework for a potential longer-term solution to US-China problems. However, the US trade representative, Robert Lighthizer, has noted that whether or not China will live up to the commitments is as yet uncertain, and depends on whether the hardliners or the reformers in Beijing will prevail during the implementation of the trade deal. Both, the US and large multinational companies will be watching the implementation of this deal, to assess whether or not the Chinese leadership will effectively implement the agreement.

This period of uncertainty is significant because it allows the window of opportunity to be open, but only to a limited extent. In such a situation, India has only a short period of time to conclude its intense process of policy consideration, which has been going on for the past several months, with the objective of making India an attractive investment destination. The window of opportunity is closing, but the opportunity to establish credibility and attractiveness of India as an alternative investment destination is still present if the policies under consideration are finalised and implemented within a couple of months. Time is of essence now.

India is a large market, but an export hub that replaces the aspirations for global trade links of large companies considering alternatives to investing in China requires access to a much larger marketplace within the context of global value chains. This, in turn, needs significant reform in operational conditions. India’s policymakers have been focused on creating such reform-based improvement, and have considered the possibility of initiating reform in some major sectors. The recent report of the High Level Advisory Group on international trade also emphasises such an approach. The current developments are very significant in this regard.

List 4B, for which the US has postponed its planned tariff increase on imports from China, contains at least two product areas which India has emphasised for its key national objectives—apparel for employment, and mobile phones for technology. Such an emphasis is required for these two sectors. Bangladesh and Vietnam now have double the apparel exports compared to India, rising from much smaller levels in 2000, or even 2005. Both these countries have expanded their exports with the help of FDI. India seems to have missed out on attracting large FDI in the apparel sector. Extensive reform is required, along with policy support, factor market reform, international institutional engagements, upscaling existing enterprise, and modernising smaller enterprises. The required reforms and incentive policies are important for both rejuvenating the established domestic industry, and attracting FDI.

For mobile phones, the top exporting economies, i.e., China, Vietnam, and Hong Kong (China), account for over 70% of the global market. India’s global export share is about 0.6% at present, but the nation has high aspirations in this sector. India’s National Policy on Electronics (NPE), 2019 aims to achieve an export of $110 billion for mobile phones by 2025—an approximately 70-fold increase. The aim is to increase in domestic design and technological ecosystem, as well as to generate a major rise in foreign exchange earnings.

The large increase in mobile phone exports can take place only if major multinational companies with extensive global market presence invest in India at scale. It is significant that the largest global mobile phone companies are present in India. However, their additional investments and commitment to a business plan that helps achieve the NPE 2019 target would depend on policy changes and reform. This has to happen during the short period for which the window of opportunity for countries to attract investment that seeks locations other than China is still available. This period is of not more than a few months. A quick decision and implementation within a couple of months or so would give India credibility, bringing back the attention of large investors to the country in this period of uncertainty.

Other countries such as Vietnam attract FDI due to their ease of doing business and by implementing an incentivising policy framework. These policies give FDI in Vietnam a commercial advantage of about 9-12% over India’s mobile phone production. In this competitive situation, a WTO panel has found India’s main export incentive schemes, like the Merchandise Exports from India Scheme (MEIS), to be inconsistent with WTO provisions. India will have to phase out MEIS, and some of the other schemes found to be in violation of WTO provisions. Meanwhile, ironically, India has actually reduced the level of its prevailing MEIS incentive, thus lowering the support provided to investors/exporters. While the window of opportunity is closing, Indian policy incentives are actually becoming less attractive.

This results in a number of adverse effects. One, it results in future policy uncertainty for investment decisions. Two, it reduces the attractiveness of establishing export hubs in India when other competing countries are providing incentives, especially for large investors. Three, for large export orders—India wishes large firms to increases exports by several billions of dollars—a 2% lower margin of competition due to reduction of MEIS would have a large aggregate impact on earnings and ability to compete. Four, the business of large exports necessitates creating advance orders, inventory planning and hiring of workers to address export demand, systemic clearances (including from the importing market) to ensure that the planned exports can take place smoothly, and established business relationships to create and maintaining large exports. A significant change in the incentive and competitive margin disrupts all these aspects, and creates a reluctance on the part of major investors to invest and make large efforts for exports. An alternative support policy is required to mitigate these negative impacts.

Indian policymakers have been aware of the need to implement policy support and incentives. Intense discussions and efforts have taken place in several government departments and institutions for some months now, to develop WTO-consistent policy alternatives that will encourage investment by major firms in India, particularly in areas with high technology and export potential. This process should now be concluded, and the relevant policies implemented in the near term, to encourage major investments and exports, especially for the priority areas for which US tariff increases have been postponed, i.e. products in List 4B mentioned above.
(Kher is former Commerce Secretary of India & Singh is former Deputy Director General of WTO. Views are personal)