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China-centric Global Supply Chain corroding! India urgently needs to play with clay of Policy Packages!

TIOL - COB( WEB) - 722
JULY 30, 2020

By Shailendra Kumar, Founder Editor

SINCE early 1990s, the engine of globalisation gathered eye-watering bouts of steam. Several multilateral organisations fuelled it further as efficient catalysts. During the course of its journey, the 'behemoth' also acquired digital powers, which further sharpened its teeth to bite deep into physical boundaries of Sovereign States! The wheels of capital (FDI) nimbly moved to all those geographical pockets which provided cheap labour, not necessarily skilled ones! Multinational Companies from America and Europe aggressively streamed to them in spite of their ropey infrastructure. Most of the poor and emerging economies offered almost equally competitive 'no environmental costs' string for setting up large carbon-footprint factories (a la the present Climate Change Crisis)! But what decided the winners were rapid structural and policy changes for different factors of production - land, labour, capital, technical knowhow and an eco-system for new-age technology. Thus emerged China as the most agile, robust and quick-footed country to grab 'unfairly' large number of humongous factories built on the strength of its elephantine infrastructural transformation! It turned itself into 'the Factory of the World' with almost 27% share of the global manufacturing output. In other words, the story of globalisation is a tantalising tale of unidirectional supply chain!

Everything was going gung-ho for the glamorously dynamic motorcade of globalisation and supply chains till 2017. Then resonated a loud siren of 'America First'! This clearly sounded a scary alarm for the predominantly China-centric global supply chain! Stung by the 'scorpion of large trade deficit', the Trump Administration ignited its trade war machine specialising in erecting tariff walls against goods and services imported from China. It was a tactical gambit for Mr Trump to disrupt the China-tethered supply chain and bring millions of jobs back to America. With the United States imposing high tariff on a large basket of Chinese goods, key trade negotiators from Beijing came to the negotiation table and some sort of patchy and duplicitous agreement was hammered out. Since China found itself at the receiving end in this pact, its Orwellian President Xi Jinping had already built other 'dragon designs' in his cerebral factory! China splutteringly began to honour the conditions of the trade pact. Realising that legal-scrubbing would not help, the American trade and commerce department reported the same to its undiplomatic and jeering President.

What provided incendiaries to already piqued and ready-to-pounce President was the stealthy grand entry of Coronavirus into America! With the 'Wuhan Virus' rapaciously trampling down the health infrastructure in the city of New York, all hell broke loose! Trump Administration launched a sustained oral assault against China and all such organisations which were seen acting cosy with Xi Jinping. All these geopolitical developments amounted to tangible horror for the China-centric edifice of global supply chain! Even as the MNCs were evaluating the vulnerability of their supply chains, Mr Xi overlooked the economic costs of the diplomatic war and preferred to take a plunge into multiple theatres of actual war. Obviously, he saw a slice of opportunity in the COVID-19-ravaged world to give wings to his unremitting lust for the throne of Global Superpower! His well-instructed army took a walk into the undefined territory controlled by India. His naval aircraft carriers floated afar into South China Sea to establish undisputed ownership!

All such misadventures of China have done a long-term and irreversible damage to the edifice of global supply chains. Realising the tactical error of suicidal dependence on the Chinese economy even for the manufacture of essential drugs and other goods, many industrialised economies decided to offer subsidies to their private sectors for shifting their factories back home or to other East or South Asian countries. Japan announced a kitty of USD 2.2 billion to bankroll such decisions of its MNCs. And, as per the latest reports, Japan has approved a list of 87 companies which have applied for subsidy for shifting their factories from China. Many have got paid for moving to Vietnam, Thailand and other Asian countries also.

Japan is not a loner in this sudden twist and turn! As per various international surveys of MNCs operating from China, their bosses are not only thinking of diversifying their supply chains by setting up additional factories either in America or Europe but also shifting out of China. Depending on the nature of product and the criticality of raw materials, a good number of them may take years to do so but one long-term change is going to be the principle of setting up factories close to the consuming countries. The new supply chain matrix is expected to be not only shorter but also smarter. If the consumption bowl is America, it can be anywhere in Northern America such as Mexico or Canada. If it is Europe, it can be any East Asian economy like Cambodia or Vietnam or Thailand. So far as India goes, it is a huge consumption basket in itself and, going by the double-digit growth in the size of the middle class, it would remain an undiluted consumption basket for most foresighted MNCs. India is truly an attractive destination, not only to serve India, but also other Asian and African countries. Some of them may even service EU from India. Another twist which the supply chain needs to go through is that some of the economies like US, India and Australia have banned some of China-made goods. This largely means that to serve these markets, most MNCs require to set up factories outside China. Yet another factor which may espouse the cause of economics for shifting factories out of China is the eye-wateringly expensive warehousing costs. To cater to the North American markets, an MNC needs to set up inventory for a minimum period of 100 days. Such a cost can be saved by diversifying the supply chain and bringing factory close to the consumption market.

This is where India can take advantage of the existing supply chain being wrecked and new supply chain in-the-making! The two unavoidable policy decisions needed to attract FDI are - a long-term FDI policy intertwined with India's foreign policy. India needs to lay down its foreign policy based on its long-term geopolitical interests and then play with the clay to give shape to its FDI, industrial and fiscal policies. What an investor looks for is the certainty in the macro policy environment. If China is to be kept at arm's length, our policy should be very clear about it. Let's club some more economies with China over a long-run perspective of at least 20 years and then embrace FDI in all sectors, including sensitive ones. I am confident that it would be a shoo-in policy framework for success.

The second step should be to set up Central or Federal Manufacturing Zones in close tandem with willing States in India. All such zones should be developed in terms of robust infrastructure and a single window administrative approval for all empirical purposes. Such manufacturing zones may be put in fiscal wrapper to make them more attractive. While doing so, India needs to focus on teething problems enveloping all factors of the production - Land, labour, capital and tech policy. Central and State policies for all these parameters should be laid down with a long-term perspective. Red tapism should be shredded to its bare skeletons so that it does not create bumps. True, these are gigantic challenges! But, if India wants to be a viable rival to China, it has no choice but to go for major reforms which should promise labour arbitrage, easy capital for domestic players, easy access to land and an innovation-friendly tech policy coupled with efficient and cost-effective logistical infrastructure to transport goods and raw materials.

What should go hand in hand with the foreign and FDI policies is our free trade agreements (FTAs). Rather than signing FTAs without keeping an eye on our manufacturing and exports strengths, it is better not to ink any such trade pact like RCEP. Recently, the Indian Foreign Minister, Mr S Jaishankar, said that India has failed to take advantage of FTAs. India is rather a loser if an analysis of FTAs is done. The PMO has set up four inter-ministerial working groups to review our FTAs. India has largely treated FTA in the past as political junk-food - superficially appetising but damaging in the long-run! India urgently needs to lance the boil of foreign policy populism!

The key terminologies which need in-depth examination in these FTAs are - value-addition, rules of origin and methods of verification. To achieve value-addition, rules of the game should be clear in terms of percentage of domestically-manufactured inputs and percentage of imported inputs. Most ASEAN partners are taking undue advantage of this gaping hole. They import cheap components from China and assemble them to scale up to the threshold of prescribed value-addition and then export to India. Indian devastated electronics industry is one good example of such policy loopholes! Secondly, margin of profit should logically not be a part of value-addition which is the extant case today. Thirdly, method of verification of value-addition and rules of origin should be inbuilt into all FTAs as safeguards and also to provide a level-playing field to serious players. Too many cases of abuse of FTAs have been detected by the DRI and the Customs but Indian policy makers have failed to cut much ice and help domestic industry.

In a nutshell, India has offered a huge consumption bowl to some of the trading partners on a platter without Indian exporters taking advantage of such trade pacts. A model FTA, very similar to Bilateral Investment Protection Agreement(BIPA), should be put in place as India is keen to ink more FTAs with Britain, America, Australia and EU in the coming years. However, Mr Jaishankar is apt in his observation that India's engagement with multilateral entities need not be FTA-centric as the globe is turning protectionist and regionalism may substitute multilateralism in the New International Order!