Global Intelligence Series

Challenges and Opportunities for India-Japan Economic Partnership

Date December 16, 2020
Speaker Amb. Sujan R. CHINOY (Director General, Manohar Parrikar Institute for Defence Studies and Analyses (Manohar Parrikar IDSA), India / Former India's Ambassador to Japan)
Speaker Saroj Kumar MOHANTY (Professor, Research and Information System for Developing Countries (RIS), India)
Commentator FUKUOKA Noriyoshi (Director, Southwest Asia Office, Trade Policy Bureau, METI / Consulting Fellow, RIETI)
Moderator WATANABE Tetsuya (Vice President, RIETI)

India has become the fifth-largest economy in the world, surpassing Britain, the former colonial power. It is said that India will overtake Germany and Japan to become the world's third-largest economy within the next 10 years. What challenges and opportunities are there for India and Japan, which are important partners in the free and open Indo-Pacific initiative? Former Ambassador to Japan and the current director of the Indian Defense Research Institute (IDSA), H.E. Amb. Chinoy, one of India's leading experts on Japan and China, and Professor Mohanty from RIS, one of India's top think tanks, will present lectures on how to strengthen economic relations between the two countries.


What is resilience in supply chains?

Sujan R. CHINOY:
In my view, resilience in supply chain management relates to ensuring that the effects of costly disruptions are delayed or avoided, and in the event that a disruption cannot be avoided, ensuring that one can respond appropriately and recover in the shortest possible time. Supply chain disruptions can be natural, man-made or both.

Allow me to explain this with examples. Natural calamities, like the Great Tohoku Earthquake of 2011, commonly cause disruptions all over the world. Man-made disruptions, like the terrorist drone attacks on Aramco's oil refineries in Saudi Arabia in September 2019, are also a reality in the globalized economy. War is another man-made disruption. Japan is no stranger to supply chain disruptions, but it has mitigated their impact through innovation.

Supply chain politics

Not every country has fully benefited from the rapid integration of the global economy. China has utilized the liberal global trading system to create monopolies and dependencies, exploiting its membership in the WTO since 2001 to become a factory for the rest of the world. It has hollowed out domestic manufacturing capabilities and capacities in many countries by exporting cheaper products with hidden subsidies. It practices its own brand of state capitalism and has long practiced supply chain politics.

The entire world is reeling from the effects of the COVID-19 pandemic. The global economy has suffered a major downturn just as multilateralism has also suffered retrenchment due to the politics of the pandemic. The priority in every country is to stimulate economic recovery. The global community was taken by surprise by the pandemic and by major disruptions in global supply chains caused by the pandemic-related lockdowns in China at the beginning of 2020. The adverse effects were universal. In India, Japanese companies experienced disruptions in the automotive, electronics and white goods sectors. Globally, temporary trade restrictions and shortages of pharmaceuticals and critical medical supplies, such as ventilators and personal protective equipment, enhanced vulnerabilities.

Disruptions caused by the U.S.-China trade war were compounded by the politics of the pandemic: economic nationalism and trade protectionism. Suddenly, it felt as if the world was moving in the opposite direction to free trade and the liberal global trading order. Taking into account China's unacceptable trade practices, unilateralism, assertive behavior and militarization, the U.S. has imposed restrictions on the export of microchips to China's biggest semiconductor manufacturer, SMIC. Leading Chinese companies such as Huawei and ZTE have not been spared. The trend towards greater weaponization of trade and technology is likely to continue in the future. The incoming Biden Administration in the U.S. is unlikely to be in a position to roll back the export control restrictions already in place without compromising on U.S. security considerations.

Because of these challenges, in September 2020, India, Japan and Australia agreed to work together to achieve supply chain resilience in the Indo-Pacific. This great initiative is expected to look at ways of reducing undue reliance on any one country for products or materials. Automobiles and parts, petroleum, steel, textiles, financial services and IT are some of the sectors identified under this supply chain resilience initiative. This initiative is expected to contribute to the global risk mitigation strategies not only of companies in Japan, Australia and India but also those of other nations operating in the Indo-Pacific.

Geopolitics and geoeconomics can never be truly separated. One cannot have truly stable economic relations with any nation in the absence of stable political ties. One likewise cannot base your strategic calculus on the presumption that trade and economic ties can remain normal in the face of territorial and geostrategic contestation. Henry Kissinger called this principle "linkage" in his analysis of U.S. relations with the Soviet Union. When the Nixon Administration came to power in 1969, the Soviet Union was keen on reaching trading arrangements with the U.S. and Western economies. The Soviet Union wanted access to certain technologies, yet it was unwilling to relent on strategic and military issues. Kissinger pointed out that compartmentalizing issues would encourage Soviet leaders to use cooperation as a safety valve while striving for unilateral advantages elsewhere.

Over the last several decades, China has been using this very policy of trying to maintain normal trade and economic engagement to its advantage without moderating its behavior on critical strategic and territorial issues. In fact, China has developed the ability to use deeper economic engagement with countries like Japan and Australia to weaken their resolve on political and strategic issues into a fine art.

Japan's strategy for ameliorating supply chain disruption

Japan has recently earmarked a USD 2.2 billion economic stimulus package to help Japanese companies shift production out of China and another USD 200 million to move production to ASEAN, India and Bangladesh. Since the normalization of diplomatic ties, Japan's economic ties with China have deepened tremendously. Japan has invested hundreds of billions USD in the Chinese economy. Much of the growth of Japanese companies comes from their manufacturing facilities and supply chains in China. This makes decoupling difficult to achieve in the short term. It may not be entirely feasible in some sectors. However, a pragmatic global risk mitigation strategy requires entrepreneurs to diversify. This means that supply chain disruptions can be reduced or even avoided altogether by creating new supply chains through active relocation of manufacturing facilities, investment in technology transfer and skilling manpower in alternative destinations. A certain amount of planned redundancy or overlap in supply chains will also be necessary as insurance against disruption.

Japanese companies have shown a capacity to pursue such a strategy for quite some time. Japan has pursued China Plus One, also known simply as Plus One, as a business strategy to avoid investing only in China or to diversify investments to include other countries, particularly ASEAN countries. In recent years, this strategy has been expanded to include South Asia, notably India. In Phase-1 of the relocation package, which was worth USD 653 million, 89 Japanese companies applied for subsidies to shift out of China. Of these, 57 companies relocated to Japan, 30 moved their manufacturing to Southeast Asia and two companies transferred manufacturing to India. These two are Sumida Corporation, a large company in the auto components sector, and Toyota Tsusho Co. Ltd., which is also a large company in the rare earths sector. A very large number of small and medium-sized enterprises (SMEs) went to Southeast Asian countries such as Vietnam, Thailand and Malaysia. Companies in the fields of healthcare and medical devices would have benefitted more by shifting to India, which offers a much larger local market as well as lower labor costs.

Japan has emerged as one of the largest investors in the Indian economy, with cumulative investments of USD 33 billion. Japan is present in every large infrastructure project and is a key player in every flagship program in India. Its contributions are especially valued in the automotive sector, skill development and the digital and start-up space. A panoply of agreements has facilitated growing relationships in electronics, healthcare, agriculture and food processing.

India's case

In the aftermath of the pandemic, India has taken several measures to support investors. India has announced production-linked incentive schemes in 11 key sectors: advanced chemistry cell batteries, telecom and networking products, textile products, pharmaceuticals, medical devices, food products, high-efficiency solar PV modules, automobiles and auto components, electronics and technology products, specialty steel and white goods, such as air-conditioners and LEDs. India's Foreign Trade Policy for 2015-2020 has also been extended to continue incentives under various export promotion schemes for one more year. India has particularly emphasized boosting these 11 sectors.

I also believe that India offers many new opportunities in EDTECH, FINTECH and remote working tools as we all transition to the "new normal" created by the pandemic. EDTECH will see millions of young people across the world—about 770 million, according to an estimate by the United Nations—turn to companies that offer online learning. India has one of the world's largest populations of young people, with 60% below the age of 35. Indians can offer online English language classes to Japanese students and vice versa. FINTECH, likewise, is likely to rely even more on the digital space in the future. Even healthcare will have to adapt to the new digital norm for conducting online consultations and treatment.

Opportunities await Japanese entrepreneurs

The Indian automotive sector is the world's fourth largest and India is the fifth largest producer of automobiles in the world. The Indian automotive industry contributes about 7.5% to India's GDP. The Indian auto components sector accounted for 2.3% of India's GDP and 25% of its manufacturing GDP. It employs about 5 million people in India. The pandemic caused a breakdown in global supply chains in the automotive sector since most manufacturers had concentrated their facilities in China. China also accounts for 27% of India's imports of automotive parts, and this also includes some components required by Japanese auto companies based in India.

Japanese companies, such as Suzuki, have achieved global brand recognition due to their presences in India. Suzuki contributed greatly to the development of vendor supply chains in the automotive sector in India. Overall, the setback due to the pandemic is expected to be short-lived. The Indian automobile industry is set to grow stronger once the growth rate of 18.3% that was achieved two years ago is regained. Moreover, the market is expected to grow with the rapid expansion in the road network across India.

Healthcare, ESDM and steel sectors

The medical device industry in India is currently worth USD 11 billion with an estimated growth rate of 15.8%. India currently has about 800 medical device manufacturers. However, despite being the fourth largest market in Asia, India has an import dependency of 80%. Among the biggest exporters to India in this field are China, the U.S., Germany, Singapore and Japan. I believe this to be unsustainable. I believe this is the right time for Japanese companies to ramp up their presence in India to fill this gap through local manufacturing.

One of the most important sectors for building resilient supply chains is the Electronic System Design and Manufacturing (ESDM) industry. India's electronics industry was worth USD 112 billion in 2017-2018. This has been forecasted to grow to USD 400 billion by 2024. Moreover, India's consumer electronics industry is huge and fast-growing, with many opportunities for Japanese companies to expand their presences in India. India currently produces consumer electronics, medical electronics, industrial electronics, automotive electronics, telecom products and related IT hardware.

The government of India has taken additional measures to ensure India's emergence as a major global ESDM manufacturing hub. India is poised to increase its presence substantially in global supply chains by attracting the semiconductor components and packaging industry to the country while building a robust ecosystem of domestic companies engaged in the manufacturing of printed circuit boards (PCBs), active and passive components, electromechanical and wound components. As Indian electronics manufacturing moves from completely knocked down (CKD) assembly to high value addition, components and semiconductors are being targeted through a slew of policy measures in the National Policy on Electronics of 2019, including capex and production linked incentives, conformance to standards, trusted value chains, etc. We should make greater efforts to take advantage of the MoU concluded between the India Electronics and Semiconductor Association (IESA) and Japan's Asia Semiconductor Trading Support Association (ASTSA). The steel sector is also important. India is the world's second largest producer of steel with an output of 112 million tons of crude steel in 2019. It accounts for 2% of India's GDP. With major thrusts on infrastructure and the housing sector, demand for steel is only going to rise further.

Self-reliant India and the defense sector

Prime Minister Modi announced "Atma Nirbhar Bharat" in an address to the nation on May 13, 2020. It literally means "Self-reliant India." Under this scheme, India has provided a robust framework for combining reforms with plans for long-term development. The five main pillars of the scheme are the economy, infrastructure, systems, demography and demand. A special economic stimulus package of about USD 268 billion, equivalent to 10% of India's GDP, has been announced to mitigate the adverse impact of the pandemic and lockdown. This will dovetail with efforts to impart a renewed impetus to Make In India 2.0.

The defense sector is also important. Defense and security cooperation is a crucial pillar of our bilateral engagement. Today, the Indian government is seeking to provide a big boost to defense manufacturing in India under the Make In India program. It has identified 101 items of which it will not permit imports, covering a vast range of defense items and equipment including important weapons systems. There is a tremendous opportunity for Japanese companies to enter into JVs and tie-ups with reputable Indian defense manufacturers. A second list may also be put out soon for even more sophisticated items.

The key question is whether Japanese companies are ready to risk entering into joint ventures (JVs) or 100% investments in India in this sector without any guarantee of contracts beforehand. They will have to bid like other companies in a tendering process, and prototypes made in India will have to pass tests. They will be competing against companies from the U.S., UK, France, Israel and other places which are very familiar with the Indian defense sector. However, Japanese companies will have to think big and think out of the box, and to be able to compete without G to G contracts that they are used to. Most Indian majors would prefer to have the Japanese as partners provided the costs of technology and production in India can remain competitive. We already have a Defense Industry Forum to advance mutual understanding between the defense industries of Japan and India. This Forum can be activated for this purpose.

I must make it clear that the push for self-reliance in India is not an autarkic policy. It does not imply foreclosure of the Indian economy to foreign trade and participation in the global economy. It is rather aimed at strengthening India's ability to participate more vigorously without falling prey to supply chain disruptions. India has the capacity and the potential to become one of the world's largest investment destinations and manufacturing hubs in the aftermath of the pandemic. The time is ripe for India and Japan to work together to create new, reliable and durable supply chains. We can make modest beginnings in a few sectors that are mutually beneficial.

Saroj Kumar MOHANTY:
My focus will be on the changing India-Japan economic relationship and the possibility of trade and investment in the global value chain (GVC) sector. The entire global economy has been very adversely affected by the pandemic. Growth prospects have fallen drastically and the impact can be seen in both India and Japan. It has been predicted to decline by 10.4% in India. India will become one of the top four economies in the world by 2035 and we should work together.

Implications of COVID-19 and partnerships

COVID-19 has had very diverse impacts on the world economy. Japan, Korea, the U.S., Italy, Germany and China have been very badly affected by the global supply chains and this has also impacted the rest of the world. They have also been affected by supply disruptions. Japan and other countries are striving to diversify their industries by relocating to other places.

The relationship between India and Japan has been pretty strong under the AAGC. Japanese businesses in Africa can expand their manufacturing activities in India and gain market access in Africa using the strong network that India has there.

Technology has played a very important role in India's economic development and Japan has been very important in bringing new technologies to the Indian manufacturing sector. JBIC ranked India as one of the most desirable places to do business. I think with the power of Japan in technology and India's proven position in manufacturing, software and other areas, we can really develop strong synergies between both countries.

GVC has been badly disrupted during the pandemic. Automobiles, ICT and other sectors were all very adversely affected. We need to work together to solve the supply issue.

The rise of India and the role of trade

India has had a very high growth rate since 1991 and it's been over 6% for most of the past two decades. Looking at various macroeconomic fundamentals—openness, the current account deficit, etc.—India has become a very important economy. By 2035, India will be the world's third largest economy with a GDP of around USD 13 trillion.

The trade deficit is a major challenge for India but bilateral exports and trade are rising. India's GVC trade with the rest of the world has been small but is rapidly expanding, with both GVC imports and exports on the rise. The semi-processed segment between both countries has been very strong. Japan's GVC exports to India have been huge while India's exports to Japan are small but consistent and growing. Looking at the growing importance of GVCs in trade with Japan, in the GVC sector alone, India has a trade potential of USD 7.5 billion. The top sectors will be machinery, automobiles and precision metal instruments. Other sectors are non-negligible.

India faces huge difficulties in terms of trade concentration in certain areas and products. India wants to diversify to other locations. We have identified 281 products on which India has price competitiveness in the Japanese market. Each product could be worth USD 50 million or more. Japan can really augment its exports to India and there are huge opportunities for Japan in the Indian market.

Significant demand exists in certain areas in India but at the same time there are fewer opportunities to diversify on these products globally. India wants to indigenize some of these products. Most are in sectors like chemicals, base metals and machinery and mechanical appliances. Japan could support the indigenization process through technology.

Japanese investment in India is huge while Indian investment in Japan is very small. India's bilateral investment has been mostly in the services sector and to a large extent the manufacturing sector.

Commentary / Q&A

FUKUOKA Noriyoshi:
I would like to comment on the supply chain resilience initiative promoted by Japan, India and Australia. ASEAN is currently a manufacturing hub for Japanese companies. India has great potential as a manufacturing base but is ranked 63rd on ease of doing business. Japanese companies hesitate to enter the market because of underdeveloped infrastructure and unique business practices in India. The economic ministers of Japan, Australia and India started discussions on supply chain resilience on September 1, 2020. Based on these discussions, we would like to implement matching events between companies in participating countries, and support programs for digitization of trade procedures and implementation of supply chain upgrading efforts.

Sujan R. CHINOY:
The issue of resilient supply chains is not related to any particular country. It is essentially aimed at creating greater predictability in the business environment in our globalized economy. METI is doing exactly the right thing by bringing Japanese industry closer to decision-makers, policymakers and industry and entrepreneurs in India. I agree that Japanese companies will not come to India simply because they are invited or simply because they have some problems in another place. India will have to create the right policy framework and environment. We will have to work even harder to create the infrastructure in India to support economic development. The government in India attaches the greatest priority to the development of infrastructure and has done a great deal over the past six years to improve the environment, the infrastructure and create the right framework for Japanese companies to come.

Saroj Kumar MOHANTY:
There are many gaps in India that really impact the progress of any further mutual agreement and the operation of many companies. The new Indian government has improved bureaucratic procedures over the past six years and we have very quickly moved up in the ease of doing business ranking. In coming years, we will be doing much better work. The government is very much involved in the process. I hope many Japanese companies will be encouraged to come to India in the near future.

Sujan R. CHINOY:
There is a question I would like to quickly address: what was the most memorable job for me in Japan? I must say the most memorable job for me in Japan was creating Japan-India Institutes for Manufacturing (JIMs) in India by encouraging every Japanese company in India to invest in what we call vocational training and imparting shop floor production techniques to Indian labor. I think that was a very big achievement. The second big achievement was creating a framework in which we were able to participate in Japan's technical intern training program whereby young people could be trained in India in Japanese techniques and economic practices and then sent to Japan for a short duration to work. A third area where we achieved great success is the healthcare sector where we were able to make Japan the very first partner for India as soon as our national healthcare scheme was announced by the government of India. The digital sector, again, where we created an innovation hub is another area where we achieved great success.

*This summary was compiled by RIETI Editorial staff.