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Remaking global supply chains – India’s opportunity

The COVID-19 pandemic has led to global supply chains unravelling as many countries imposed lockdowns, causing companies to look elsewhere for manufacturing and sourcing and creating opportunities for low-wage emerging countries including India.

This is an extract from our 2021 outlook for India

The health crisis exposed the dependence of businesses on a few markets for manufacturing and caused cracks in the lean or the ‘just-in-time’ inventory strategies that had allowed many manufacturers to maintain minimum raw material stocks. As a result, the search for attractive alternatives has included Thailand, Vietnam, Malaysia, Indonesia, the Philippines – and India.

India’s strengths as a hub for business

As a stable economy with a host of enabling factors for attracting investments, we believe India is a natural choice in filling the supply chain vacuum the exodus from China has left. Recognising this opportunity, India’s prime minister has laid out his vision of a ‘Self-reliant India’.

The strength of India’s case lies in its diverse business landscape, skilled workforce, and sizeable domestic market with growing disposable incomes. Labour costs are relatively low – monthly minimum wages in India are USD 73 compared with USD 320 in China [1], USD 132 in Vietnam and USD 127 in Indonesia (see Exhibit 1).

India has the fifth largest gross domestic product, as estimated by the World Bank. It was ninth on the list of recipients of global foreign direct investment in 2019. [2] Its population is young and has a wide base of English speakers. Macroeconomic indicators have been robust. High consumption levels are another factor in India’s favour.

Production-linked incentives – a new approach in India’s industrial policy

Beyond ‘Infant industry protection,’ in a somewhat rare instance of the Indian government working closely with industry, it has announced production-linked incentive (PLI) schemes for 13 sectors to encourage growth and boost exports. The schemes involve companies being awarded meaningful pre-set incentives upon meeting production targets.

The PLI scheme is a significant turn in India’s industrial policy: linking incentives to output should encourage scale and specialisation. Also, the scheme is largely compliant with the World Trade Organisation (WTO) norms, unlike earlier export-oriented incentives.

However, one drawback of the scheme is that the benefits will accrue only to a handful of large players that will make incremental investments in greenfield projects, precluding incumbents and small businesses.

The PLI schemes aim to create a conducive environment for manufacturing in India and to offer incentives comparable with those offered in other countries to attract large investments.

For instance, the large-scale electronics manufacturing sector suffers from the absence of a level playing field. This includes a lack of adequate infrastructure, domestic supply chains and logistics; the high cost of finance; the inadequate availability of quality power; the industry’s limited design capabilities and focus on research and development; and inadequacies in skill development.

The PLI scheme seeks to compensate for some of these deficiencies.

Potential to add 1.7% to GDP, change the trade balance meaningfully

Details are available for only three sectors: large scale electronics manufacturing, bulk drug production and medical devices. For the remaining 10 sectors, the list of companies that qualify should be published this month.

According to industry estimates, the schemes could generate USD 150 billion in new sales, and USD 70 billion of domestic value-add, or 1.7% of 2027 GDP. They could add a substantial 0.3% to annual GDP growth between 2023 and 2027.

The direct impact of these schemes is likely to be larger on labour (an estimated 2.8 million new jobs) than on capital spending (estimated at USD 28 billion). There is likely to be significant upstream activity as a result, driving further gains in jobs and spending.

Sectors and firms that are not benefiting directly from the PLI schemes could see a surge in domestic production volumes, likely bringing in fresh investment. Even though the incentives are for additional production, the choice of sectors implies a large part of the goods would be exported (given the existing domestic self-sufficiency). This could cause a roughly USD 55 billion shift in India’s annual trade balance.

Challenges left to overcome

While India offers global investors a large and attractive market, a sizeable demographic advantage and a vibrant private sector, there are a few obstacles to be addressed if the country is to realise its immense potential as a global manufacturing hub.

Two of the most frequently cited impediments are poor infrastructure and stifling bureaucracy. Further challenges could be:

  • Uncertainty on the final design of the remaining 10 PLI schemes
  • No details on penalties for not meeting milestones
  • Slow payouts of the incentives by the government
  • The need for a definition and specifics of value-addition.

For detailed insights, read the outlook for India in 2021 – The year of reimagination

More blog articles on emerging markets

[1] Source: PhillipCapital India Research, 2019

[2] Source: United Nations Conference on Trade and Development (UNCTAD)

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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