India and Southeast Asia offer calm in the storm

The economic, political and financial restructuring of the world will likely bring multiple shocks for the vulnerable emerging and developing economies. But the self-sufficiency end goal that is a core tenant of our Fragmentation Game theme is still a stretched concept, and as major global economies de-link, there will also be a need to re-link and find new friends. India remains a key partner choice for many global economies not just in terms of trade, but also in security and technology, bringing long-term investment opportunities in a fragmenting world. A number of Southeast Asian economies also stand to gain in a fragmenting global economy.

India’s ambition as reliable trade partner

The US-China rivalry brought about the first clear signs of a shift in manufacturing supply chains, and the Covid-19 pandemic and Russia’s invasion of Ukraine further boosted the need for resilient supplies. While focus has clearly been to shift away from over-dependence on China – the factory of the world – global economies have struggled to find a reliable trading partner that can provide the scale and skills of Chinese workers. India, Vietnam and Mexico have emerged as key beneficiaries of the supply chain shifts. Tailwinds for India include solid economic fundamentals, a sound digital infrastructure and favourable demographics. However, India’s manufacturing gains have been constrained by its protectionist stance and a weak business climate.

The dynamics are now changing quickly, with India working hard to position itself as an attractive manufacturing and export hub for multinational companies. The Modi administration has been offering financial incentives to companies that are keen on making India their production hub. The Production Linked Incentive (PLI) scheme has been a key force to attract investments in some of the prioritised sectors such as vehicles and auto components, speciality steel, advanced batteries, solar panels, mobile phones, electronics components, pharmaceuticals and food processing.

In addition, India has made a clear shift of attitude on free trade deals, pivoting towards a focus on reducing trade barriers, eliminating tariffs and looking to gain preferential access to global markets. Bilateral deals appear to be India’s key focus, and pacts with Australia and the UAE were concluded in 2022, and ongoing negotiations with partners such as the EU, the Gulf Co-operation Council, Israel and the UK to be concluded by 2025. These initiatives are driving a favourable shift in India’s image as a global trading partner. Apple’s intention to make its latest iPhone 14 model in India has been a victory lap.

India continues to make strides, but old issues remain

While this focus on attracting manufacturing has allowed India’s exports to soar to a record high in FY2022 (year ending March 2022), India is also making strides to achieve significant structural shifts in the trade product basket by being more integrated in global value chains and also in the geographical composition of its foreign trade in order to reduce its dependence on imports from China, while expanding its market access to Australia, Japan and the U.S.

While all of the major economies want India by their side in the new world order, India’s corporate governance issues, as recently highlighted by the Adani crisis as well, may continue to be a key headwind. Sub-standard bureaucracy and infrastructure, as well as a lack of skilled labour and poor production quality, are key risk factors. Indian corporates also remain less competitive due to the protected domestic market, and that is a key reason why India continues to lag behind other economies like Vietnam, Bangladesh or Turkey in gaining a more significant presence in global manufacturing supply chains. While a large domestic market means India has a bigger potential to gain a significant portion of the manufacturing pie, India still has a lot of catch-up to do. Do note that Turkey’s sharp rise in manufacturing output as a percentage of GDP is due to the rising export value of its output in local currency GDP terms due to a significant Turkish lira devaluation.