Better days for business between India and China?

Image: courtesy CKGSB

China and India may be neighbours; but politically, they share an uneasy relationship. A war in 1962 and a long-standing border dispute have led to a sense of distrust on both sides which often seeps into business relations. But Anil Gupta, the Michael D. Dingman Chair in Strategy and Entrepreneurship at the Smith School of Business at University of Maryland, is optimistic. He believes that business relations between China and India, two of the world’s fastest growing economies, are going to change for the better especially because India and China are likely to be among the four largest global economies by 2025. Additionally, he feels, India’s intent to usher in an infrastructure revolution will give a boost to Chinese companies.

Gupta, who recently co-authored The Silk Road Rediscovered: How Indian and Chinese Companies Are Becoming Globally Stronger by Winning in Each Other’s Markets (with Haiyan Wang and Girija Pande), feels that the nature of the business relationship will also change: while the China-India business relationship was largely trade-driven so far, it will be increasingly driven by investment in future.

However, this relationship will be marked by “greater convergence” rather than the “complementarity” which political leaders often talk about. We sat down with Gupta, who has spent a long time studying businesses in both countries, to understand how the China-India business relationship is changing and the opportunities for businesses from both sides of the border.

Q. The number of Indian companies doing business in China and vice versa seems small compared to the opportunities that both India and China represent. Historically, what has held Indian and Chinese companies back from crossing over?
A. In one sense we can say that it is very small. In another sense, it’s not. If you take China’s or China Inc.’s foreign direct investment (FDI) into the US, the world’s largest economy, it is about $30-32 billion. India’s economy is one-eighth or one-ninth of the US, so if China’s investment into India, which clearly is a function of the size of the economy, was proportional to China’s investment in the US, we would expect it to be about $3-4 billion. Instead, it’s about $1 billion. It is smaller, but I wouldn’t compare the $1 billion into India with the $32 billion into the US, because the US is a much bigger economy.

The bulk of Chinese investment, more than 75%, is for natural resources. If you are investing for resources, India is not the place [for] that. Followed by that, investment from China has gone into real estate. If you look at [Chinese real estate companies] Wanda, Vanke, Soho, etc., [they are] typically going into the US, UK and Australia: not [to India] yet. The two segments that pretty much complete Chinese investment abroad are technology or brands. For that you go to US and Europe. So it’s more like why Chinese companies are going abroad and in the context of their objectives, where does India fit in?

Looking ahead, the China-India economic relationship is at the cusp of transformation. [In] the next five years, I expect it to be dramatically different. The transformation will come about because of India’s push on infrastructure and manufacturing.

Let’s look at the high-speed rail system that [Narendra] Modi and his government are talking about. Very recently, the cabinet approved 100% FDI. When it comes to the actual operations of the high-speed train, there is zero chance that a Chinese company would be allowed to have any role. But I could imagine a Japanese, French or German company potentially having a major stake in even the network but with an Indian partner. But I don’t expect a Chinese stake.

On the other hand, for the high-speed rail network, you’ll need locomotives, rails, etc., so somebody has to manufacture that. That will be new factories, new technology and lots of capital. Chinese companies could be part of that game. As India launches an infrastructure revolution in the way that China did starting from 1995, I would expect there will be a significantly greater involvement.

Also, there are serious discussions taking place between the Chinese and the Indian governments for setting up of China-focused industrial parks. There the idea is that the Chinese companies that want to invest would be able to get single-window clearance, [they] would have land, infrastructure, and would be able to invest in infrastructure.

As these special economic zones (SEZs) and industrial clusters, get established, and infrastructure build-up happens, we will see manufacturing investment. I don’t expect [big moves] by Chinese companies in consumer goods. We could see interesting developments in certain technology domains. As India’s telecom market moves into 4G, the capacity and scale will become much larger. There will be more pressure on Huawei to manufacture in India. Given a choice between not having a major market share in India and trying to export from China versus having the doors open and manufacture in India, they will choose to manufacture in India. Xiaomi’s business model is to sell from its own website. The Indian government’s e-commerce policy is that foreign companies are allowed to sell directly from their own website if they manufacture in India. Otherwise they have to go through somebody else’s website. So Xiaomi is working with Flipkart. That’s fine if all you want to do is to sell. But Xiaomi’s business model is also to get feedback and incorporate that feedback to keep making changes to the product and to localize it. You can’t really do that well through Flipkart. As Xiaomi’s scale in India builds up, there [may] be incentive for Xiaomi to actually think of manufacturing in India.

Q. Both countries haven’t shared a particularly pleasant political relationship over the years. Can business between them thrive despite the tensions?
A. The answer is yes. The emotional baggage that exists between China and Japan is far greater compared to the emotional baggage between China and India. Despite that, China and Japan have done actually bigger business together over the last at least three decades than India-China. The China-India relationship has, of course political tensions, border tensions, geopolitical tensions, etc., but the emotional baggage is much less.

The emotional baggage between India and China is all related to the unresolved border issue. Leaders on both sides have said repeatedly that they believe that they will be able to resolve it peacefully at some point.

The third thing I would add is the creation of the New Development Bank (BRICS bank) and the Contingent Reserve Arrangement (CRA). All of the five member countries (the BRICs countries) and definitely China and India, are very committed to the BRICS bank and the CRA, essentially a complimentary ‘mini IMF’ and ‘mini World Bank’. The creation of these two institutions in an unexpected way will have a spillover effect on India-China, because if India and China were to get into a war, the BRICS bank and the CRA will collapse. I don’t think China or India would want [that to happen].

The geopolitical tensions are not going to go away any time soon, but they are not a barrier in any way to the burgeoning economic relationship except in certain ways. For example, I don’t see Chinese companies being allowed to operate in airports, to manage telecom networks, have an ownership stake in an Indian telecom operator, run the rail network. Certain areas would be out of bounds.

Q. There is still a degree of suspicion and even a sense of disregard between both the countries. For instance, the common perception in India regarding Chinese products is ‘low quality and cheap’. There are also security concerns. Is that starting to change now?
A. Not yet. When I talk to Indian executives and CEOs, the perception still is about low quality, cheap goods. In some quarters the perception could be changing, for example, Reliance and Bharti, who are buying Huawei [equipment], will probably say that Huawei equipment is of high quality based on their experience. But I think the Indian consumer continues to believe that Chinese goods are of low quality. The problem is that you have a Bell curve. [As the factory of the world, China] has the world’s lowest quality and best quality manufacturers. Then it depends on the Indian importer [who] comes to China, buys good and then markets them in India. Where on the Bell curve does the Indian importer target to buy? The Indian importer goes to the lowest costs. The sellers here want to make some money. So they may promise better quality goods, they may show decent quality samples. But as the price is horribly low, eventually they will cut corners.

Indian consumers are basing their perceptions on their experiences. That will take time to change, because I think the Chinese goods that go into India are still primarily machinery and capital goods. There you don’t have millions of buyers—just a few companies, it’s all B2B. Their perception can change much faster. Consumer goods, I think, that needs to wait.

Q. Indian companies come into China either via services like TCS and NIIT, or to manufacture locally like Mahindra, Sundaram Fasteners and Thermax. Do you see that diversifying?
A. Not any time soon, because it depends on competitive advantage. If you look at manufacturing, in most cases, China or Chinese companies have an advantage. Therefore, it’s very hard for Indian companies to export from India to China and succeed. So the Indian companies have to manufacture in China. Sundaram Fasteners and Mahindra initially thought they could export, but pretty soon they realized that Chinese costs are actually lower so they have to manufacture in China.

Then the question is: is it too late? Mahindra came in [at] a much better time to enter as compared to today because the size of the market is bigger so the competitors are bigger. If you come in [now], you need to come in at a bigger scale. It’s harder to start small. Direct entry remains open, but an easier way to enter China for an Indian company is indirectly. Tata Motors entered China through Jaguar Land Rover, so essentially from India to UK to China. Mahindra now owns SsangYong from South Korea, and South Korea as a country brand in automotive is much stronger than India. So if Mahindra wants to bring Mahindra-branded SUVs to China, they would have a tougher time. But they could have a much easier time coming in through South Korea under the SsangYong brand.

Certainly we would see [Indian companies] in services, but in services the government enterprises are a huge market. There are some barriers which have existed for Indian IT service companies.

I think that will get addressed. I would see, in terms of direct entry, Indian service companies in the IT sector continuing and the opportunity becoming better for them. On the manufacturing side, we will see some direct, but we may see more indirect entry into China.

Q. You say that the next 10 years will be marked by greater convergence rather than complementarity. What do you mean by this?
A. If you look at media reports, certainly in the west it’s about India and China. If you look at the statements that the Chinese leaders make when they go to India [or] Indian leaders [make when they] come to China, often enough… on the surface, [they] sound very appropriate: “China is very strong in hardware and India is very strong in software, if we could combine the strength of the two, we could take on the world.” That sounds very nice, but it’s hard for me to imagine how we can combine India’s strength in IT services and China’s strength in manufacturing steel, cement or cars and take on the world. The two are completely different sectors. Therefore, the whole theory of complementarity is nice for PR but not really true on the ground.

Looking ahead, the Indian government is committed to addressing India’s weakness in manufacturing. India [will] begin to take over from China as the factory of the world because India’s labor costs are already significantly cheaper than China, India’s engineering, management and organizational skills are very strong. [But] India’s infrastructure is very weak and that’s the biggest reason why China’s much stronger than India in manufacturing. As the infrastructure weakness begins to get taken care of, India actually could give China a run for its money.

At the same time in China, the government wants to move the economy from manufacturing towards the services sector. As that begins to happen, including in the IT sector, we will see China becoming more balanced, strong in manufacturing, but also strong in services. India will also become more balanced. In that sense, the two economies, in terms of their structure, are likely to be a bit more similar in 2025 than they are today. So that’s what I mean by convergence.

Q. How big will the China-India discussion potentially be?
A. Overall, if you look across the world’s bilateral relationships, we can see some bilateral relationships are very strong and some are very weak in terms of both trade and investment and so on. How do we explain this variance? It’s like explaining variance in national incomes and explaining variance in people’s heights. The single biggest factor that academic research has found across time and across bilateral relationships that explains this is essentially the ‘gravity theory’, which is like the gravitational pull [and] the size of the two economies. In the case of trade and investment linkages, one would say it’s the size of the two economies, but of course the mass of the earth, sun and the moon does not change very much, but the size of the economies does change. Therefore, we look at the size of the two economies and the growth rate of the two economies. Ultimately, it’s the size of the gravitational pull that accounts for whether trade is small or large, whether mutual investment is small or large.

Today, China is the world’s second-largest economy. India is the 10th largest. We can very safely say that China will be the world’s largest economy in 2025 and that India will be No. 4 unless India just goes to sleep. But I don’t think that’s likely. Therefore, India would be either No. 4 or No. 3 in terms of—this is not purchasing power parity—but actually market exchange rates.

Then you have the world’s largest economy and the third or fourth-largest economy and they will still be two of the fastest-growing major economies in the world sitting right next to each other. I would predict that unless there is massive emotional baggage between them, just the gravitational pull will make the bilateral economic relationship between India and China among the 5-10 biggest in the world. That’s really the story which is beginning to unfold.

[This article has been reproduced with permission from CKGSB Knowledge, the online research journal of the Cheung Kong Graduate School of Business (CKGSB), China's leading independent business school. For more articles on China business strategy, please visit CKGSB Knowledge.]