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How India should play the trade war

Indian policy makers have been trying to figure out how to gain strategic advantage from the US China trade war. Its response needs to encompass trade, investment, tax, regulatory, exchange rate policies

The recent surge in proposals for greenfield foreign direct investment in some Asian countries should pique the interest of all those who ask whether India can benefit from the intensifying trade war between the US and China. The United Nations Conference on Trade and Development released data last month that shows how international firms have announced plans to pour money into new projects in Indonesia ($28 billion), Vietnam ($18 billion) and the Philippines ($12 billion). It is quite likely that these new greenfield investment proposals—that come in the midst of an overall decline in global foreign direct investment—could be because international firms are trying to relocate parts of their supply chains to other countries in the region, as Donald Trump turns the screws on Chinese mercantilism.

There are lessons for India here. Indian policy makers have been trying to figure out how to gain strategic advantage from the trade war between the two largest economies in the world. The first task is to identify the opportunities. India has few manufacturing capabilities in many of the largest items in the US import bill—mobile phones, telecom equipment, household appliances, toys, televisions, semiconductors, industrial machinery. Where India can get into the game is in sectors such as textiles, clothing, auto components and certain types of chemicals, a government official told me. A similar exercise can be carried out with respect to what China imports from the US. But that is not all.

It is well known that modern trade is dominated by the exchange of inputs—or intermediate goods—through supply chains that straddle across international borders. India has generally been unable to become an active participant in these supply chains. The fact that so much of international trade is now between firms rather than from producer to final consumer means that it is impossible to separate trade policy from investment policy in an interconnected world. That is why the surge in foreign direct investment in Indonesia, Vietnam and the Philippines deserves closer attention in India. It could be linked to US companies gradually increasing their purchases of inputs from Asian countries other than China.

Getting large investment projects—backed by either domestic or foreign money—will thus be central to any strategy to take advantage of the trade war. Such projects will help India plug into international supply chains. A global equity investor I recently met said that many large US companies are actively considering options to reduce their geopolitical risk by shifting some of their suppliers to other Asian countries. This is a strategic opening for India to get into the reckoning, though that will require a comprehensive look at import tariffs, investment policy, ease of doing business and moving to a goods and services tax (GST) that encourages exports by zero rating them.

The reality has been messy. India has moved up the ease of doing business rankings of the World Bank. Foreign direct investment has been steadily climbing, though not enough is coming into new industrial projects. The transition to GST as well as the demonetization shock disrupted many existing supply chains. Trade policy seems to be taking a protectionist turn; Abba P. Lerner showed way back in 1936 that an import tariff has the same economic effects as an export tax.

Trump hopes to close the US trade deficit, though it is safe to guess that the largest economy in the world will continue to run a large current account deficit in the coming years because its domestic savings are far lower than domestic investment. However, US trade policy will be disruptive. The key question is whether what Trump is doing will lead to trade diversion away from China or worldwide trade destruction. Trade diversion should benefit India if the government plays its cards well, and that is a big if. Trade destruction will harm all the major economies in the world. India too will get singed. There is reason to bet on trade diversion rather than trade destruction right now.

India has failed to do what Asian countries from Japan in the 1950s to Korea in the 1980s to China in the 2000s did so successfully—export labour-intensive goods to the developed world. At least two contemporary hot-button issues are directly linked to this failure. The first one is job creation in formal enterprises. The second one is recurrent balance of payments scares. Look at the case of textiles, an industry where India has deep historical capabilities. The opportunity that came our way after the multi-fibre agreement was scrapped at the turn of the century was frittered away, even as China, Vietnam, Bangladesh and Sri Lanka grabbed the opportunity.

The trade war could provide another such strategic opening as long as it does not destroy the liberal trading system. However, the Indian response needs to encompass trade, investment, tax, regulatory and exchange rate policies. Trade will not be automatically diverted from China to India. There is a lot of hard work to do. The initial fear is that the likes of Indonesia, Vietnam and the Philippines are walking away with the prize. That should hopefully focus some minds in New Delhi.

Niranjan Rajadhyaksha is research director and senior fellow at IDFC Institute.

(Source: Niranjan Rajadhyaksha, The Live Mint, October 31, 2018)