With it now easier to do business in many EMs around the world, corporates have taken the opportunity to transform their supply chains and trade policies, adopting a model known as the vertical supply chain. In a vertical chain, the basic functions in the production cycle are outsourced to countries with low labour costs and the higher skilled functions are kept in traditionally more high-skilled countries – Apple’s goods, for instance, are designed in California and assembled in China.
The growth of vertical supply chains has transformed China and has seen the country being nicknamed ‘the factory of the world’, sitting at the heart of many global supply chains. China has been able to take the lead in this regard because its vast population has allowed for huge volumes of output and also for labour costs to be kept low. But recent signs suggest China may be intentionally loosening its grip as the world’s manufacturing hub as it shifts towards a more consumption-based economy, looks to expand its service sector, and its middle class grows. These developments are seeing workers in China demanding higher wages and thus the cost of business is increasing.
Make in India
It is against this backdrop where India’s opportunity lies. The country already boasts a sizeable economy worth over $2trn and posted a 7.4% growth rate in 2014 making it the fastest growing major economy along with China. Unsurprisingly, GDP per capita is also on the rise, increasing to $1,610 in 2014 from $1,560 the previous year. Continuing at this growth rate, the economy should move from the ‘lower middle income’ category to the ‘upper middle income’ level in the space of ten years.
“To help achieve this there is now a big push in the country to transform India into a manufacturing hub,” says Anjali Mohanty, Head of Global Transaction Banking – India at Deutsche Bank. As well as helping boost the economy the move will also benefit the Indian population. As Mohanty explains: “India has a population over 1.3 billion and with more than ten million people moving into employment each year, the country has a vast workforce. Manufacturing is the only sector that can produce jobs to this scale.” As Chart 1 depicts only 9.4% of India’s 487 million strong workforce is employed in the manufacturing sector.
Chart 1: Industrial revolution
Source: Bloomberg Business Week
There is good reason for this: when compared to other economies, India’s trajectory is quite unique. It progressed from an agricultural economy straight into a services-based economy, essentially skipping the manufacturing phase which most go through. As a result, India exports around 3% of the world’s services but only 1.7% of merchandise. “To transform the Indian economy into one based on manufacturing therefore is not an easy task and one that hasn’t been attempted by any country before,” adds Mohanty.
To help achieve this, the Modi government have implemented a number of initiatives that build on the work done by previous administrations. The most notable of these is ‘Make in India’ – a national program that is designed to facilitate investment, foster innovation, enhance the skills of the workforce and ultimately build a best-in-class manufacturing infrastructure.
“This is just one of many initiatives that the Modi government has implemented or is looking to implement,” says Mohanty. For instance, the government is beginning to invest heavily in, and seek outside investment in infrastructure – something that can be argued as being underdeveloped. “The cost of doing business in India due to the leakage that occurs because of the poor infrastructure is one of the biggest drains on a company’s profitability.”
Overall the main objective of these initiatives is to make India an easier and thus more attractive place to do business. Although there has been some progress made already, India is regarded by the World Bank as being the 142nd most difficult country to do business (out of 189), Mohanty therefore advises caution: “These changes won’t occur overnight,” she says. “India is an extremely large and complex market and it will therefore take time before we begin to see results.”
Diversifying trade flows
Once change does occur and India begins to play an even more important role in global trade, its key trading partners are likely to be based in the East. The China/India corridor is one that looks set to gain particular significance. “China has already replaced the US as India’s primary trading partner,” says Sonal Priyanka, Managing Director, Regional Head of Trade, South East Asia, India and the Middle East at Societe Generale. “This corridor will continue to grow as India develops into a manufacturing hub and potentially becomes the world’s largest as the country purchases intermediate goods from China, converts these into finished goods before exporting them to the rest of the world.”
The Modi administration has also began investing in India’s regional neighbours to facilitate greater trade flows. “ASEAN for example, will be a key trading partner for India moving forward. In recent years we have already seen India invest in the region to drive further trade,” says Vijay Vashist, Global Head of Trade & Supply Chain Finance and Trade Asset Management at DBS. “As part of this focus, the Modi government has recently given the green light to support a new tri-lateral highway, a road which links Thailand to India.”
Away from Asia, Africa and the Middle East will also play a big role in Indian cross-border trade moving forward. “We are already seeing a lot of development and growth in these trade corridors,” says Societe Generale’s Priyanka. In 2014 India’s trade with Africa was worth $74bn, up 80% since 2008 while it is expected that by 2030 Indian trade flows with the Middle East and Africa will reach up to $2.7trn, up from just under $200bn in 2013 – making it the region’s top trading partner.
In terms of what India will be trading, the country wants to be at the heart of, it seems, all sectors. On the ‘Make in India’ website, there are 25 different sectors ranging from automobiles to wellness. Of course, it would be a tough ask for India to be at the centre of trade flows for all of these sectors, but there are some that the country already has an advantage in and that provide a big opportunity to corporates.
“Tourism is an industry that employs 40 million people and it is predicted to grow at rates of 8% in coming years,” says DBS’ Vashist. “However the tourism infrastructure is underdeveloped, so this presents a good opportunity for airlines and hotel companies to expand in the country.” Aside from this, Vashist highlights industries such as textiles, automobiles and software where India has been strong in exports and opportunities are expected to grow.
A paper-based ecosystem
As Indian corporates begin to increase the amount they trade cross-border with counterparts and as India becomes an increasingly important location for multinational supply chains, trade financing products will be needed. Today, 85% of global trade occurs on Open Account – otherwise known as non-documentary trade. Yet, in India, Open Account is not the dominant tool and Letters of Credit (LCs) are still used heavily by corporates for both imports and exports – according to SWIFT data, India is in the top five countries globally in this regard.
Of course, in today’s increasingly digital world, corporates globally are striving to move away from paper-based products. As a result, some of the banks operating in India have stepped in to move the documentary burden away from corporates. This is a service that Deutsche Bank for example, has begun to offer its clients by managing the paper documents and offering a view of these through a single online portal. “This helps mitigate risk, increases security and also makes reconciliation easier and quicker,” says Mohanty.
The Indian government has also recognised the challenges that such a high usage of paper creates for corporates in India of all sizes. One of the biggest is that because of the inefficiency associated with paper and also the red tape that exists, many Indian companies – especially small and medium enterprises – are paid late. To counteract this, the government introduced the Factoring Regulation Bill in 2012 that provided a statutory framework for factoring and has addressed the issue of late payment.
Despite these developments and attempts by some corporates to digitise their operations in India, it is no easy task to remove paper from the process. “These digital solutions need to work in the regulatory framework of India which currently is very paper intensive,” says Societe Generale’s Priyanka.