It is easy to whip up anti-Chinese emotions

However, significant policy reform would also be necessary to attract investors

Escalating tensions could affect the economic relationship between India and China. India is considering imposing tariffs on Chinese goods, and it may restrict activities of Chinese corporates including foreign portfolio investors (FPIs). China may retaliate.

Both economies are struggling. In 2019-20, annual bilateral trade amounted to about Rs 7.3 trillion (approximately $102 billion), with India logging a deficit of Rs 3.70 trillion. That is, India exports about Rs 1.79 trillion and imports about Rs 5.5 trillion. In terms of Gross Domestic Product (GDP), China exports about 0.6 per cent of GDP to India and imports 0.2 per cent of its GDP from India. India imports about 3 per cent of GDP, and exports about 0.9 per cent of GDP to China.

China exports smartphones, electrical appliances, renewables equipment, other capital goods, fertilisers, auto components, steel products, telecom equipment, pharma ingredients, chemicals, plastics and other engineering goods. India exports chemicals, fuels, cotton, and other low value-added material. At the consumer level, Chinese goods from buckets, to mobiles and air conditioners flood the market.

Assume a dip in trade (this may happen anyway due to Covid-19). There are few companies and sectors, which will not be affected. India will be more affected because a larger share of GDP is involved. India would have to pay more to substitute China imports and find new export markets. 

China also has a large investment footprint with many Indian start-ups dependent on Chinese investors. Chinese FDI into India was between $4bn to $5 bn in 2019-20. There are also Chinese FPIs, and their companies bid for tenders in many sectors. 

The economic relationships have developed out of hard-headed considerations since the Chinese offer value. When it comes to pharma, renewables and certain electronic components, our dependency is overwhelming. There are no realistic alternative sources, either. Investors will have to be braced for corporates in these sectors will suffer escalating costs and supply chain disruptions. 

In other sectors, components may be replaceable. But when retooling a supply chain, it isn’t necessarily the high-value components that are hardest to substitute. It could be a small item, only made in China, at scale. The alternatives to Chinese components will be more expensive.

Indian manufacturing would need huge policy changes to reliably match the Chinese value-proposition. Policy reform would also be necessary to attract investors to replace Chinese FDI. What's being mooted now is tariff hikes. That is sub-optimal policy. Tariff hikes will force consumers to pay more and won’t give Indian entrepreneurs any incentive to cut costs. 

It’s important to make Indian manufacturing more efficient. This means removing roadblocks affecting ease of doing business.

There are multiple areas of concern. One issue is labour laws, which make hiring and firing difficult. Another is land acquisition and change of land usage.

A third is generic red tape. Multiple agencies are involved in clearances, inspections, etc. Tax codes are complex, making compliance hard. The legal system make disputes tedious to resolve.

Supporting infrastructure like reliable power supply, decent roads, good telecom networks, etc., is also not available in uniform fashion across India. Law and order may be a problem in many places. Then, businesses need access to loan capital at acceptable interest rates. That is hard, partly because the government borrows a lot, crowding out the private sector.

All the issues mentioned above can only be sorted out by focussed policy reforms driven by political will. Unfortunately, the people running government have vested interests in not pursuing reforms. Complicated tax codes and red tape offers bureaucrats and politicians leverage over the business community and that leverage can be monetised.

Placing tariffs on imports and whipping up sentiment against Chinese goods is easy. Reworking policy to make manufacturing more competitive will be hard. This geopolitical crisis is an opportunity to do that. Unfortunately nothing in this government’s six-year record suggests it is willing, or capable, of carrying out this sort of sweeping reform.

Businesses will face teething troubles as they reorganise supply chains, and in certain key sectors, they will remain dependent on China for years. But companies, which do manage to fill the gap by import substitution, will generate higher margins due to tariff protection. Investors and consumers will suffer as this process takes hold.