India's missed trade opportunities as others gain from US-China tensions

India has not been able to attract a notably greater share of global FDI. Some of this is due to political resistance to stronger ties with China, some of it is held back by structural barriers

The US presidential elections, now a week away, could trigger a reordering in global trade, especially if Donald Trump is re-elected and ratchets up tariffs on China. This is raising expectations in India that it could benefit from an increase in US substitution demand, propelling its struggling manufacturing sector.

 

Trade tensions between the US and China aren’t new — they’ve been escalating for years, especially since a wide range of bilateral tariffs was introduced in 2018-2019. The sectors targeted by tariffs overlap heavily with goods that are also exported by India; hence, the rising hopes of a healthy trade tailwind.

 

But those hopes have so far been disappointed. What’s more, Oxford Economics thinks it’s unlikely the next phase of the trade war will deliver a stronger boost. For over a decade, and despite all political efforts, the contribution of the manufacturing sector to India’s economy has remained broadly stagnant at 17 per cent, versus the goal under the Make in India scheme of lifting it to 25 per cent by 2025.

 

India’s Asian peers have benefitted to a much greater extent from the US rerouting of demand away from China. Vietnam leads, followed by Taiwan and South Korea, with India in fourth place. Although India’s total share of US imports rose by 0.6 percentage points (ppts) to 2.7 per cent between 2017 and 2023, the gap left by China was much bigger — its share of US imports dropped by around 8 ppts to just under 14 per cent.

 

Looking at where India has gained or lost to its rivals helps to understand why an escalation of the trade wars may not deliver the boost to Indian manufacturing that has been hoped for. India has gained most US market share in the commodities and products sectors of the “old” economy.

 

Specifically, India’s gains have mainly been in smaller import markets such as textiles, leather and clothing (around 5 per cent of US imports in 2023), fuel, and minerals (1-2 per cent of US imports). These are relatively low value-added products that rarely benefit from advancements in technology, meaning that production growth rates in these sectors are slower and will likely fall more rapidly.

 

Furthermore, competition from the other players in the region is fierce. Apart from China, Vietnam and Bangladesh are strong contenders in textiles and clothing in Asia. In basic metals, Indian producers likely won’t have a significant edge either because steel and aluminium are viewed as strategic sectors by the US in which it has pledged to reduce its external reliance.

 

A relatively bright spot has been computers and electronics, the US’ second-largest import market at around 15 per cent of all imports. China’s share has plummeted by 19 ppts since 2017, whereas India’s share has risen nearly tenfold since then to 2.1 per cent. Electronics now also make up a greater share of India’s export mix overall.

 

But despite this remarkable catch-up, India remains far behind its Asian peers in terms of competitiveness and, consequently, market share. India supplies mainly telecommunications equipment — think Apple ramping up its iPhone production in India. More cutting-edge electronics like semiconductors are supplied by South Korea and Taiwan.

 

What’s perhaps more worrying is that the production gains that have been realised have not translated into greater domestic value added — that is, the contribution made by Indian producers to the final product over and above the component input costs. High-tech exports rose by an impressive 350 per cent, but domestic value-added output shrunk by nearly 18 per cent between 2017 and 2023 (all in nominal US dollar terms). Domestic manufacturing, especially of components, has been struggling to keep up with final (external) demand growth.

 

So, much of India’s production gains have been enabled by greater imports, especially from China, whose imports have moved largely in tandem with exports. This trend isn’t unique to India and has been going on for some time.

 

China is India’s most important import source for its major industrial sectors. In electronics, machinery, and chemicals and pharma, China accounted for around one-third of imports in 2023. This leaves India at risk of being subjected to US trade restrictions, alongside other third countries such as Vietnam that are already experiencing greater US protectionism.

 

For Indian manufacturing to capitalise more on the current geopolitical winds, domestic supply chains will need to be strengthened to reduce import reliance, which, in turn, will require substantial investment. Indeed, the rising tensions between China and the US and its allies have also raised hopes for greater international investment inflows. At the same time, Chinese firms have also sought to increase their footprint abroad.

 

So far, however, India has not been able to attract a notably greater share of global foreign direct investment, even though flows to China have plummeted. Some of this is due to political resistance to stronger ties with China, some of it is held back by structural barriers. This includes India’s huge bureaucracy, for instance, the regulatory complex governing land and labour.

 

India’s relatively low average human capital levels are also impeding its enormous growth potential, which, in fact, we believe lies to a much greater extent in services than in manufacturing. Although overall enrolment levels are high, the quality of education lags most of its peers. As a share of gross domestic product (GDP), education spending by the central government and states has been stagnant for years. More political focus will need to be directed to improving education on a broad basis.

 

In sum, India’s future looks bright. But the right reform efforts will need to be stepped up for its growth story to not lose its shine.

 

The author is lead India economist at Oxford Economics