Will the ‘India boom’ shake Japan?

Author: Richard Katz, TOE

Once again, talk of an ‘India boom’ has emerged in Japan.

Two apprentice geisha from Kyoto appear at a cultural exchage event in New Delhi in India on 22 February 2014. (Photo: AAP)

This year, India came in second (behind Indonesia) in a government survey on the top countries in which Japanese firms want to set up operations in the medium term and first in the long term— and, at last count, nearly 1000 Japanese firms had already set up there. Some of these new firms are suppliers to Japanese companies who already have operations in India.

Japan abounds with talk of sales to the burgeoning Indian middle class — often said to amount to as many as 300 million people. The Suzuki Maruti joint venture, which has a 37 per cent market share, will be joined by a major campaign from Honda. And Panasonic unveiled a new line of air conditioners (AC) for the Indian market — raising its share of the Indian AC market to 15 per cent in 2013, up from only 3 per cent in fiscal 2009. It wants to overtake South Korea’s LG Electronics — the largest consumer durables maker in India. As more Indians can afford ACs, the market is growing at about 35 per cent per year.

In 2011, India and Japan signed a bilateral free trade agreement (FTA) that will end tariffs on goods accounting for 94 per cent of their trade flows over 10 years. And Prime Minister Shinzo Abe is now making diplomatic forays to India as he tries to build close ties to other countries that feel threatened by China.

Yet the oft-expected boom in Japan–India economic ties has repeatedly failed to come to fruition. Trade with India forms a tiny part of Japan’s global imports and exports. In April–September 2013, Japan’s exports to India amounted to a miniscule 0.14 per cent of its entire global exports, and imports from India in 2013 amounted to just 1.1 per cent of Japan’s global imports.

Meanwhile, Japan’s FDI into India forms a tiny portion of its global FDI. India is less important to Japan than Japan is to India, particularly as a source of FDI. During 2000–13, Japan supplied, on average, 7 per cent of total global FDI into India, and in 2013 was the third-largest investor in India at 8 per cent.

Japanese experts like Joichi Kimura, chief at the government-affiliated Japan Bank for International Cooperation’s (JBIC) office in New Delhi, often point to India’s poor infrastructure as a reason for the relatively low rate of Japan’s FDI into India as well as bilateral trade. India’s infrastructural deficiencies in communication, transport and energy have created a major bottleneck to maintaining the higher growth path it has achieved in the past two decades.

Japan is now working with India to improve India’s industrial infrastructure, not just to increase commerce directly between the two countries but also to help India become a hub in the multi-country supply chain that spans the Asia Pacific.

Japan is involved in India’s gigantic Delhi–Mumbai Industrial Corridor Project, a State-Sponsored Industrial Development Project, which aims to develop a 900-mile industrial zone with a 4000-megawatt power plant, three seaports and six airports spanning six states. The two countries signed an agreement to set up a project development fund, with the aim to build the fund to US$10 billion. The hope is to create 3 million mostly industrial jobs, triple industrial output from the region and quadruple the region’s exports within five years.

India also lacks world-class manufacturing capability: another reason multinational corporations (MNCs) have not looked upon it as a potential supply base along the lines of China, Thailand and Malaysia. Again, as in infrastructure, Japan is very skilled at manufacturing and, in a host of countries, FDI from MNCs has improved industrial capability by upgrading the skills of workers and the technological prowess of indigenous firms used as suppliers to the MNC’s factories.

Japan could benefit from the software capacity shown by India and Indians in America’s Silicon Valley and abroad. Japan, which has focused on custom-made software, has not been able to step up to the plate to produce software for exports. Japan needs to work with Indian firms or help Indians set up their own firms within Japan to become providers, rather than just hiring individuals who may be absorbed in a firm’s traditional way of doing things.

With so many opportunities, why haven’t we seen better growth in trade and FDI between Japan and India?

Traditionally, Indians, like Japanese, feared that too much inward FDI would mean a quasi-colonisation of India on the economic front. Despite a quantum leap in FDI into India, foreign firms say the road to such investments is still filled with tacks, including in the key bottleneck areas of communication, energy and transport.

Also, items that don’t fit Japan’s needs dominate India’s exports. Out of a total of US$300 billion in exports in 2012, its biggest export was petroleum products at US$56 billion (20 per cent of the total). But Japan’s own refiners dominate the production of petroleum products and so Japan imports little. Until India becomes much more adept at exporting manufactured goods, Japan and Japanese affiliates overseas will not be a good market for Indian exports.

Japanese firms also prefer to import manufactured goods from their own affiliates overseas rather than from indigenous firms. Japanese affiliates in Asia have accounted for the lion’s share of Japan’s increase in manufactured goods from Asia over the past decade. Japan’s Ministry of Economy, Trade and Industry calls these goods ‘reverse imports’, and they have almost doubled from 15 per cent of Japan’s total manufactured goods imports in 2001 to 27 per cent in 2012.

Meanwhile, out of India’s US$490 billion in imports in 2012, only 13 per cent of the top items were in product areas where Japan has comparative advantage. This is the import structure of a poor country, not a newly industrialising one. Until this import structure matures, the market for Japanese exports will be limited.

Finding ways to make increased Japan–India economic cooperation possible will result in internal reforms that help each country grow. In virtually every country where reform has been successful, increased globalisation — trade and inward FDI — has been a pivotal ingredient in the recipe. Globalisation breaks down the collusion among vested interests that impedes growth.

India has made much more progress globalising than Japan. India’s cumulative stock of inward FDI soared from only 0.5 per cent of GDP in 1990 to 10.4 per cent today. By contrast, during the same period, inward FDI stock in Japan only rose from 0.3 per cent to 3.4 per cent of GDP. Also, India’s trade–GDP ratio has risen from 15 per cent in 1990 to 55 per cent today, while Japan’s trade–GDP has risen more slowly from 20 to 30 per cent.

India has been, and remains, a tiny part of Japan’s global trade. At the same time, Japan is a relatively minor trading partner for India, accounting for just 2 per cent of India’s exports and 2 per cent of its imports. Unless India overcomes infrastructural deficiencies, and Japan overcomes structural flaws — resisting imports from competing firms — the ‘boom’ in economic relations may remain just talk.

Richard Katz is Editor at The Oriental Economist Report.

A version of this article first appeared in the January 2014 edition of The Oriental Economist Report.