Why India Is Losing the Race with China – and What It Can Do to Gain Ground

By Jason Simpkins
Associate Editor

India, no doubt, has corned the global market in the service sector. Think of it as the call center to the world. But China has established itself as the world's factory floor, making everything from Barbie dolls to match sticks.

Yet while the growth in India has been impressive (its economy grew by 9.4% last year), it's lackluster numbers on the manufacturing side have Indian entrepreneurs and policymaker disappointed and frustrated.

India's service sector now accounts for more than half of the nation's GDP. And that's where its greatest growth has been, rising from 37% in 1990.

The only problem is that manufacturing has hit a wall, growing only by 2% of GDP from 1990 to 2005.  And many Indian entrepreneurs and policymakers fear India is losing out to China in a big way.

In China, manufacturing now accounts for 35% of GDP, according to the Boston Consulting Group. Compare that to 6% in India. Same goes for global trade. China clocks in at 7%. India a meager 1%.

"In our manufacturing potential, we are fast losing the race with China," J.J. Irani the director of Tata Sons said in an interview with BusinessWeek. Tata Sons is the parent company of the Indian conglomerate Tata Group, which is comprised of 98 companies that span across seven business sectors.

"China is more organized and faster than India," Irani went on to say, "The gap is widening."

Easing Up On Government Regulation May Help

Over the past two decades, India has been loosening its former dirigiste model, with strong government influence, in favor of a market-based economy. Direct taxes were reduced, government licensing of industrial activity was dissolved, and large companies were given more avenues for investment.

But some outmoded laws and restrictions still remain in effect, weighing heavily on manufacturing, curtailing Indian exports, and stifling the nation's economic growth.

Labor laws are notoriously strict in India, and the manufacturing sector has been bound in a cocoon of red tape. For example, in the manufacturing industry, a company that employs more than 100 people must notify the government of any plans to layoff or fire a single worker. However, that law does not apply to the service sector.

"We are overpoliticized and all of our problems have a political solution," Irani said.  "Economic problems need economic solutions. Religious problems need religious solutions. Social problems need social solutions. But everything here is an industrial solution, a political solution."

The Paris-based Organization for Economic Cooperation and Development agrees. Last week it released a report that stated: "The government's target of reaching GDP growth of 10% in 2011 is achievable if reforms continue."

The report also concluded that: "In service sectors, where government regulation has been eased significantly or is less burdensome, output has grown rapidly, with exports of information technology-enabled services particularly strong."

The OECD is clear on its position that the country still has to loosen "restrictive" labor laws and the "inefficient" regulation of product markets if it wants to reach its goal. Additionally, policymakers must simplify the tax codes and encourage privatization.

Building From the Ground Up

Another key focus for India to gain competitiveness is infrastructure.

Expensive and unreliable electricity make blackouts all too common. Insufficient roadwork has left streets riddled with potholes and jammed with traffic.  Rolling blackouts force some factories to maintain costly back up generators.

India's transport network is so inefficient it's estimated that up to 40% of the country's farm produce ends up rotting in fields or spoiling en route to customers. The price of food staples rises as a result, and that drives inflation.

BusinessWeek pointed out that the India of today bears a striking resemblance to the China of a decade ago.  Ten years ago China's economy was getting ready to takeoff, but the infrastructure wasn't there. So Beijing launched a massive modernization initiative, building 25,000 miles of expressway.  But India still has just 3,700 miles. That's because only 4% of India's GDP gets reinvested into infrastructure development. In China that number is more than double that, closer to 9%. 

Plans for improvement are ambitious, and India is taking the matter seriously. But putting the plans into action will be costly and time consuming.  New airports are currently under construction in Bangalore and Hyderabad. Nearly 3,750 miles of highways were built between 1999 and 2005 at a cost of about $7 billion.

And a little more than $12 billion went into the Golden Quadrilateral highway, which links India's four biggest cities of Delhi, Mumbai, Chennai and Kolkata.

But right now, only 760 of the planned 4,500 miles of highway running north to south, and east to west, across the country, have been actually been completed. 

The heavy price tag that has come with progress has forced India to operate with a very high margin of debt. They country's debt equates to 75% of its GDP (down from 82% in 2004), one of the worst ratios in the world. So, what's an emerging country to do?

The Struggle to Attract Foreign Investment

If India wants to keep moving forward, it's going to have to count on some big time contributions.  The Indian government estimates (or at least hopes) that public and private organizations will contribute between $330 billion and $500 billion to the nation's development over the next five years.

That may very well be the case, but India is also going to need some help from abroad.  Inflows of foreign direct investment increased to 2% of India's GDP from less than 0.1% in 1990. And the country only attracted $8 billion in foreign direct investment last year. China attracted $63 billion. 

Last year, Intel (NASDAQ:INTC) passed over India and chose Vietnam as the site of a new chip assembly plant. Intel made no secret of the fact that it looked to India as a home for the project first, and the snub baffled the country's business community. Intel never offered a public explanation. Industry insiders have said it was the lack of reliable water and electricity that turned off the software giant.

The estimated cost of that plant was $605 million, and now Intel is ready to spend $1 billion on a semiconductor test and assembly plant in Vietnam.  This is just a fraction of the foreign investment that has retreated to other Asian interests in light of India's shortcomings. 

Still, with many improvements underway and others on the docket, India isn't out of the race.  Ford, Hyundai and Suzuki all export a significant number of cars from India. LG, Motorola, and Nokia all turn to India for to produce hardware for their respective phone services. And Honeywell, Siemens, and Schneider have all built factories for a variety of electronic products. Also, India has close to 60 manufacturing plants that adhere to the requirements of the U.S. Food and Drug Administration, the largest number outside of the United States.

Investing in India

India is losing the race with China but it has made a very strong impression in the service sector. If government reforms, infrastructure development, and foreign investment continue to increase then it may be able to make up some ground, but it's going to be a tough road ahead literally and figuratively.

There aren't many places to look if you're interested in getting in on India's developmental push.  A good place to start however would be Sterlite Industries India Ltd. (SLT). The company's primary business is the production of copper in India. Sterlite's copper cathodes and cast copper rods can be put to use in housing wires, electrical cables, and telecom cables. The company also mines bauxite and zinc ore, and produces aluminum conductors and other aluminum products.

A more diverse play might be the India Fund Inc. (IFN). The India Fund is a non-diversified, closed-end management investment company that invests in Indian equity securities.  At least 80% of the Fund's total assets are invested in equity securities of Indian companies. Its portfolio includes common stocks, warrants and short-term investments.

News and Related Story Links:

• Money Morning Investment Analysis:
  India's Outsourcing Capacities are Evolving and Shrinking at the Same Time

• Money Morning Investment Analysis:
  India's Richest Realtor Lobbies For a Rate Decrease Despite Strong Growth

• Organization for Economic Cooperation and Development:
  India needs more economic reforms to widen benefits from growth, says OECD report

• BusinessWeek:
  'We Are Fast Losing the Race With China'

• BusinessWeek:
  The Trouble With India

Tags: Asia, India, Volatile