By Namrata Mittal & Varnika Khemani
The prevalent narrative is around shifting of manufacturing capacities out of China with the objective of reducing the world’s dependency on Chinese exports. If this were to be playing out, then there should be some signs of slowing exports out of China or a loss in market share for Chinese exports. But data seem to suggest otherwise.
Contrary to the running rhetoric of China+1, China has gained exports market share by 1.7% in the last five years. China’s exports mix has also shifted away from consumer goods and increasingly towards capital goods.
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At present, India is promoting its manufacturing sector largely by providing a subsidy to a specific set of companies in identified sectors. The subsidy grants are conditional on yearly milestones in investment, production, and domestic value addition in specific cases.
On the other hand, the Chinese government has identified a few strategic sectors, specifically in the realm of new-age industries, and appears much more aggressive than other countries in its industrial policy support. As a share of gross domestic product (GDP), China spends over twice as much as South Korea on its industrial policy. And in dollar terms, China spends more than twice as much as the United States does (as of 2019). The main mechanisms of support are tax incentives, subsidies, and preferential access to funding. These factors work in combination with other state assistance to potentially improve the return on invested capital and make it more attractive for private investment.
And consequently, we can see significant capacity addition and production out-performance in the automobile, electrical machinery, chemical, nonferrous metal, railway shipbuilding, and aerospace sectors. Gradually, the production capacity is outpacing demand, leading to reduced capacity utilisation in a few sectors. At the current pace of industrial capex push, the problem of overcapacity could accentuate in the future. And hence, Chinese manufacturers with excess capacity, and cost advantages, will have adequate incentive and capability to price competitively.
This means that at least one of the factors (i.e. China’s cheap exports) that contributed to structurally lower inflation over the past two decades is not going away, and potentially even getting stronger.
China’s real estate boom drove the commodity upcycle in 2003-2011. However, the current policy focus is strictly towards industries which are less material-intensive (barring a few exceptions). More so, even as manufacturing investment is on the rise, overall fixed asset investment in China is growing at low single digits (3% in 2023). Thus, the current investment cycle in China may not lead to a parallel surge in commodities. Neither does it have the potential to completely pull out the country of its growth struggle and put it back on a 10% nominal growth path.
In the past, other countries gave in to the Chinese industry hollowing out their own manufacturing sector. Today, they are pushing back. After the US, Europe is aiming at more aggressive anti-dumping policies against Chinese automobiles and solar equipment exports.
India has been increasingly active in blocking Chinese investment and banning mobile apps and attempting to enforce import restrictions on electronics imports. And since August 2023, Mexico has temporary import duties of up to 25% on goods (including steel, aluminium, textiles, footwear, tires, plastics, glass, paper, cardboard, electrical equipment, and ceramic products) from countries with whom it does not have a preferential or free trade agreement, of which China is by far the most prominent. However, it wouldn’t be a one-way battle. China would likely impose countervailing duties and try to arm-twist nations where it has significant loans.
Today, globally, policy making is focused on the industrial capex. Knowing the competition is critical for India while designing its policy framework and for us as an investor while riding on the manufacturing sector and industrial capex theme. Some of the sectors like electric vehicles, solar panels, semiconductors, and other high-end equipment manufacturing may face stiff competition from increased Chinese supply in the future. At the same time, China is indeed vacating the space in some of the low-value consumer products.
Secondly, China+1 has so far been a limited exports opportunity for India. It provided an increased market share gain in the US market. But more than the China+1 policies or shift in sourcing, there has been the reduced industrial production in Germany and a few other European countries (probably driven by the energy crisis after the Russia-Ukraine war) which has played out favourably for Indian exporters.
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Third, we often debate industrial policy support and whether taxpayers should subsidise ‘rich’ businesses. In today’s environment, if Indian manufacturers do not receive sufficient policy support, perhaps the Chinese manufacturing process could hollow out India’s production potential and leave India as a permanent import-dependent and current account-deficit nation. No nation is playing by the fair rule of comparative advantage. In fact, we find that other countries (both the US and China) have increased support to R&D spending by the industries. Perhaps, India could also design its policy with a greater bias towards innovation.
Namrata Mittal serves as the Chief Economist, while Varnika Khemani is an Economist at SBI Funds Management Ltd.
Views are personal.
By Namrata Mittal & Varnika Khemani
The prevalent narrative is around shifting of manufacturing capacities out of China with the objective of reducing the world’s dependency on Chinese exports. If this were to be playing out, then there should be some signs of slowing exports out of China or a loss in market share for Chinese exports. But data seem to suggest otherwise.
Contrary to the running rhetoric of China+1, China has gained exports market share by 1.7% in the last five years. China’s exports mix has also shifted away from consumer goods and increasingly towards capital goods.
At present, India is promoting its manufacturing sector largely by providing a subsidy to a specific set of companies in identified sectors. The subsidy grants are conditional on yearly milestones in investment, production, and domestic value addition in specific cases.
On the other hand, the Chinese government has identified a few strategic sectors, specifically in the realm of new-age industries, and appears much more aggressive than other countries in its industrial policy support. As a share of gross domestic product (GDP), China spends over twice as much as South Korea on its industrial policy. And in dollar terms, China spends more than twice as much as the United States does (as of 2019). The main mechanisms of support are tax incentives, subsidies, and preferential access to funding. These factors work in combination with other state assistance to potentially improve the return on invested capital and make it more attractive for private investment.
And consequently, we can see significant capacity addition and production out-performance in the automobile, electrical machinery, chemical, nonferrous metal, railway shipbuilding, and aerospace sectors. Gradually, the production capacity is outpacing demand, leading to reduced capacity utilisation in a few sectors. At the current pace of industrial capex push, the problem of overcapacity could accentuate in the future. And hence, Chinese manufacturers with excess capacity, and cost advantages, will have adequate incentive and capability to price competitively.
This means that at least one of the factors (i.e. China’s cheap exports) that contributed to structurally lower inflation over the past two decades is not going away, and potentially even getting stronger.
China’s real estate boom drove the commodity upcycle in 2003-2011. However, the current policy focus is strictly towards industries which are less material-intensive (barring a few exceptions). More so, even as manufacturing investment is on the rise, overall fixed asset investment in China is growing at low single digits (3% in 2023). Thus, the current investment cycle in China may not lead to a parallel surge in commodities. Neither does it have the potential to completely pull out the country of its growth struggle and put it back on a 10% nominal growth path.
In the past, other countries gave in to the Chinese industry hollowing out their own manufacturing sector. Today, they are pushing back. After the US, Europe is aiming at more aggressive anti-dumping policies against Chinese automobiles and solar equipment exports.
India has been increasingly active in blocking Chinese investment and banning mobile apps and attempting to enforce import restrictions on electronics imports. And since August 2023, Mexico has temporary import duties of up to 25% on goods (including steel, aluminium, textiles, footwear, tires, plastics, glass, paper, cardboard, electrical equipment, and ceramic products) from countries with whom it does not have a preferential or free trade agreement, of which China is by far the most prominent. However, it wouldn’t be a one-way battle. China would likely impose countervailing duties and try to arm-twist nations where it has significant loans.
Today, globally, policy making is focused on the industrial capex. Knowing the competition is critical for India while designing its policy framework and for us as an investor while riding on the manufacturing sector and industrial capex theme. Some of the sectors like electric vehicles, solar panels, semiconductors, and other high-end equipment manufacturing may face stiff competition from increased Chinese supply in the future. At the same time, China is indeed vacating the space in some of the low-value consumer products.
Secondly, China+1 has so far been a limited exports opportunity for India. It provided an increased market share gain in the US market. But more than the China+1 policies or shift in sourcing, there has been the reduced industrial production in Germany and a few other European countries (probably driven by the energy crisis after the Russia-Ukraine war) which has played out favourably for Indian exporters.
Third, we often debate industrial policy support and whether taxpayers should subsidise ‘rich’ businesses. In today’s environment, if Indian manufacturers do not receive sufficient policy support, perhaps the Chinese manufacturing process could hollow out India’s production potential and leave India as a permanent import-dependent and current account-deficit nation. No nation is playing by the fair rule of comparative advantage. In fact, we find that other countries (both the US and China) have increased support to R&D spending by the industries. Perhaps, India could also design its policy with a greater bias towards innovation.
Namrata Mittal serves as the Chief Economist, while Varnika Khemani is an Economist at SBI Funds Management Ltd.
Views are personal.
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