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Rethinking supply chains and trade architecture in South Asia

Expert Comment

Written by Ganeshan Wignaraja, Aliasger Bootwalla

Image credit:Port of Colombo | Photo: fotopanorama360/Shutterstock

Amid geopolitical tensions and slowing growth in major advanced economies, India emerges as a bright spot for global growth and supply chain expansion. Neighbouring Bangladesh and Sri Lanka may also hold supply chain potential. By encouraging regional FDI from Indian businesses and improving South Asia’s trade architecture of FTAs and regional institutions, India can foster inclusive growth to its neighbours.

The world economy continues to be in a state of flux in 2024, shaped by rising geopolitical tensions stemming from the Russia-Ukraine and Israel-Hamas conflicts, elections uncertainty in the US, tightening monetary policy by central banks, and waning business confidence. Dark clouds are hovering over global trade with the slowing of major economies like the US, UK, and China. Where does South Asia fit into this global growth and trade scenario and what are India’s prospects, are pressing questions occupying the minds of policymakers.

India rising in global manufacturing?

In this decade of navigating global divergences with the world economy changing, and trade patterns shifting, India could become a top three global economy by 2030 as it develops as a manufacturing and services hub, moving towards export-driven growth. Interest in India is growing as multinational companies look to reduce their reliance on China due to factors such as rising wages, domestic supply chain bottlenecks, and investor concerns about tighter regulation of foreign firms, coupled with the country’s escalating trade war with the US.

The disruption of China-centric global supply chains seems to be occurring, with reports indicating that inward FDI is falling to historic lows for this G2 economy. Countries like Vietnam (dubbed as the new China by some) and Thailand are big winners in supply chain shifting. India also has the potential to become a complementary Asian manufacturing hub to China. Studies place India among the largest global FDI recipients, driven by its rapid economic growth, a large educated labour pool, and large domestic market.

Supply chain pessimism on India seems to be finally shifting. The World Trade Organization (WTO) ranks India as the fifth-largest importer of intermediate goods, parts, and components, in the second quarter of 2023 – up from the 10thrank in the second quarter of 2021. At the micro-level, Apple is ramping up its manufacturing of iPhones in India, Toyota stepping up its investment by setting up a new plant in Karnataka, and Hyundai increasing its capacity and fostering technological advancement by its recent investment in Maharashtra. India’s manufacturing sectors in areas such as automotives, pharmaceuticals, and electronics assembly are already well-established and may benefit from a series of policy initiatives – from Make in India and Atmanirbhar Bharat to the Production Linked Incentive (PLI) Scheme – which have increased FDI equity inflow in the manufacturing sector by 57% between 2014 and 2022 compared to the previous eight-year period (2006-2014).

India’s service sectors, including information and communications technology, financial and professional services, and transport and logistics, are also positioned for growth. To sustain its economic transformation, India needs reforms that promote trade openness, cut red tape regulations strangling businesses, and facilitate investments in renewable green energy. Closer policy coordination between the central government and India’s semi-autonomous states is also necessary.

The Modi government’s trade diplomacy

Since 2022, the Modi government has placed renewed emphasis on preferential openings with trading partners through a flurry of bilateral trade deals such as the UAE-India Comprehensive Economic Partnership Agreement and the Australia-India Economic Cooperation and Trade Agreement (ECTA), and joining big regional trade frameworks like the Indo-Pacific Economic Framework (IPEF). Additionally, there are ongoing negotiations on trade deals with both the EU and the UK to conclude comprehensive high-standard FTAs.

It makes economic sense for India to spread the gains from this trade regionally, promoting resilient and cost-effective regional supply chains in South Asia. This would stabilise the region, create jobs, and make the region less vulnerable to Chinese investments. In this spirit, India-Sri Lanka FTA talks have resumed, with a view to concluding an investment deal in 2024, followed by a more comprehensive FTA. Stronger investor protections in Sri Lanka are crucial to attracting Indian foreign investors in the country’s ports, renewable energy, and privatisation of state-owned enterprises. Over time, such ventures will help generate much-needed foreign exchange and provide Sri Lanka with a path away from indebtedness and towards transformative growth.

Can the rest of South Asia join?

Currently, much of South Asia is not a major part of India’s trade story, despite the economic potential of some countries. According to the World Bank’s Global Economic Prospects Report 2024, South Asia’s growth story so far can be divided into three parts. India and Bangladesh have better growth prospects; Nepal, Bhutan and Maldives are reasonable; and Pakistan and Sri Lanka in debt distress situations have weaker growth prospects.

A sure way for South Asia to have resilient and cost-effective regional supply chains is for Indian businesses to invest in the region and foster significant local linkages and spillovers for its South Asian partners. This is already happening to a limited extent in Sri Lanka and Bangladesh. The Adani Group, for example, has invested in a joint venture with John Keels Holdings to develop the West Container Terminal in Colombo Port and wind power in Northern Sri Lanka. This interest can be traced to Sri Lanka’s favourable geographical location along the main East-West global sea route and windy land comprises about 6% of Sri Lanka which could support almost 20,000 MW of potential installed capacity. Foreign investment from India and elsewhere offers Sri Lanka an opportunity to raise non-debt creating foreign exchange and a route of indebtedness towards economic transformation in the future.

Bangladesh is growing rapidly with a larger domestic market and cheaper wages than Sri Lanka. This has made it attractive for Indian FDI in the manufacturing sector. Tata Motors, Hero MotoCorp, Sun Pharma, Godrej, VIP, CEAT Tyres, and Aditya Birla Cement, have established or set up factories in Bangladesh. Increased private investment in consumer-oriented sectors and start-ups focused on fintech, healthcare, and agritech could further develop a local ecosystem with access to seed funding and technology transfer from India.

Building South Asia’s trade architecture

Hence the need to rethink South Asia’s trade architecture.

The rise of FTAs in the 2020s largely occurred in East Asia, with nations like Japan, China, Korea, and Singapore, taking the lead. Over time, these deals can increase trade and foreign investment gains for India, thus leading to more foreign exchange, technology transfer, better energy security, cheaper food, and market access.

It will be useful for India to carefully re-evaluate the gains from mega FTAs in Asia, such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and Regional Comprehensive Economic Partnership (RCEP), which include agendas for services, trade, investment rules, intellectual property rights, government procurement, and other pertinent issues to support the spread of supply chains. Consultations with businesses during FTA negotiations and providing business development services for FTA implementation is also essential as trade and investment do not necessarily pick up because an FTA is signed.

Alongside trade deals, regional institutions which shape local diplomatic and technical discussions are another facet of South Asia’s trade architecture. Sadly, initial optimism for the South Asian Association for Regional Cooperation (SAARC) has failed to materialise and its outlook seems bleak. Recognising this, India is switching its diplomatic efforts to bilateral engagement and other minilateral approaches such as the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) and the Indian Ocean Rim Association (IORA) which are more relevant to South Asia. The 10-year BIMSTEC Masterplan for Transport Connectivity is an important outcome of such efforts and can foster greater movement of goods across regional borders. However, unlike ASEAN, these institutions currently lack substantive mandates and resources to be truly effective. For now. An Indian diplomat assuming the Secretary-General of BIMSTEC, presents an opportunity for India to shape its mandate and bolster its resources. Sri Lanka and others should support such efforts for the greater regional good.

There is a new global buzz around India rising as a global economic superpower in an uncertain global growth and trade era. A more regionally focused India which includes the rest of South Asia in the process through regional supply chains and a better trade architecture is a win for India and its South Asian neighbours. There is cautious optimism that a better integrated South Asia could become a significant growth pole for the global economy and individual South Asian countries like Bangladesh and Sri Lanka.