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by EOS Intelligence EOS Intelligence No Comments

COVID-19 Unmasks Global Supply Chains’ Reliance on China. Is There a Way Out?

Dubbed as the factory to the world, China is an integral part of the supply chain of a host of products and brands. From manufacturers of simple products such as toys to complex good such as automobiles, all are dependent on China for either end products or components. However, China’s ongoing trade war with the USA and the COVID pandemic have made several brands question their supply chain dependence on this country, especially in some industries such as pharmaceuticals. Moreover, aggressive investment incentives offered by countries such as India and Japan have further cajoled companies to reassess their global supply chains and reconsider their dependence on China. However, with years of investment in the supply chain ecosystem, a shift such as this seems easier said than done.

China emerged as the manufacturing hub of the world in the 1990’s and hasn’t looked back since. Owing to vast availability of land and labor, technological advancements, and overall low cost of production, China became synonymous to manufacturing. Over the past decade, increasing labor and utility costs, and growing competition from neighboring low-cost countries such as India, Vietnam, Thailand, etc., have resulted in some companies shifting out from China. However, so far this has been limited to a few low-skilled labor intensive industries such as apparel.

The year 2020 has changed this drastically. The COVID pandemic along with the ongoing trade war between the USA and China made companies realize and question their dependency on China. In the beginning of last year, COVD-19 brought China to a halt, which in turn impacted the supply chain for all companies producing in China. Moreover, several pharmaceutical companies also realized that they are highly dependent on China for few basic medicines and medical supplies and equipment, which were in a considerable shortage throughout 2020. This pushed several companies across sectors such as pharmaceuticals, automobiles, and electronic goods, to reconsider their global supply chains to ensure reduced dependence on any one region, especially China.

Currently, several companies such as Apple, Google, and Microsoft are looking to shift their production from China to other South Asian countries, such as Vietnam and Thailand.

Some of the companies looking to reduce dependence on China:

Apple

In November 2020, Apple, along with its supplier Foxconn, expressed plans to shift assembly of some iPad and MacBook to Vietnam from China. The facility is expected to come online in the first half of 2021. Moreover, Apple is also considering shifting production of some of its Air Pods to Vietnam as well. In addition, it has invested US$1 billion in setting up a plant in Tamil Nadu, India to assemble iPhones that are to be sold in India. Apple and Foxconn are consciously trying to reduce their reliance on China due to the ongoing USA-China trade war.

Samsung

In July 2020, Samsung announced plans to shift most of its computer monitor manufacturing plants from China to Vietnam. The move is its response to hedge the supply chain disruptions it faced due to factories being shut in China during the early phase of the pandemic. In addition, in December 2020, the company shared its plans to shift its mobile and IT display plants from China to India. Samsung plans to invest about US$660 million (INR 48 billion) to set up the new facility in Uttar Pradesh (India).

Hasbro

Hasbro has been moving its production out of China into Mexico, India and Vietnam over the past year. It aimed to have only 50% of its products to be coming out of China by the end of 2020 and only 33% of its production to remain in China by the end of 2023. In 2019, about 66% of its toys were produced in China, while in 2012, 90% of its toys were manufactured in the country. The key reason behind the consistent switch is the souring trade relations between the USA and China.

Hyundai

During the past year, Hyundai Motors has been looking at developing India into its global sourcing hub instead of China in order to reduce its over-reliance on the latter. It has been encouraging its vendors, such as Continental, Aptiv, and Bosch, to ramp up production in India so as to move their supply chain away from China. It plans to source its auto parts from India (instead of China) for its existing factories in India, South America, Eastern Europe as well as planned facility in Indonesia.

Google

Google is looking to manufacture its new low-cost smartphone, Pixel4A, and its flagship smartphone, Pixel5A in Vietnam instead of China. In addition, in 2020, it also planned to shift production of its smart home products to Thailand. This move has been a part of an ongoing effort to reduce reliance on China, which in fact gained momentum post supply chain disruptions faced due to the coronavirus outbreak.

Microsoft

In early 2020, Microsoft expressed plans to shift the production base of its Surface range of notebooks and desktops into Vietnam. While the initial volume being produced in Vietnam is expected to be low, the company intends to ramp it up steadily to shift volumes away from China.

Steve Madden

In 2019, Steve Madden expressed plans to shift parts of its production out of China in 2020, given growing trade-based tensions between the USA and China. However, due to the COVID pandemic, it could not make planned changes to its supply chain. In October 2020, it again expressed plans to start shifting part of its production away from China by spring 2021. It plans to procure raw materials from Mexico, Cambodia, Brazil, and Vietnam to reduce reliance on China.

Iris Ohyama

The Japanese consumer goods player expressed plans to open a factory in northeastern Japan to diversify its manufacturing base, which is based primarily in China. The company made this move on the back of increasing labor cost in China, rising import tariffs to the USA, along with the supply disruptions it faced for procuring masks for the Japanese market. In 2020, it also set up a mask factory in the USA. In addition, the company plans to open additional plants in the USA and France for plastic containers and small electrical goods to cater to the local demand in these markets.

Nations using this opportunity to promote domestic production

In August 2020, about 24 electronic goods companies, including Samsung and Apple, have shown interest in moving out of China and into India. These companies together have pledged to invest about US$1.5 billion to setup mobile phone factories in the country in order to diversify their supply chains. This move is a result of the Indian government offering incentives to companies looking to shift their production facilities to India.

In April 2020, the Indian government announced a production linked incentive (PLI) scheme to attract companies looking to move out of China and set up large scale manufacturing units in the electronics space. Under the scheme, the government is offering an incentive of 4-6% on incremental sales (over base year FY 2019-20) of goods manufactured in India. The scheme, which is applicable for five years, plans to give an incentive worth US$6 billion (INR 409.51 billion) over the time frame of the scheme.

In November 2020, the Indian government subsequently expanded the scheme to other sectors such as pharma, auto, textiles, and food processing. In addition, it is expected to provide a production-linked incentive of US$950 million (INR 70 billion) to domestic drug manufacturers in order to push domestic manufacturing and reduce dependence on Chinese imports. Apart from incentives, India is developing a land pool of about 461,589 hectares to offer to companies looking to move out of China. The identified land, which is spread across Gujarat, Maharashtra, Tamil Nadu, and Andhra Pradesh, makes it easy for companies looking to set shop in India, as acquiring land has been one of the biggest challenges when it came to setting up production units in India.

On similar lines, the Japanese government is providing incentives to companies to shift their production lines out of China and to Japan. In May 2020, Japan announced an initiative to set up a US$2.2 billion stimulus package to encourage Japanese companies to shift production out of China. About JNY 220 billion (~US$2 billion) of the stimulus will be directed towards companies shifting production back to Japan, while JNY 23.5 billion (~US$200 million) will be given to companies seeking to move production to Vietnam, Myanmar, Thailand, and other Southeast Asian countries.

In the first round of subsidies, the Japanese government announced a list of 57 companies in July 2020, which will receive a total of US$535 million to open factories in Japan, while another 30 companies will be given subsidies to expand production in other countries such as Vietnam and Thailand. The move is a combination of Japan looking to shift manufacturing of high value-added products back to the country and the initial disruptions caused to the supply chain of Japanese automobiles and durable goods manufacturers.

Similarly, the USA, which has been at odds with China regarding trade for a couple of years now, is also encouraging its companies to limit their exposure in China and shift their production back home. In May 2020, the government proposed a US$25 billion ‘reshoring fund’ to enable manufacturers to move their production bases and complete supply chain from China preferably back to the USA and in turn reduce their reliance of China-made goods. The bill included primarily tax incentives and reshoring subsidies. However, the bill has not been passed in Congress yet and now with the leadership change in the USA, it is expected that president Biden may follow a more diplomatic strategic route with regards to China in comparison to his predecessor.

In addition to individual country efforts, in September 2020, Japan, India, and Australia together launched an initiative to achieve supply chain resilience in the Indo-Pacific region and reduce their trade dependence on China. The partnership aims at achieving regional cooperation to build a stable supply chain from the raw material to finished goods stage in 10 key sectors, namely petroleum and petrochemicals, automobiles, steel, pharmaceuticals, textiles and garments, marine products, financial services, IT services, tourism and travel services, and skill development.

Similarly, the USA is pushing to create an alliance called the ‘Economic Prosperity Network’, wherein it aims to work with Australia, India, Japan, New Zealand, Vietnam, and South Korea to restructure global supply chains to reduce dependence on China.

COVID-19 Unmasks Global Supply Chains’ Reliance on China by EOS Intelligence

Is it feasible?

While these efforts are sure to help companies move part(s) of their supply chain out of China, the extent to which it is feasible is yet to be assessed. Although the coronavirus outbreak has highlighted and exposed several supply chain vulnerabilities for companies across sectors and countries, despite government support and incentives, it will be very difficult for them to wean off their dependence on China.

Companies have spent decades building their manufacturing ecosystems, which in many cases, are highly reliant on China. These companies not only have their end products assembled or manufactured in the country, but also engage Chinese suppliers for their raw materials, who in turn use further Chinese suppliers for their inputs. Therefore, moving out of China is not a simple process and will take tremendous amount of time as well as financial resources.

While companies such as Google or Microsoft are looking to shift their assembling plants out of China, they are still dependent on China for parts. This is all the more relevant in case of high-technology products, such as automobiles and telecommunication infrastructure, where companies have made significant investments in China for their supply chain and are dependent on the nation’s manufacturing capabilities for small, intricate, but technologically advanced parts and components.

Moreover, despite significant efforts and reforms from countries such as India, Vietnam, and Thailand, they still cannot match China in terms of availability of skilled labor, infrastructure, and scale, which is required by many companies especially with regards to technologically advanced products. That being said, more companies are looking at a strategy where they are maintaining their presence in China, while also developing relatively smaller operations outside the country to have a fallback and to reduce total dependency on China. This is also dubbed as the China + 1 strategy.

Another reason going in China’s favor has been its capability to bounce back from the pandemic and resume production in a short span of time. While production had been halted in January to March 2020, it ramped up April onwards and was back to normal standards within no time. This reinforced the faith of many companies on Chinese capabilities. Therefore, as some companies are already cash-strapped due to the pandemic, they are not interested in investing in modifying their supply chains when in most cases normalcy resumed in a relatively short span of time.

EOS Perspective

Companies have been looking to diversify their supply chains and reduce dependence on China for a couple of years now, however, the trend has gained momentum post the coronavirus pandemic and growing US-China trade tensions. The onset of the COVID-19 outbreak exposed several vulnerabilities in the supply chain of global manufacturers, who realized the extent of their dependence on China. Moreover, several countries realized that they relied on China for key medicines and medical supplies, which cost them heavily during the pandemic.

Given this situation, several nations such as Japan, India, and the USA – together and individually, have started giving incentives to companies to shift production from China into their own borders. While this has resulted in several companies, such as Apple, Microsoft, Sanofi, Samsung, etc., to expand their manufacturing operations out of China, it does not necessarily mean that they are moving out of China. This is primarily due to heavy investments (in terms of both time and money) that they have already made into developing their intricate supply chains as well as the inherent benefits that China provides – technologically skilled labor, sophisticated production facilities, and quick revamping of production after a calamity.

That being said, it has come into the conscience of companies to reduce their over-reliance on China and while it may not impact the scale and extent of operations in the country in the short run, it is quite likely that companies will phase out their presence (at least part of it) in China over the coming decade.

A lot depends on the level of incentives and facilities provided by other nations. While countries such as India, Vietnam, and Thailand can offer low cost production with regards to labor and utilities, they currently do not have the technological sophistication possessed and developed by China. Alternatively, while Japan and the USA are technologically advanced, without recurring incentives and tax breaks, cost of production would be much higher than that in China. Thus, until there is a worthy alternative, most companies will follow the China +1 strategy. However, with growing trade tensions between China and other nations, and ongoing efforts by other nations to encourage and support domestic production, China may risk losing its positioning as the ‘factory of the world’ in the long run.

by EOS Intelligence EOS Intelligence No Comments

Global Economy Bound to Suffer from Coronavirus Fever

Global economy has slowed down in response to coronavirus. Factories in China and many parts of Europe have been forced to halt production temporarily as some of the largest manufacturing hubs in the world battle with the virus. While the heaviest impact of the virus has been (so far) observed in China, global economy too is impacted as most industries’ global supply chains are highly dependent on China for small components and cheaper production rates.

China is considered to be the manufacturing and exporting hub of the world. Lower labor costs and advanced production capabilities make manufacturing in China attractive to international businesses. World Bank estimated China’s GDP in 2018 to be US$13.6 trillion, making it the second largest economy after the USA (US$20.58 trillion). Since 1952, China’s economy has grown 450 fold as compared with the growth rate of the USA economy. International trade and investment have been the primary reason for the economic growth of the country. This shows China’s strong position in the world and indicates that any disturbances in the country’s businesses could have a global effect.

On New Years’ Eve 2019, an outbreak of a virus known as coronavirus (COVID-19) was reported in Wuhan, China to the WHO. Coronavirus is known to cause respiratory illness that ranges from cough and cold to critical infections. As the virus spreads fast and has a relatively high mortality rate, the Chinese government responded by quarantining Wuhan city and its nearby areas on January 23, 2020. However, this did not contain the situation. In January 2020, WHO designated coronavirus a “public health emergency of international concern” (PHEIC), indicating that measures need to be taken to contain the outbreak. On March 11, 2020, WHO called coronavirus a pandemic with the outbreak spreading across about 164 countries, infecting more than 190,000 people and claiming 7,800+ lives (as of March 18, 2020).

Coronavirus threatening businesses in China and beyond

Businesses globally (and especially in China) are feeling the impact of coronavirus. Workers are stuck in their homes due to the outbreak. Factories and work places remain dormant or are running slower than usual. Also, the effects of coronavirus are spreading across the globe. Initially, all factory shutdowns happened in China, however, the ripple effects of the outbreak can now be seen in other parts of the world as well, especially Italy.

Automotive industry

Global automobile manufacturers, such as General Motors, Volkswagen, Toyota, Daimler, Renault, Honda, Hyundai, and Ford Motors, who have invested heavily in China (for instance, Ford Motor joined ventured with China’s state-owned Chongqing Changan Automobile Company, Ltd., one of China’s biggest auto manufacturers) have shut down their factories and production units in the country. According to a London-based global information provider IHS Markit, Chinese auto industry is likely to lose approximately 1.7 million units of production till March 2020, since Wuhan and the rest of Hubei province, where the outbreak originated, account for 9% of total Chinese auto production. While the factories are reopening slowly (at least outside the Wuhan city) and production is expected to ramp up again, it all depends on how well the outbreak is contained. If the situation drags on for few months, the auto manufacturers might face significant losses which in turn may result in limited supply and price hikes.

American, European, and Japanese automobile manufacturers, among others, are heavily dependent on components supplied from China. Low production of car parts and components in China are resulting in supply shortages for the automakers globally. UN estimates that China shipped close to US$35 billion worth of auto parts in 2018. Also, according to the US Commerce Department’s International Trade Administration, about US$20 billion of Chinese parts were exported to the USA alone in 2018. A large percentage of parts are used in assembly lines that are used to build cars while remaining are supplied to retail stores. Supply chain is crucial in a connected global economy.

Coronavirus outbreak poses a risk to the global automotive supply chain.

South Korea’s Hyundai held off operations at its Ulsan complex in Korea due to lack of parts that were supposed to be imported from China. The plant manufactures 1.4 million vehicles annually and the shutdown has cost approximately US$500 million within just five days of shutting down. However, Hyundai is not the only such case. Nissan’s plant in Kyushu, Japan adjusted its production due to shortage of Chinese parts. French automaker Renault also suspended its production at a plant in Busan, South Korea due to similar reasons. Fiat Chrysler predicts the company’s European plant could be at risk of shutting down due to lack of supply of Chinese parts.

However, very recently, automobile factories in China have started reopening as the virus is slowly getting contained in the region. While Volkswagen has slowly started producing in all its locations in China, Nissan has managed to restart three of its five plants in the country.

That being said, auto factories are facing shutdowns across the world as coronavirus becomes a pandemic. Ford Chrysler has temporarily shut down four of its plants in Italy as the country becomes the second largest affected nation after China.

Automobile supply chains are highly integrated and complex, and require significant investments as well as a long term commitment from automobile manufacturers. A sudden shift in suppliers is not easy. The virus is spreading uncontrollably across Europe now and if France and Germany are forced to follow Italy’s footsteps of shutting down factories to contain its spread, this will spell doom for the auto sector as the two countries are home to some of the biggest automobile manufacturers in the world.

Technology industry

China is the largest manufacturer of phones, television sets, and computers. Much of the consumer technologies from smartphones to LED televisions are manufactured in China. One of the important sectors in the technology industry is smartphones.

The outbreak of coronavirus is bad news for the technology sector, especially at the verge of the 5G technology roll-out. Consumers were eagerly waiting for smartphone launches supporting 5G but with the outbreak, the demand for smartphones has seen a decline. According to the China Academy of Information and Communications Technology, overall smartphone shipments in China fell 37% year over year in January 2020.

Foxconn, which is a China-based manufacturing partner of Apple, has iPhone assembling plants in Zhengzhou and Shenzhen. These plants, which make up a large part for the Apple’s global iPhone assembly line, are currently facing a shortage of workers that will ultimately affect the production levels of iPhone in these factories. According to Reuters, only 10% of workers resumed work after the Lunar New Year holiday in China. As per TrendForce, a Taiwanese technology forecasting firm, Apple’s iPhone production is expected to drop by 10% in the first quarter of 2020.

Moreover, Apple closed down all its retail stores and corporate offices in the first week of February 2020 in China in response to the outbreak. On March 13, 2020, it reopened all of its stores in China as the outbreak seems to be under control. However, while Apple seems to recover from the outbreak in China, it is equally affected by store shutdowns in other parts of the world (especially Europe). On March 11, Apple announced that all stores in Italy will be closed until further notice. Italy has been hit by the virus hard after China. The Italian government imposed a nationwide lockdown on the first week of March 2020.

On the other hand other multinational smartphone giants such as LG, Sony Mobile, Oppo, Motorola, Nokia, and many others have delayed their smartphone launches in the first quarter of 2020 due to the outbreak.

The coronavirus outbreak is more likely to be a disaster for smartphone manufacturers relying on China.

Other sectors such as LCD panels for TVs, laptops, and computer monitors are mostly manufactured in China. According to IHS Markit, there are five LCD factories located in the city of Wuhan and the capacity at these factories is likely to be affected due to the quarantine placed by the Chinese government. This is likely to force Chinese manufacturers to raise prices to deal with the shortage.

According to Upload VR, an American virtual reality-focused technology and media company, Facebook has stopped taking new orders for the standalone VR headset and also said the coronavirus will impact production of its Oculus Quest headset.

Shipping industry

In addition to these sectors, the new coronavirus has also hit shipping industry hard. All shipping segments from container lines to oil tanks have been affected by trade restrictions and factory shutdowns in China and other countries. Shipyards have been deserted and vessels are idle awaiting services since the outbreak.

According to a February 2020 survey conducted by Shanghai International Shipping Institute, a Beijing based think-tank, capacity utilization at major Chinese ports has been 20%-50% lower than normal and one-third of the storage facilities were more than 90% full since goods are not moving out. Terminal operations have also been slow since the outbreak in China. The outbreak is costing container shipping lines US$350 million per week, as per Sea-Intelligence, a Danish maritime data specialist.

According to Sea-Intelligence, by February 2020, 21 sailings between China and America and 10 sailings in the Asia-Europe trade loop had been cancelled since the outbreak. In terms of containers, these cancellations encompass 198,500 containers for the China-America route and 151,500 boxes for the Asia-Europe route.

Moreover, shutting down of factories in China has resulted in a manufacturing slowdown, which in turn is expected to impact the Asian shipping markets. European and American trade is also getting affected as the virus spreads to those continents. US retailers depend heavily on imports from China but the outbreak has caused the shipping volumes to diminish over the first quarter.

The USA is already in the middle of a trade war with China that has put a dent in the imports from China. National Retail Federation (world’s largest retail trade association) and Hackett Associates (US based consultancy and research firm) projects imported container volumes at US seaports is likely to be down by 9.5% in March 2020 from 2019. The outbreak is heavily impacting the supply chains globally and if factory shutdowns continue the impact is more likely to be grave.


Read our other Perspectives on US-China tensions: Sino-US Trade War to Cause Ripple Effect of Implications in Auto Industry and Decoding the USA-China 5G War


Other businesses

In addition to the auto, technology, and shipping industries, other sectors are also feeling the heat from the outbreak. Under Armour, an American sports clothing and accessories manufacturer, estimated that its revenues are likely to decline by US$50-60 million in 2020 owing to the outbreak.

Disney’s theme parks in California, Shanghai, Tokyo, and Hong Kong have been shut down due to the outbreak and this is expected to reduce its operating income by more than US$175 million by second quarter 2020.

Further, IMAX, a Canadian film company, has postponed the release of five films in January 2020, due to the outbreak.

Several fast food chains have been temporarily shut down across China and Italy, however, most of them have opened or are in the process of reopening in China as the outbreak is slowly coming under control there. While the global fast food and retail players have limited exposure in China, they are suffering huge losses in Europe, especially Italy. The restaurant sector is severely impacted there, where all restaurants, fast food chains, and bars have been shut down temporarily till April 3 in an attempt to contain the outbreak.

Another significantly affected industry is the American semiconductor industry as it is heavily connected to the Chinese market. Intel’s (a US-based semiconductor company) Chinese customers account for approximately US$20 billion in revenue in 2019. Another American multinational semiconductor and telecommunications equipment company, Qualcomm draws approximately 47% of its revenue from China sales annually. The outbreak is making its way through various industries and global manufacturers could now see how much they have become dependent on China. Although the virus seems to be getting under control as days pass, the businesses are not yet fully operational. Losses could ramp up if the virus is not contained soon.

Global Economy Bound to Suffer from Coronavirus Fever by EOS Intelligence

 

Housebound consumers dealing with coronavirus

Since the virus outbreak, people across many countries are increasingly housebound. Road traffic in China, Italy, Iran, and other severely affected countries has been minimized and public places have been isolated. People are scared to go out and mostly remain at home. This has led local businesses such as shopping malls, restaurants, cinemas, and department stores to witness a considerable slowdown, while in some countries being forced to shut down.

TV viewing and mobile internet consumption on various apps have increased after the outbreak. According to QuestMobile, a research and consultancy firm, daily time spent with mobile internet rose from 6.1 hours in early January 2020 to 6.8 hours during Lunar New Year (February 2020).

While retail outlets and other businesses are slower, people have turned to ordering products online. JD.com, a Chinese online retailer, reported that its online grocery sales grew 215% (year on year) to 15,000 tons between late January and early February 2020. Further, DingTalk, a communication platform developed by Alibaba in 2014, was recorded as the most downloaded app in China in early February 2020.

EOS Perspective

International businesses depend heavily on Chinese factories to make their products, from auto parts to computer and smartphone accessories. The country has emerged as an important part in the global supply chain, manufacturing components required by companies globally. The coronavirus outbreak has shaken the Chinese economy and global supply chains, which in turn has hurt the global economy, the extent of which is to be seen in the months to come. Oxford Economics, a global forecasting and analysis firm, projected China’s economic growth to slip down to 5.6% in 2020 from 6.1% in 2019, which might in turn reduce the global economic growth by 0.2% to an annual rate of 2.3%.

A similar kind of outbreak was seen in China in late 2002 and 2003, with SARS (Severe Acute Respiratory Syndrome) virus. China was just coming out of recession in 2003 and joined the World Trade Organization, attaining entrance to global markets with its low cost labor and production of cheaper goods. The Chinese market was at its infancy at that time. As per 2004 estimates by economists Jong-Wha Lee and Warwick J. McKibbin, SARS had cost the global economy a total of about US$40 billion. After SARS, China suffered several months of economic retrenchment.

The impact of coronavirus on Chinese as well as global economy seems to be much higher than the impact of SARS, since COVID-19 has spread globally, while China has also grown to be the hub for manufacturing parts for almost every industry since the SARS outbreak. In 2003, China accounted for only 4% of the global GDP, whereas in 2020, its share in the global GDP is close to 17%.

Currently, the key challenge for businesses would be to deal with and recover from the outbreak. On the one hand, they need to protect their workers safety and abide by their respective governments’ regulations, and on other hand they need to safeguard their operations under a strained supply chain and shrunken demand.

In the current landscape, many businesses in China have reopened operations but the outbreak is rapidly spreading to other parts of the world (especially Europe and the USA), where it is impacting several business as well as everyday lives. The best thing for manufacturing companies in this scenario is to re-evaluate their inventory levels vs revised demand levels (which may differ from industry to industry), and consider a short-term re-strategizing of their global supply chains to ensure that raw materials/components or their alternates are available and accessible – bearing in mind their existing production capability with less workers and customer needs during this pandemic period.

With the rapid spread of the virus, it seems that the outbreak is likely to cause considerable damage to the global economy (both in terms of production levels as well as psychological reaction on stock markets), at least in the short term, i.e. next 6 months. However, many experts believe that the situation should soon start coming under control at a global level. For instance, some experts at Goldman Sachs, one of the world’s largest financial services companies, believe that while this pandemic will bring the lowest growth rate of the global GDP in the last 30 years (expected at 2% in 2020), it does not pose any systematic risks to the world’s financial system (as was the case during the 2008 economic crisis).

Having said that, it is difficult to estimate what real impact the coronavirus will have on the global economy yet, and if opinions such as Goldman Sachs’ are just a way to downplay the situation to keep the investors calm. It is more likely to depend on how long the virus continues to spread and linger and how effectively do governments around the world are able to contain it.

by EOS Intelligence EOS Intelligence No Comments

Tax Cuts – Enough to Make India a Global Manufacturing Hub?

India has recently announced an unprecedented reduction in its corporate tax rates. Not only is this a respite for domestic and existing foreign companies, but it is also expected to boost India’s position as a preferred investment destination for international companies looking to diversify their manufacturing footprint. Amidst the ongoing trade war between China and the USA, many companies, such as Apple, are looking to relocate a chunk of their manufacturing facilities away from China as part of a de-risk strategy. This presents the perfect opportunity for India to swoop in and encourage manufacturers to set base there instead of other Asian countries. However, tax reduction alone may not be enough to score these investments as the government needs to provide additional incentives apart from improving logistics and infrastructure, as well as land and labor laws in the country.

For the past three decades, India had one of the highest corporate tax rates in the South Asian region standing at 30% (effective rate of about 35% including surcharge and cess), making it one of the biggest sore points for investors looking at setting up a shop here.

However, September 2019 brought an unprecedented move, as the Indian government slashed the corporate tax rate to 22% from the existing 30%. Moreover, new manufacturing units established after 1 October 2019, are eligible for even lower tax rate of 15% (down from 25%) if they make fresh manufacturing investments by 2023.

The effective tax rate in these cases (subject to the condition that companies do not claim benefits for incentives or concessions) will be 25.75% (in case of 22% tax rate) and 17.01% (in case of 15% tax rate). These companies will also be exempt from minimum alternate tax (MAT). The tax cuts in effect are believed to have improved India’s competitiveness among investment destinations in the region.

The tax cuts in effect are believed to have improved India’s competitiveness among investment destinations in the region.

To put this into perspective, India’s new tax rate is lower than the rate in China (25%), Korea (25%), Bangladesh (25%), Malaysia (24%), Japan (23.2%), however still a little higher than that of Vietnam (20%), Thailand (20%), Taiwan (20%), Cambodia (20%), and Singapore (17%). However, for new companies/MNCs looking to set up a unit in India, the country offers the most competitive rates in the region.

This tax break by India is also well-timed to exploit the degrading US-China relationship, which is resulting in several US-based companies, such as Apple, Google, Dell, etc., to look for manufacturing alternatives outside of China. Currently, Vietnam, Taiwan, and Thailand have been the prime beneficiaries of the trade war, with the three countries attracting about 80% of the 56 companies that have relocated from China during April 2018 to August 2019. However, India’s recently introduced tax cuts may act as a major stimuli for companies (that are looking to partly move out of China or are already in the process of doing it) to consider India for their investments.

While the tax reform stands across all industries, India is looking to boost investment in the labor-intensive electronics manufacturing sector including smart phones, televisions, etc. To achieve this, the government recently scrapped import tax on open cell TV panels, which are used to make television displays. In addition to large brands such as Apple, India is also targeting component and contract manufacturers for such companies (such as Wistron, Pegatron, and Foxconn) to shift their business from China and set a shop in India.

India's Tax Cuts Not Enough by EOS Intelligence

Is a tax break enough?

While this is a big step by the Indian government to attract foreign investments in the manufacturing space, many feel that this alone is not enough to make India the preferred alternative to its neighbors. Companies looking to relocate their manufacturing facilities also consider factors such as infrastructure (including warehousing cost and set-up), connectivity (encompassing transportation facilities and logistical support), and manpower (such as availability of skilled manpower and training costs) along with overall ease of doing business, which covers the extent of red tape, complexity of policies, and transparency of procedures.

The Indian government has to work towards improving the logistical infrastructure, skilled labor availability, and cumbersome land-acquisition process, among many other aspects. As per the World Economic Forum’s Global Competitiveness Report 2019, India ranks 70 (out of 141 countries) in terms of infrastructure. While India heavily depends on road transportation, it needs to invest in and develop modern rail and water transportation and connectivity if it wishes to compete with China (rank 36).

India also ranks poorly with regards to skilled workforce and labor market, ranking 107 and 103 on the indices, respectively. To put this in perspective, Indonesia ranks 65 with regards to skilled workforce and 85 for labor market, and Vietnam ranks 93 for skilled workforce and 83 for labor market. Other than this, India also struggles with complex land acquisition laws and procedures, and must look into streamlining both to position itself an attractive investment destination.

Apart from this, the government also needs to provide additional incentives for investments in sectors that are its key priorities, such as tech and electronics manufacturing for export. As per industry experts, electronics manufacturing in India carries 8-10% higher costs in comparison with other Asian countries. Thus the government must provide other incentives such as easy and cheaper credit, export incentives, and infrastructural support, to steer companies into India (instead of countries such as Vietnam, Indonesia, and Thailand).

Several experts and industry players suggest that the government should provide the electronics manufacturing industry incentives for exports that are similar to those under the ‘Merchandise Exports from India Scheme’, which provides several benefits including tax credits to exporters.

In August 2019, the Ministry of Electronics and Information Technology (MeitY) proposed incentives to boost electronics manufacturing in India. These include a 4-6% subsidy on interest rates on loans for new investment, waiver of collateral for loans taken to set up machinery, and the renewal of the electronics manufacturing cluster (EMC). EMC creates an ecosystem for main company and its suppliers to operate in a given area (the previous EMC scheme ended in 2018).

Apart from this, industry players are also seeking an extension of another scheme, Modified Special Incentive Package Scheme (MSIPS), which also ended in 2018. MSIPS provided a subsidy of about 25% on capital investment.

EOS Perspective

India’s tax break came at an extremely opportune time, with several MNCs having expressed their plans to branch out of China (for at least 20% of their existing manufacturing facilities). From imposing some of the highest corporate taxes, India has now become one of the most tax-friendly markets, especially for new investments.

This is likely to put India in the forefront for consideration, however, it is probably not enough. The government needs to work on several other facilitating factors, especially infrastructure, land laws, and availability of skilled labor, which are more favorable in other Asian countries.

Moreover, the appeal of some countries, such as Vietnam and Thailand, seems to remain high, as several of them introduced a ‘single point of contact’ facilities for investors. Under these facilities, in various forms, investors are provided with investment-related services and information at a single location, and/or are provided with single point of contact within each ministry and agency they have to deal with. This makes the access to information and investment procedures much easier for foreign investors, and increases the perception of transparency of the whole process. India on the other hand struggles with bureaucracy, fragmented agency landscape, and red tape. Despite initiating a single window policy, multinational representatives need to visit multiple offices and meet several officials (also in many cases offer bribes) to get an approval of their proposals and subsequently get the required permits. Bureaucratic and procedural delays, as well as poor work culture remain to be considerable deterrents for foreign investors.

India struggles with bureaucracy, fragmented agency landscape, and red tape. Bureaucratic and procedural delays, as well as poor work culture remain to be considerable deterrents for foreign investors.

Also in 2018, India only managed a mere 0.6% of its GDP from manufacturing FDI, indicating a low confidence level among foreign companies to make medium to long-term commitments in India. However, large part of the reason for this were also the high tax rates. Therefore, the recent tax reduction is a major step in the right direction, while the government still has some distance to bring India to replace China in the position of manufacturing giant of Asia, especially in the electronics sector.

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