The Hindu Business Line : How FDI has created a dual economy in China

The flood of foreign direct investment into China over the last decade and a half has spurred rapid growth in that country’s economy. The FDI-invested Chinese economy is growing at the rate of 18 per cent a year, while the non-FDI-invested part has notched up a growth of just 5-6 per cent. Had the FDI-invested economy plateaued, the growth would have been restricted to 7-8 per cent, according to a recent study.

Gross foreign investment accounts for about 5 per cent of Chinese GDP (compared to 0.8 per cent in India). FDI accounts for 30 per cent of output, 50 per cent of exports and 60 per cent of imports. The dual economy (some call it a ‘partition economy’) has led to wide variations in development and prosperity across regions.

In contrast, FDI in India has generated a fairly horizontal growth-spread, covering the North, West and South fairly uniformly. Since 1991, nearly 70 per cent of FDI has flowed into these regions, which have also been enriched by a simultaneous boom in domestic investment. Both FDI and domestic investment have led to significant structural changes in industry. The country’s manufacturing and service sectors have turned into efficient hubs for many innovative production and outsourcing programmes.

Gartner Inc has described India as the leader in global outsourcing. India also accounts for about 65-70 per cent of the global offshoring pie. GE has accorded India global outsourcing hub status for all its core businesses and to develop and manufacture its products locally.

Hewlett Packard has chosen India to produce the next generation of products for the world market. Royal Shell group has its largest R&D centre in Bangalore. And Suzuki Motor Company of Japan will make India the hub for its new “world car” in the country.

China restrictions

Even though China continues to top in the A.T Kearney’s 2007 Foreign Investment Confidence Index Survey, the investment climate is likely to be suffocated by China’s reining in FDI. China has invoked several measures which indicate a reversal of FDI promotion policy.

China has abrogated the preferential corporate tax system for foreign investors. Earlier, foreign investors were paying, on an average, tax at the rate of 15 per cent, in contrast to 33 per cent by the domestic enterprises. China invoked a uniform tax rate of 25 per cent, nudging out the special preference to foreign investors. It ruled out blanket approval for FDI in export-oriented projects under the threat of embargo on exports.

The Chinese government also introduced a new set of guidelines to promote FDI in technology upgradation to control industrial pollution and rectify the east-west growth imbalance.

China banned FDI in small and mid-sized refineries and in projects that mined rare-earth minerals. The FDI restriction in central and western areas were done away with. In the construction sector, FDI was restricted to hotels, villas, office towers and exhibition malls.

The restrictions led to a fall in FDI flow into China. The potential global investors, such as Japan, South Korea and the US turned their gaze elsewhere. FDI from these countries started sliding in China. In 2006, investment from these countries declined by 30 per cent, 25 per cent and 6 per cent respectively. They were expected to decline further in 2007.

China lacks quality FDI inflow. A substantial portion of FDI in China represents capital flow only, without linking to modern technology. About half of the FDI originates from Hong Kong and British Virgin Island.

Such foreign capital has failed to transfer modern technology to the Chinese economy, except making volume investment.

Most of such FDI were meant for exports. As a result, the domestic entrepreneurs in China are lagging far behind foreign investment firms in terms of technology upgradation. There has been no Chinese brand with any real global presence.

Opportunity for India

Will the Chinese restrictions translate into opportunities for India?

The move has already begun, with FDI growing 153 per cent in 2006-07, from $7.7 billion in 2005-06 to $19.5 billion. The momentum will continue. FDI flow is expected to touch $25 billion in 2007-08, an increase of 25 per cent. Even though in terms of total FDI flow, India is far behind China, on the basis of long-term potential, India signifies a better prospect for foreign investors.

Unlike China, FDI in India has posed challenges to domestic enterprises. This led domestic entrepreneurs to reinvent their strategies from closed economy to open economy. Domestic enterprises such as the Tata group, Bajaj, TVS, Godrej and Reliance sprang up to counter the competition from these MNCs.

Who could imagine a few years ago that the Tatas could actually deliver on their promise of producing a Rs 1-lakh car in the country? And that they could foray successfully into the global market to acquire a company such as Corus Steel and emerge the fifth largest steel conglomerate in the world. Bajaj Auto too regained its lost vigour after shifting from scooters to motorcycles against the tough competition from Japanese companies.

These manifest a balanced growth between FDI and domestic investment. Today, the Indian corporate sector is on an investment binge.

Capital expenditure planned by the private corporate sector was expected to rise by 60.2 per cent in 2006-07, over and above the increase of 23.1 per cent in 2005-06, according to a RBI survey.

Can India edge out China?

Nowadays, a favourite subject of discussion is whether India can edge out China in the long run. The Japanese, the third largest foreign investors in China, have already been advised by their government to adopt a “China-plus-one” strategy, meaning that they should not put all their eggs into one basket.

IBM, Cisco and Dell have pitched India as their future destination. Hyundai Motor Company considers India a better investment destination than China.

All surveys show India riding the crest of high profitability. It is now time for foreign investors to decide.

(The author is Adviser, Japan External Trade Organisation, New Delhi. His views are personal.)

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