Xiaomi to bullet trains: Modi needs to drive a hard bargain with China’s Xi Jinping

The government is seized with the issue of lopsided bilateral trade with China. As against the general perception that imports are of cheap consumer items, the figures show that the largest imports from China are that of engineering goods, electronics and electrical equipment. Over the last three years, China has sold almost $30 billion of engineering goods to India, almost $10 billion a year.

During the same period, $43 billion worth of electronic and electrical equipment, both for industrial and consumer use, has also found their way into India from China.

Why are these import figures alarming? The fact that the core of any country’s manufacturing base is made up from its capability to produce engineering goods and that this sector in India is made not by large companies but by mid-sized, family-owned business spreading from Ludhiana to Coimbatore, makes the issue very critical to the country.

These SMEs are the backbone of the manufacturing base, because when an auto major sets up a plant it is these small manufacturers who become ancillary base, adapt and develop machines. This is where the manufacturing innovation is happening, bigger companies just focus on innovations in product or product engineering. Even if a Bajaj or a Mahindra & Mahindra wants to customise a product or a component, it is the ingenuity of these manufacturers that matters the most.

Interestingly, the ministry of commerce clubs the whole data of these imports under the second largest product category, the head Nuclear Reactors, Boilers, Machinery and Mechanical Appliances. Only when you dig deeper, you find that the largest imports are that of automated data processing (ADP) machines, which stood at almost $2 billion in 2013-14, according to a study done by Aranca, a Mumbai-based research firm.

This is an anachronism of the Indian customs that still refers to computers and peripheral equipment as ADP machines. It defines an ADP as a computer with a mouse connected to it. It shows that underneath the Indian IT industry growth engine is a Chinese computer. India bought $6 billion worth of such goods over the last three years. A separate classification of CPUs shows it is the second-largest imports.

While the product head says nuclear reactors and boilers it is difficult to ascertain from the break up whether this is a substantial part of Chinese imports. At least, in the top five products categories it does not figure.

China is a major contributor to India’s power sector. Chinese suppliers had become popular with Indian power producers as equipment came with credit on very easy terms from Chinese banks. BHEL, a PSU company, that has a monopoly in manufacturing power sector equipment in India, actively lobbied against Chinese imports.

[KEY: A - Electrical machinery and equipment and parts; B - Nuclear reactors, boilers, machinery and mechanical appliances, parts; C - Organic chemicals; D - Project goods, some special uses; E - Fertilisers; F- Plastic and articles thereof; G - Articles of iron and steel]

BHEL could not keep pace with the demand in 2007-10. Lobbying against Chinese equipment, particularly in capital and projects, is a norm not from Indian manufacturers but European and American companies. A similar lobbying story had played out in the telecom sector, when the build out was happening. European and American vendors tarred Huawei as a proxy for the Chinese government.

Almost every manufacturer Indian, European and American is afraid of the Chinese. The fear is genuine as the Chinese are capable of decimating a whole industry by predatory pricing. There are several studies, the most interesting one is in the book ‘Airborne’ by James Fallows that chronicles how the Chinese government spent half-a-trillion dollar to get into the aviation industry.

The Chinese plan capacity at the government level, they do not look at domestic demand but global demand. Then like Indians, Chinese entrepreneurs and banks also have a herd mentality, if a manufacturing unit is set up in one province, it is quickly followed by several others.

Not only entrepreneurs get into this competitive frenzy, but provinces, bureaucrats and even banks get into it. This creates clusters of manufacturing for industries and gives the scale to manage cheap prices. Chinese banks are also lenient in terms of sustaining loss-making units as they provide employment. This allows the Chinese to cut prices as long as sales are guaranteed.

The Chinese also negotiate prices in a very different manner. On a backpacking trip to China with two kids, it was enlightening to learn the way they negotiate. A Chinese street vendor in Xian will not break the negotiation he will quote a high price, and even if you cut it by half, he will give it to you grudgingly after bringing it down slowly. Once you have bought the first item, he will quickly offer a similar or same item at a price even lower than the one you negotiated.

The learning from this trip to seven cities in China was that the Chinese are far more capitalist than westerners. The rules or norms expected from western countries do not apply in China.

Therefore, when Prime Minister Narendra Modi meets Chinese President Xi Jinping, he should take into account the hard negotiations by China and follow own rules. China is also exporting electronic items, from mobile phones to television, worth $14 billion every year to India. This is the largest product category of imports from China to India. The two largest product categories constitute almost 46% of the imports from China, according to Aranca, a Mumbai-based research firm. The Indian market is also important as the western markets are saturated and have turned wary of Chinese imports.

Modi wants to make India a hub for manufacturing. His Independence Day speech talked about initiatives on manufacturing. Manufacturing is about jobs, and jobs in a democracy are not only about livelihood, but also votes. In China too, the government knows that as long as it can keep the job engine churning, it can keep an aspiring population in check.

Therefore, China would like to continue its exports to India and we need to expand our manufacturing base. This is a conflict area and needs to be handled well. But there are other things that need to be done if we need to build a manufacturing base.

One of the areas that has to be addressed is what I call the import gateways into India – the e-commerce sites such as Amazon and Flipkart. The recent sales of mobile phones by Chinese manufacturer Xiaomi on Flipkart shows that the company does not need to set up a distribution network. The $5 billion Xiaomi has found out that the best way to reach Indian consumers is through e-commerce sites. It sold its latest phone Redmi in less than 4.5 seconds. What this does is subvert the way India controls foreign firms.

The Indian government forced Nokia to set up a manufacturing unit in the country by refusing to allowing it to continue with a liaison office and insisted that it needs to set up a subsidiary in India. Nokia tried canalising its imports through HCL Infosystem for some time but finally set up a manufacturing unit. India cannot even dream about exerting a similar kind of pressure on Xiaomi.

Moreover, for all we know that Xiaomi would be canalising all its imports into India through Singapore or any other country where Flipkart has its subsidiary. An email sent to Xiaomi 10 days back on this issue remained unanswered. There are several aspects of routing imports if it not done through a local subsidiary, one is the crucial loss of income tax revenues that would accrue on sales and profits.

Import gateways also have to be controlled if domestic manufacturing has to get a boost. Most people and even some experts fail to understand the government policy of FDI in retail, they think that the BJP government opposes it because it is a party of traders. It is not just the traders or the kirana stores who get affected by FDI in retail, as a matter of fact e-commerce has a more debilitating impact on these stores than organised retail. What FDI in retail or FDI in e-commerce needs is regulation that would control imports of products that bypass regular channels.

Moreover, FDI in retail particularly foreign retail or even organised retail opens up import gateways and has to be controlled and regulated if domestic manufacturing has to get a boost.

The biggest fallacy on imports and import gateways is that it is free trade, and the US educated economists always want to have more of it. This is a philosophy perpetuated by American think tanks. The reality is that populous countries like India need to adopt trade strategies that build their job engines.

China promising bullet trains or even industrial parks need to be seen from just one prism: will it help generate manufacturing jobs or not. Industrial parks should not become a euphemism for assembly or function as warehouses for Chinese goods, they have to be pegged to the number of jobs created.