Indo-Japan Economic Engagement: Moving from ‘ODA’ to ‘FDI’

“In a world where your purchases have more influence than your political vote, it is

imperative that you take all factors into

consideration before pulling out your wallet

….”

Indo-Japan Economic Engagement: Moving from ‘ODA’ to ‘FDI’

Prerna GandhiResearch Associate, CAPS

Structure for Presentation1.1 Introduction1.2 Beginnings of Modern-Day India- Japan Economic Engagement1.3 Indo-Japan Economic Engagement: The China Factor1.4 CEPA Provisions1.5 Role of Japan in Infrastructure Development in India1.6 Unexplored Potential for India-Japan Economic Engagement1.7 Conclusion: Areas for Improvement

1.1 INTRODUCTION

“It is of crucial importance to Japan’s national interest that it further strengthen ties with India…. It would not be a surprise if in another 10 years, Japan-India relations overtake Japan-US and Japan-China relations.”

Power Stalemate in Asia-Pacific

US-China Power Rivalry vs. US-China Economic Ties

US-Japan Security Alliance vs. Japan’s Changing Security Identity

Majority Middle Powers- US Security Partner vs. China No.1 Trading Partner

Flashpoints vs. Economic Production Networks

The Elephant in this Room…..

International Diplomatic Position

Battle-Hardened Military Untapped Market

Literally the Elephant….. India is bound to play a “game-changing” role by virtue of its…..

Economic Relations- Instrument of PolicyIn modern times a strategic bilateral relationship between major powers cannot be sustained without its having a significant economic content.

More often than not it is the economic content which rests the bilateral relationship with its strategic character.

This is critical for Japan which has been an economic powerhouse without a military-offensive arm to sustain and effect its national interests.

Japan has therefore used economic relations as means of pursuing its strategic goals.

What began as an act of atoning for the war through reparations, transformed into a conciliatory medium by Japan for normalizing relations with neighbours by extending yen loans with concessionary conditions.

At a time when hostilities towards Japan were at an all-time high, by assisting its neighbours with technical and monetary aid, Japan was able to get back in the regional fold (and cultivate its later pacifist image).

Japan was able to achieve the dual objectives- export markets and imports of raw materials- that were critical for the resource-starved Japan.

Later Japan tried to make up for its lack of offensive capability by using its “checkbook diplomacy” to “manipulate” foreign – diplomatic, political and economic relations in its favour.

•Studies have shown that the concentration of Japanese ODA projects on economic infrastructure had a significant positive impact on Japanese investors location choice even though other profit-maximizing factors such as economic agglomeration had a higher spill over effect.

•Further studies have shown that FDI influences trade. While horizontal FDI trades o lower trade costs against ffhigher xed cost, fi vertical FDI takes advantage of cheaper factor prices to produce in a host nation and then export the intermediate/finished goods.

•For Japan investment takes precedence over trade in economic relations- because it is keen to utilize cheap labour and resource factors in the home country while managing the knowledge intensive unit in production itself.

1.2 BEGINNINGS OF MODERN-DAY INDIA-JAPAN ECONOMIC ENGAGEMENT

•While India-Japan cultural relations date back to millennia with the arrival of Buddhism into Japan from India, the massive geographical distance between the two countries did not allow for robust political or economic relations until the modern era.

•1950s saw a brilliant era of India-Japan relations. While India wholeheartedly supported Japan to get back in the fold, Japan repaid India’s efforts with contributing economic assistance for India’s growth & development.

•1960s and 1970s saw a decline. While India’s relations with its neighbours deteriorated, Japan’s relations with its neighbours became upbeat. On the whole different economic perspectives and strategic agendas created a rift between the two.

•1980s saw a revival. While India began partial liberalization and looked for technical and monetary aid, Japan looked to widen its foreign policy options.

•Two large scale JVs between Maruti Udyog Limited and Suzuki Japan in 1982 and Indian Hero Group an Japanese Honda Group in 1983 cemented India’s later position in Automobile and Components Industry.

•1990s saw a transition in both India’ and Japan’ economies. When India faced a severe BOP crisis in 1991, Japan’s unconditional financial assistance left a deep impression on India.

•India initiated both the liberalization program and Look East Policy in early 1990s that transformed its strategic outlook completely.

1.3 INDO-JAPAN ECONOMIC ENGAGEMENT:

THE CHINA FACTOR

•While China renounced reparations under the Peace Treaty in 1978, Japan framed its engagement policy of “kanyo seisaku” of providing political and economic incentives to China to assist with its modernization.

•This was to ensure that China followed a moderate policy steady with Japanese interests. However at the same time, Japan decided to contribute 10% to maintenance of US forces in Japan to ensure the viability of US-Japan Security Alliance.

• ODA did not have the same emotional impact as reparations. Japan saw ODA as an opportunity to undo the wrongdoings of the past by assisting countries that had been under the Imperial Japanese rule.

•China rather than seeing this aid as Japan’s “largesse” as Tokyo intended, saw it as “debt” or “blood money” that Japan owed to China for its atrocities on China during World War II.

•While Japan definitely gained by giving aid to China, Japanese ODA did contribute significantly to China’s economic development process.

•On the whole as Japan entered a second decade of recession in 2000s, China saw a spectacular rise in the regional political, economic and military arenas.

•2005- the year that Japan become China’s largest investor & importer-saw the largest anti- Japanese demonstrations in China since the two countries normalized diplomatic relations in 1972.

•An evident lack of gratitude on China’s part and a very aggressive preparation and execution of the 2008 Olympics, led to Japanese decision to end ODA to China the same year by stating China had come of age.

Three phases of Japanese Investment Boom in India- post 1990

Post-Liberalization 1990s until 1998 Pokhran Tests• Changing International Environment coupled with change in domestic economies gained momentum with the positivity that built up with Japan’s aid to India after the BOP Crisis.

• 1998 Nuclear Tests increased Japan’s ire after India’s refusal to sign the CTBT which led to a complete breakdown.

Post- 2005 Anti-Japanese Protests in China until 2008 global financial crisis• India- US Nuclear Agreement signalled US’s approval of India.

• Volatility in political relations with China led Japanese business to be apprehensive about security of business interests in China.

Post-2012 East China Sea Conflict• Increasing Belligerent Behaviour of China towards Japan after surpassing Japan to become the second-largest economy after the US, coupled with its 2010 temporary embargo on exports of rare-earth minerals to Japan- signalled to Japan that China would not hesitate to let politics to influence economics.

1.4 CEPA PROVISIONS

IJCEPA- JICEPANegotiations for conducting a CEPA were initiated during Manmohan Singh’s visit to Japan in December 2006. The CEPA was signed between India and Japan on 16th February, 2011 which came into effect from 1st August of the same year. What is a

CEPA? How is it different

from an FTA?

What is an FTA?Free Trade Agreements or FTAs are arrangements between two or more countries or trading blocs that primarily agree to reduce or eliminate customs tariff and non tariff barriers on substantial trade between them. Besides trade in goods, FTAs also cover trade in services, IPRs, investment, government procurement, movement of natural persons etc.Easier

Market Access

Preferential

Treatment over Non-

FTA members

Increased Foreign Investmen

t

Non- Tariff

Barriers and MRAs

Different Kinds of FTAs•PTA or Preferential Trade Agreement•FTA or Free Trade Agreement•CECA/CEPA or Comprehensive Economic Cooperation/Partnership Agreement

•Customs Union•Common Market•Economic Union

*Early Harvest Scheme (EHS)

•IJCEPA is divided into 15 Chapters and 147 Articles along with 8 Annexes covering issues from trade in goods and services to rules of origin, customs procedures, technical regulations, standards and conformity assessment procedures, movement of natural persons, investment, improvement of business environment, dispute settlement etc.

•Using the internationally standardized tariff nomenclature of the Harmonized System, the CEPA defines abolition of tariffs in various product categories to cover 94 per cent of items traded between India and Japan over a period of 10 years.

•Japan has undertaken tariff liberalisation on a number of major Indian exports enlarging the potential areas of benefit for India.

•PM Modi's visit to Japan in late August this year led to far-reaching results for India's business and trading community. However the talks to expand CEPA to include pharmaceutical exports have not yielded any results.

1.5 ROLE OF JAPAN IN INFRASTRUCTURE

DEVELOPMENT IN INDIA

What does Infrastructure include?the RBI has defined infrastructure to include:•power•telecommunication•railways•roads including bridges •sea port and airports •industrial parks •urban infrastructure (water supply, sanitation, sewage projects etc.)

•Social and commercial infrastructure (hospitals, educational institutions, hotels etc.)

Source: MOFA 2011

Infrastructure in India•‘The Global Competitiveness Index' of the WEF ranked India at the 71st place in 2013-14. India ranks well below other BRIC nations- China at 28, Brazil at 57, S. Africa at 56 and Russian Federation at 53. The report states that inadequate supply of infrastructure is the key constraint for doing business in India.

•The Planning Commission of India has set a cumulative target of $1 trillion (at 2006-07 prices) for investments in infrastructure over the 12th plan period (2012-13 to 2016-17).Industry reports calculate infrastructure investments will rise to Rs 40 trillion over 2011-12 to 2015-16.

•Power, oil & gas and roads will account for almost two-thirds of the investments.

Japanese Role in Infrastructure Development•Since 2003, Japan has been India’s single largest bilateral donor. Unlike other countries, India was exempted from cuts in ODA following the 2011 Triple Disasters.

•During PM Modi’s visit to Japan in late Aug 2014, Japan committed to give $35 billion to India through public and private funding over the next 5 years for infra projects, including building of smart cities and Modi’s pet projects such as to clean-up of river Ganges and introduce bullet trains in India.

•Assistance in the form of grants-in-aid and soft loans for development projects in India, such as the Delhi Metro, DFC and DMIC are notable.

1.6 UNEXPLORED POTENTIAL FOR INDIA-JAPAN ECONOMIC

ENGAGEMENT

India-Japan Complementarities

INDIA

•Requires capital in all areas and technology

•Many investment opportunities with strong domestic demand

•More than 50% population below 25

•Easy availability of scientific, technical and skilled personnel

•Global powerhouse in software solutions

•Extremely cost competitive

JAPAN

•Surplus capital with businesses and technology powerhouse

•Limited investment opportunities and stagnant domestic demand

•Aging population - 23% above 65 years

•Limited availability of skilled and technical manpower

•High tech hardware and technological capabilities

•High cost economy

Japanese FDI Inflows in India•Japan is the fourth-largest FDI investor in India after Singapore, Mauritius, and the Netherlands (2012-2013).

•At the macro level, Japan has increased its investment flows substantially in absolute terms in recent years, but the share has declined compared to earlier levels.

•Japan is seen as making gains only in capital-intensive markets. Great potential remains unexplored especially in integrated knowledge fields such as biotechnology, pharmaceuticals and IT that are far easier for late entrants than other labour-intensive or capital-intensive fields.

•However with the further opening up of the Indian market, especially in the services sector such as finance, retail, and applied-research industries, potential for greater engagement has widened for Japanese companies in India’s tertiary sector.

Rare-Earth Minerals •China produces more than 95% per cent of the world's rare earths. Japan sources virtually all its rare earths from China.

•Japan has been trying to find new sources of supply since China put temporary embargo in 2010 during row over disputed islands for which it received WTO’ criticism.

•Figures from China Customs show that China’s rare earth exports increased 86.3% from 2013 to 6,565 tons of rare earth to Japan in the first seven months of 2014.

•India produces a little over 2% share of global output of rare earths, but is still the 2nd largest producer after China. Following Modi’s visit, IREL, wholly owned subsidiary of India's DAE, and Japanese Toyota Tsusho signed a JV contract wherein roughly 15% of Japan's needs will be sourced from India.

Pharmaceutical Sector•Pharmaceuticals is India’s third largest overall export product.

•Under the CEPA, Japan accords national treatment to Indian drug makers vis-à-vis its domestic manufacturers.

•However due to lack of any formalized agreement, Indian bulk drug manufacturers suffer major non-tariff barriers.

•The TPP- a mega trade pact being negotiated by 12 countries- intends to introduce stricter patent and IPR laws, especially in the pharma sector have led to Japan delaying the signing of MRA in the pharmaceuticals sector with India.

1.7 CONCLUSION: AREAS FOR IMPROVEMENT

Variables affecting Japanese FDI•Location Advantages•Infrastructure•Control Systems•Administrative Complexities•Japanese Management Techniques

•Enterprise Specific Variables•Sales Turnover•Profit Margins

Major Issues for Japanese Companies•Underdeveloped infrastructure

•Bureaucracy•Land acquisition•Difficulty in finding a right partner

•Declining profitability

•Trade-based labour laws and unions

•Complicated tax scheme

•Lack of quality consciousness

•Difficult human resource management

•Living environment in India

•Top-Bottom Management Style

•Lack of Communication•Lack of team spirit•Gap between labour and management

“We need to stop thinking about infrastructure as an economic stimulant and start thinking about it as a strategy. Economic stimulants produce Bridges to Nowhere. Strategic investment in infrastructure produces a foundation for long-term growth.”- Roger McNamee

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