The Hindu Business Line Financial Daily from the hindu group of publications Wednesday, August 22, 2001

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The Hindu Business Line

Financial Daily
from THE HINDU group of publications
Wednesday, August 22, 2001

Post WTO-entry... -- Is the Chinese challenge real?

S. Majumder

THE prospect of foreign investment in India is under threat in the wake of China's entry into the WTO next year. Analysts fear that China, the largest recipient of foreign direct investment in Asia in the pre-WTO period ($40 billion a year), will pose a greater threat to India, after it enters the WTO.

But, happily, the Americans, the largest investors in India and third largest in China, are upbeat over India's potential to attract foreign investment. This was revealed in a recent study by the American Chambers of Commerce and international consultants, McKinsey. According to the study, India has potential to attract $100 billion foreign direct investment in the next five years at the rate of $20 billion a year against the present rate of $8.6 billion foreign direct investment in 2000.

An analysis of the scenario in the aftermath of China's accession to WTO reveals that there will be both advantages and disadvantages to India. No doubt, China is the largest recipient of foreign investment in Asia, but it, too, will be beset by certain problems that may erupt after its accession to the WTO and act as a barrier to foreign investors.

Three factors may belie the hope for a big jump in foreign investment in China after it enters the WTO. They are reduction in tariffs, keen competition in the domestic manufacturing sector, and a step-by-step opening up of service sector, now banned to the foreign investor, instead of opening the sector at one stroke.

So far, the liberalisation in China, which has been the attraction for large foreign investments, was confined to manufacturing sector. In addition, the geographical proximity to Hong Kong and faster development of infrastructure were behind the foreign investments entering China's manufacturing sector.

Almost all major Fortune 500 companies are invested in China. Of these, 21 American and 19 Japanese firms have already invested in the manufacturing sector in China. The flurry of foreign investment intensified domestic competition and led to over-capacity in China. This made the marketability of some products tough. For instance, Coca-Cola spends more in promotion and marketing in China than in the US.

Further, after two decades of reforms, local enterprises in China stepped up their productivity and sharpened the competitiveness to take on the MNCs. This is particularly true in the case of labour-intensive products, where a decade ago no Chinese entrepreneur could withstand the slightest of foreign presence.

Besides the tariff reductions, removal of unnatural quantitative restrictions and invisible subsidies after China enters the WTO will reduce the attraction of the local market. This may act as a disincentive to foreign investors engaged in export production for cheap labour.

In this scenario, the much-talked of threat to foreign direct investments in India after China enters the WTO does not hold good as the manufacturing sector in India offers greater scope for investment. In China, nearly one-third of the industrial output and one-fifth of the value added in industry are accounted for by foreign invested enterprises. But in India, foreign investment has barely participated in the domestic industry, except in automobiles and electronics.

As a matter of fact, the possible threat lies in the service sector, which has so far remained untapped by the foreign invested firms in China. As a pre-qualification to becoming a WTO member, China has committed to open its services sector which accounts for one-third of GDP. The lucrative areas for investment in this sector in China are finance (banking, service and insurance), distribution (wholesale and retail trade) and related services (warehousing, packaging, advertisements, and express services), information technology services, telecommunications, professional services (accountancy, management consultancy, and legal services), tourism, motion pictures, and audio-visual distribution.

Notwithstanding the opening up of the services sector, which is expected to boost foreign investment in China, there is a suspicion if this hope will at all materialise after China enters the WTO. The argument is that foreign investment in China cannot leapfrog in the immediate future as it requires a minimum five-year transition period to cope with various regulations in formulating regulatory and administrative measures to streamline the foreign investment in the service sector.

For instance, China does not allow foreign investments in telecommunications. Beijing has agreed to implement the BTA (Basic Telecommunication Agreement) after entering the WTO. The BTA requires WTO members to comply with six pro-competitive regulatory institutions such as competitive safeguards, interconnections, and public availability of licensing criteria.

At present, Chinese telecom sector complies with none of these six aspects. As a result, there is a big gap between the current regulatory measures and the BTA condition. These gaps will act as barriers to foreign investment in telecommunications.

But this does not mean India can rest easy. For it must look at the long term when things can change dramatically. India must gear up its efforts to face this challenge. And in this, ironically China's experience may offer a lesson. China has realised the importance of strengthening its domestic industry to face the effects of liberalisation. As a first step, it decided to put through structural reforms in the industry and focussed on automobile and electronic industries when it expected much of foreign interest.

In 1994, China formulated the Industrial Policy for the Automobile Industry, and adopted the Large Enterprise Strategy for development of the electronic industry. The aim of both these policies was to consolidate the large number of fragmented units into a few large corporate groups and leverage the benefits of scale of production, and increase productivity. The outcome of this strategy is that today a single company in China produces more TV sets all of India's output.

Along with the structural reforms, China offered incentives to promote technology transfer and rev up industrial output. In 1998, it stepped up the incentives to encourage research and development. All this attracted the MNCs to set up units in China. These MNCs played a key role in the development of technology. Till that time, foreign investments were made in labour-intensive processing industries of small and medium size that had limited role in promoting technology.

In contrast, though India opened up, it did not change its politicised industrial policy to keep pace with the increasing competitiveness in the global market. India has continued with the age-old reservation policy for small-scale industries. There are various other similar problems.

Thus, it is time for New Delhi to consider a progressive policy towards domestic production and exports that can attract foreign investments. It is imperative that India's trade and investment policies are formulated with an eye on the policies of competing/peer nations.

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