The global head of economics at Deutsche Bank on why the world may not be as accommodating of India's export-oriented manufacturing model
Singapore: While India has a strong case for manufacturing, the constraint is that the rest of the world may not be as accommodating of the country’s export-oriented manufacturing model, as they were with China, says Michael Spencer, managing director, global head of economics and head of research, Asia Pacific, Deutsche Bank AG.
“What we are seeing leaving China is the labour-intensive stuff. India is the natural next place to make these. What will become increasingly evident is that as you get into the next level and upper level of technological sophistication, it is going to be harder to compete, unless you are automating the way China is doing," Spencer said in an interview. Edited excerpts:
You are of the view that with the exception of India, where the labour market is still growing, manufacturing will increasingly be driven by robotics. You had said China is moving into robotics for its manufacturing sector. Against this backdrop, does India have a case for manufacturing, especially with regard to Make in India?
Of course India has a case for manufacturing. No country has successfully developed without having mastered manufacturing. One of the curious things about India is the perception that its people are not good at making things, and that Indians like to think that they are good at math, and information technology and Internet. Indian manufacturing has been remarkably efficient and productive... back in 2002, I remember the Daimler Group telling me their India factory was the most efficient in the world. The perception in India is: “we are not very good at making things, and we need to leapfrog from agriculture to services".
But what has held back manufacturing in India is poor infrastructure, and successive governments have understood that—we are now seeing an improvement in the physical infrastructure in India that will support a more robust manufacturing base. But other things should happen to facilitate that—from a global perspective, labour laws in India are incredibly restrictive. My personal opinion is that I would have liked to see this government address this on priority.
There are also other aspects that hold back manufacturing, like the legal system—that is a problem. There is a lot that ought to be done. Already today, you have a strong base for manufacturing—the constraint is there is a real threat to the export-based manufacturing model. It may be a pity for India, where they finally get to a point where they may be ready to embrace this model—and export-oriented manufacturing model has been hugely powerful in this part of the world—and the problem is that, the rest of the world may not be willing to let India do what China did 20 years ago.
There is a real risk there because inbuilt-oriented manufacturing has generally not worked. There are improvements in physical infrastructure in parts of the country—we have the golden quadrilateral highway, the Delhi-Mumbai corridor and there are reasons to be optimistic, that from a global perspective, India can take the hand off from China. Question is, will the rest of the world be as accommodating of India’s export-oriented manufacturing, as they were with China. What we are seeing is that, they may not be. Robots and automation part of manufacturing is not part of this—there will always be a role for labour-intensive manufacturing for technologically less sophisticated products.
What we are seeing leaving China is the labour-intensive stuff. India is the natural next place to make these. What will become increasingly evident is that as you get into the next level and upper level of technological sophistication, it is going to be harder to compete, unless you are automating the way China is doing.
What is fascinating about the Chinese embrace of robotics is that it is not driven just by labour market pressure—look at mobile phones, and when you look at the industrial Internet of Things, of putting little devices on every car, refrigerator, turbine fan—humans simply cannot operate on that scale. These can only be assembled by machines. Since 2013, China has been the largest market for robotics in the world, and will over the next couple of years, become the largest producer of robots in the world.
It is fascinating that a country of 1.2 billion people is automating production faster than anyone else in the world, but the Chinese are looking at 15-20 years down the road, when their working-age population will be ageing, and will be declining at a faster pace. To be competitive in manufacturing, you have to adopt the same labour-saving technologies that advanced countries will—we are in the cusp of a new kind of industrial automation that could provide the basis for significant productivity growth, and Asia is not only going to be the place where we are making the hardware to make that possible, but Asia could be in the forefront of using it.
The industry that over the last couple of years has been adopting automation most dramatically is the electronics industry—we’ve got things down to the size where humans cannot assemble them. China had 30 years of manufacturing growth before they reached that point. India may find that this point comes rather soon.
Are non-performing loans (NPLs) in India’s banking sector also a constraint to manufacturing taking off in the country? China, too, has an NPL problem with its banks—how do you look at the situation in both countries?
It is probably more of a constraint in India, but not at the corporate level. Across the world, corporates finance their investments through their retained earnings. They rely on bank lendings in the short term to soothe through a period of weakness or get to a new investment going, but most capex is self-financed. I think the constraint that bank NPLs poses for India is in infrastructure.
Infrastructure projects, historically in their early years, are financed by bank loans—every government in Asia is now talking about PPP (public-private partnership) as a new framework for financing infrastructure. Historically at least, bond investors only come in once the project is up and running—so you finance a toll road through bank loans for the 3-4 years it takes to build it, and then you refinance that into a 20-30 year bond and pay it off through tolls. In China, you’ve got a government that can compel banks to provide that infrastructure financing, but in India, you don’t. Even Indian state-owned banks, to their credit, behave like private sector banks. If the banking system is going to take another couple of years to work off bad loans, and help companies work out the problem loans that are resolvable, I think it may end up becoming more of a restraint on infrastructure investment.
Looking at India from outside, are investors worried about whether Reserve Bank of India governor Raghuram Rajan will get a second term?
It depends on what type of investors. For portfolio investors, who see governor Rajan as a man of integrity, great intellect and someone who has brought a new way of thinking about the role of the central bank—not just as a leader of financial reforms, and also as a source of discipline—I think portfolio investors value that. In any country, the prospect that the person in whom they have invested so much confidence might not be around is a worry. That means if there is going to be a change, portfolio investors will want someone who is of similar capacity, intellect and experience, taking over.
For FDI (foreign direct investment) investors, this is a short-term issue—but it speaks to the institutional development in India. If you are thinking about an investment that pays out over 20 years, it can’t be based on who is heading the central bank. When you talk to equity investors and fixed-income investors, this is increasingly of concern to them, but for the corporate side, it won’t move the needle.
How do you see two years of the Narendra Modi-led government?
Big picture, I am convinced that in growth terms, the vision that Prime Minister Modi has for the economy—the model he has for what will drive Indian growth over the next decade—is to me a very familiar one that has worked in this part of the world. It is to provide legal infrastructure and infrastructure underpinnings to support export-oriented manufacturing. That was never in China the main driver of growth, and it will not be the main driver of growth in India.
What it does is that, it gives you an element of your manufacturing sector, that is compelled to be competitive to succeed, and it leads the way for the rest of the industry for inculcating best practices both in terms of what to make and how to organize manufacturing and business activity. That is really the importance that export-oriented manufacturing sector has played out in Indonesia, China or elsewhere. It is not that exports are the driver of growth, but it become a way to learn how to be better at doing things... India is logically the only place in the world that offers the same kind of potential and scale, both in terms of domestic market, and also the size of the workforce and cost of that workforce.
I think the Indian government prioritized reforms differently from the way I would have…I think they are disappointed that their popular mandate has not reflected more in legislative progress, and they do not have a majority in the upper House—that has been a constraint. Their expectation is that over the next year or so, they will get that majority, and then they hope to make much more rapid progress. Even things like GST (goods and services tax), which both major political parties while in government have officially promoted over 10 years—the fact that they’ve not been able to finalize that is disappointing.
The first thing India needs to do is to tackle the very long time it takes to decide commercial disputes—the judicial system takes far too long, the legal system is creaking, and the Indian Supreme Court recently made an impassioned plea to the government to appoint more judges to automate better the function of the courts.
Are investors willing to put money into India only because there are not many other emerging markets that offer a positive investment opportunity at the moment?
If you step back, what motivated investors’ interest in India was—political change that offered an economic model that was familiar, and the fact that initially, you had very high interest rates, and in an environment when inflation was declining all over, you looked at India and Indonesia as places where government bond yields were 8% to 9%, and you said, “this is just not going to continue".
Even if you get food price shocks over the years, it was a reasonable expectation that inflation in India would generally decline, and with that bond yields—so you want to be holding that bonds.
As bond yields came down, it would lower the discount factor on corporate earnings that made equities attractive and, I think, that a large factor of the investment in India really has been motivated by taking yields down from 8.5%, more than buying into an economic story... Now that inflation has come down to around 5-5.5%, we think that it will probably end the year at close to 5%, but now it is a low enough rate that the monsoons start to matter—any upside to shock in food prices raises the possibility RBI may have to start raising rates. That is not supportive to foreign investment flows coming in.