India should plug into China's supply chain; FDI to benefit from China+1

It may not be the most prudent approach to think that India can take up the slack from China vacating certain spaces in manufacturing, the Economic Survey noted and suggested that choosing foreign direct investment (FDI) as a strategy to benefit from the China plus one approach appears more advantageous than relying on trade.

“As countries attempt to reshore and friendshore, India’s policy choices concerning China are exacting,” the Survey cautioned and added that though India may not be an immediate beneficiary of the trade diversion from China, the country has witnessed a substantial increase in its electronic exports over time.

“Will China plus one result in a total movement of trading relations away from China? This may not be the case,” it said.


Citing the case of Mexico, Vietnam, Taiwan and Korea, which were direct beneficiaries of the US’ trade diversion from China and their export shares to the US rose but they also displayed a concomitant rise in Chinese FDI.

“Therefore, the world cannot completely look past China, even as it pursues China plus one,” the Survey said.

It added that India faces two choices to benefit from the China plus one strategy: it can integrate into China's supply chain or promote FDI from China. Among these choices, focusing on FDI from China seems more promising for boosting India's exports to the US, similar to the East Asian economies. Moreover, choosing FDI as a strategy to benefit from the China plus one approach appears more advantageous than relying on trade. This is because China is India's top import partner, and the trade deficit with China has been growing.

“As the US and Europe shift their immediate sourcing away from China, it is more effective to have Chinese companies invest in India and then export the products to these markets rather than importing from China, adding minimal value, and then re-exporting them,” it said.

“Hence, it is imperative that India finds the right balance between importing goods from China and importing capital (FDI) from China,” it said.

Trade re-routing

As per the Survey, the de-globalisation trends are highly heterogeneous across countries. While the US and China are gradually decreasing their reliance on global markets, this does not seem true for the rest of the world.

In fact, the rise in trade through Mexico and Vietnam is a result of Chinese firms re-routing their supply through these countries or by locating themselves in these countries, it said.

“Further, China’s overwhelming dominance in the supply of processed critical minerals and materials for energy transition renders a true decoupling between the two nations neither easy nor likely,” it cautioned.

Economic coercion

China’s dominance over a large number of product categories creates a risk of economic coercion, where the government restrains access to crucial inputs for political leverage.

Beijing has started retaliating against these import restrictions which has further complicated the manufacturing landscape for emerging market and developing economies EMDEs, the Survey highlighted.

“In response the India’s anti-dumping probe against Chinese entities, China has been quietly blocking India’s access to solar equipment,” it said.

Given India’s large bilateral trade deficit with China, it makes India vulnerable to potential abrupt supply disruptions.

“Replacing some well-chosen imports with investments from China raises the prospect of creating domestic know-how down the road. It may have other risks, but as with many other matters, we don’t live in a first-best world. We have to choose between second and third-best choices,” it said.

India’s trade deficit with China in FY23 was $85 billion.