Indian Prime Minister Narendra Modi’s construction campaign seems to be on an upward trajectory, showing all the signs of imminent success. Multinational companies and long-term foreign investors such as private equity giant Blackstone are eyeing India. The recently presented budget has increased capital expenditure more than expected. With lots of subsidies and sweeteners, firms such as Apple Inc and Samsung Electronics are making huge commitments to the country. Still, a look at the Indian units of long-established multinationals shows how much help the industrial sector will need.
Consider publicly listed ABB India Ltd., the domestic unit of European industrial firm ABB, which manufactures products for automation and electrification, along with other industrial equipment. Orders grew 4% in the latest quarter. However, this was less than the 22% of orders from India for ABB’s global parent company. Why Gap? This is attributed to the supply by ABB India in the domestic market and the import of ABB to meet the growing backlog, the company said in a statement.
ABB India is not alone. Global companies need their parents to meet growing local demand. In a recent earnings call, officials of Cummins India, a unit of Cummins Inc, said that a project with the Gas Authority of India will be taken up by the parent entity and the local business will help in service support and installation. For most firms, large projects that are tendered end up being dependent on foreign entities because many products and supplies are not available domestically, or in some cases, do not meet global standards.
Don’t get me wrong, these firms are still doing well – as long as the orders keep coming in and the firms are able to meet them, business goes on. However, for India’s industrial sector, this means that many companies are not preparing operations for new products. Organic growth doesn’t really happen until demand is established, and any supply chain that develops is piecemeal. These are the holes Modi should focus on filling before private capital comes in.
India’s long-term solution is more local production lines. In theory, high enough demand would mean that domestic ancillary companies build factories on the ground to meet the growing need for motors, gears and other such intermediate goods. But is it enough? Determining a critical mass of real demand before businesses can invest in India is critical – and that’s hard. ABB India last week announced plans to invest $121 million over the next five years, including a factory for gas insulated switch-gear used to manage power systems in substations, railways and industrial complexes is included. Last year, it opened a smart instrumentation factory to manufacture a wide range of devices. Clearly, there is a growing need for infrastructure along with policy tailwinds. However, ABB has been invested in India for a long time. Right now the runway for new companies entering India is long. Despite production-linked incentives, the threshold for sales and upfront capital is too high for medium-sized businesses to avail the subsidy. Companies are still looking for opportunities and shopping around the states for spots.
According to consultants Roedl and Partner India, businesses need to be more open-minded to locations outside urban areas and the time it takes to set up. The southern states of Tamil Nadu and Karnataka are leading the way, with their government-led investment boards offering incentives. In central Indian states, expanding industrial areas are trying to push through the construction of province highways in hopes of increasing access to roads and infrastructure.
Industries such as electronics (including computer software and hardware) and automobiles (largely components) have drawn the bulk of foreign direct investment in the country’s manufacturing sector, pointing to its concentrated and fragmented nature so far.
To avoid becoming just an assembly line, India needs to spread love further up the supply chains. Geographical groups focusing on regions such as China, deep into the hinterland, would be a place to start. Manesar, now a not so remote area near Gurgaon, became an industrial hub and residential area as car manufacturer Maruti Suzuki set up a plant there. It also has excellent sushi and Japanese restaurants. It would also help to attract companies that make important but smaller components, not just the big headline goods.
There is a practical lesson for executives visiting India: Companies need to choose locations where other companies are already present, not states where incentives look best, or congested and saturated urban centres. And tread carefully because the opportunity is there, not where you expect.
©Bloomberg
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