Wednesday, February 3, 2010

India-China trade and industrial policy

So India has finally bitten the bullet and formally raised the issue of China's protectionist trade policy. The Commerce Ministry has issued a strongly worded demarche to its Chinese counterpart expressing its concern at restrictions, especially non-tariff barriers, imposed on Indian goods and services exports to China. Concern has been growing in New Delhi over the rapid growth in trade deficit with China which has rocketed from $1.08 bn in 2001-02 to $22.05 bn in 2008-09.

It is in this context that a decision that the Empowered Group of Ministers (EGoM) on the power sector to bar ultra mega power plants (UMPPs) from sourcing power equipment from abroad assumes significance. While the move would provide a filip to the development of domestic expertise and equipment manufacturing facilities in power equipments and heavy engineering, it would also raise electricity tariffs and slow down the capacity addition program in power generation.

Opponents of this policy restriction have argued that such restrictions could have the effect of limiting competition, spread of latest technologies and timely supply of the large number of equipments needed to meet the highly ambitious power generation capacity addition targets for the Twelfth Plan period. However the arguement is not as simple as it appears.

Consider the context. The massive capacity addition program means a huge anticipated demand for BTG (boiler-turbine-generator) and related equipments. BHEL and other smaller equipment makers cannot meet the demand. Coincidentally, Chinese power equipment makers have emerged as among the cheapest and largest suppliers in the world, with an ability to match the latest technology standards of the established manufacturers like Westinghouse, Hitachi, Siemens etc. With competition hotting up, the generators and bidders for UMPPs cannot be blamed for tie-ups with the cheap Chinese equipment makers.

Governments have two options. They can allow markets to work its magic and leave the generators to procure their equipments from anywhere, including China, and focus only on ensuring the timely completion of the approved projects. In an ideal world, as equipment demand increases, installed capacity grows and given the servicing requirements for the supplied equipments, the foreign manufacturers will find it cost-effective to establish manufacturing (or atleast assembling) facilities in India. And this will happen quickly, especially given the massive demand projections and inevitability of this demand.

However, the dynamics of the real world is much more complicated and there are too many market imperfections for this external sourcing model to work effectively. This therefore demands a second-best approach. For a start, India is too large a market to develop its generation capacity by sourcing a major share of equipments from abroad. The continuous relationship required with the equipment supplier throughout the life-cycle of the power plant and the need for close involvement of equipment makers' personnel during construction and for emergencies during operation means that a off-shore manufacturer will always struggle (witness the problems with visa for Chinese workers and employees) to effectively meet their commitments. The politics and short-term commercial dynamics of the business relationship is too complex for Chinese companies to quickly establish ventures in India as would have been expected in the ideal world.

The massive procurement requirements present a great opportunity for India to quickly ramp up its power equipment manufacturing capacity and thereby boost its heavy engineering sector. Taking a leaf out of the Chinese approach to such external procurements (most famously with aircrafts), India would do well to put in place policies that make it mandatory or encourage external suppliers to have local production facilities or production and technology transfer partnership with Indian manufacturers (apart from BHEL, L&T, Bharat Forge, JSW and GB Engineering are making power equipments).

This would not only be cost-effective for the suppliers but also dramatically improve their efficiency to quickly construct and service the generators, besides adding to the industrial base of the country and providing jobs. And it would also go a long way towards addressing the aforementioned trade deficits, besides being one of the more successful examples of industrial policy by any Indian government.

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