It all started with a seemingly innocuous transaction on April 12 when state-owned People's Bank of China (PBoC) bought an additional 0.2 per cent stake in HDFC Ltd., India's largest housing finance company. Added to PBoC's existing 0.8 per cent stake, this took the Chinese bank's equity past 1 per cent - triggering a notification to stock exchange regulator, the Securities and Exchange Board of India (Sebi).
A registered foreign institutional investor (FII) buying a stake in HDFC is perfectly legal. It was also a smart bargain. Stock markets in the world had been topsy-turvy and till that day HDFC Ltd. had seen 32 per cent erosion in market cap since the market crash triggered by the spread of coronavirus.
Yet, the transaction rang alarm bells at Sebi coming, as it did, amid allegations of Chinese firms exploiting market crash to corner stakes in strategic firms of vulnerable economies. The market regulator played safe and promptly shot off a missive to the finance ministry seeking guidance. It asked if such transactions needed special attention.
In Delhi, its chain reaction continues to unravel till this day. Taking note of the threat posed by Chinese firms to companies in India that may be vulnerable due to economic stagnation because of coronavirus, on April 17, the commerce ministry's Department for Promotion of Industry and Internal Trade (DPIIT) amended foreign direct investment (FDI) guidelines to apply curbs on investments from China. Aimed at preventing any opportunistic takeover from across the border, any fresh FDI from China now requires a specific nod from the government.
Taking a cue, Sebi wrote to custodians the very next day, seeking details of foreign portfolio investments (FPIs) from China, Hong Kong and 11 other Asian countries. While there are no restrictions on Chinese FPIs investing in Indian companies yet, Sebi specifically wants custodians to determine the level of control these investors exercise.
Even though investments - FDI, FII or FPI - from China have not been blocked yet, this has not gone down well with China. The Chinese Embassy in Delhi, in an angry response, demanded that India revise the policy, calling it 'discriminatory' and in 'violation of WTO' rules.
"The impact of the policy on Chinese investors is clear. The additional barriers set by the Indian side for investors from specific countries violate the WTO's principle of non-discrimination, and goes against the general trend of liberalisation and facilitation of trade and investment. More importantly, they do not conform to the consensus of G20 leaders and trade ministers to realise a free, fair, non-discriminatory, transparent, predictable and stable trade and investment environment, and to keep our markets open," said Chinese embassy spokesperson counsellor Ji Rong. "Companies make choices based on market principles. We hope India would revise relevant discriminatory practices, treat investments from different countries equally, and foster an open, fair and equitable business environment."
India remains unmoved and combative. "It does not violate any WTO guideline in any way. We are well within our rights to formulate or tweak any policy. Just to be clear, we are not blocking any investment, only making sure that the intent behind it is positive. What is wrong with that?" says a senior commerce ministry official.
Shots fired, the die has been cast. But this may be just the beginning of an adversarial relationship with China that will require deft economic and geopolitical manoeuvring. While regulators tighten the noose (Sebi is widely expected to follow DPIIT), even Chinese consumer firms such as MG Motors, Xiaomi, Lenovo, Oppo and Vivo are bracing for a possible consumer backlash when the lockdown is lifted. Greater scrutiny of Chinese investments will have far-reaching consequences including, but not restricted to, the Indian start-up ecosystem that is flush with capital from across the border. Chinese investors pumped in an estimated $4 billion into Indian startups in 2019 alone. And as India actively woos investments from firms looking for alternatives to China, it will have to combat the fuming dragon more often.
"China's FDI in India remains quite small, so the recent restrictions are not going to materially change the picture. The purpose is to prevent Chinese state-owned companies from opportunistically buying stock of Indian companies that are currently facing a downturn in their stock price," says geo-strategist Brahma Chellaney.
With global recession staring in the face, the friction between the two Asian economic giants is only expected to increase.
Opportunistic Raids on Firms?
The pandemic is set to push the world economy into its worst recession since the 1930s Great Depression. While the world economy is projected to shrink at least 3 per cent in 2020, the International Monetary Fund (IMF) believes India's economy will grow 1.9 per cent. The impact of the slowdown on companies would be dramatic. So, many could lose value in stock markets, making them vulnerable to takeovers. Since China, besides India, is the only other large economy expected to grow its GDP in FY21, it is feared that state-owned Chinese firms may make opportunistic purchases here. "We need to be extremely watchful of Chinese moves, including its investment instruments, and its presence in ASEAN countries," says Abhyuday Jindal, Managing Director, Jindal Stainless, India's largest stainless steel company.
But is it Realistic?
China does not figure among the Top 10 FDI or Top 10 FPI investors in India. Official FDI figures would show at first glance that the DPIIT curbs appear to be a case of much ado about nothing. Between 2000 and 2019, Chinese FDI into India barely added up to $2.3 billion, Commerce Minister Piyush Goyal told Parliament. That is barely half a per cent of all FDI during the period. The Chinese government inflates this to $8 billion but even that is under 2 per cent of total FDI.
However, these numbers do not give the full picture. The Centre is worried because these benign numbers could be misleading. A significant chunk of Chinese investments come through destinations such as Hong Kong and Singapore. India's largest smartphone manufacturer, Xiaomi, for example, has routed its Rs 3,500 crore investment in India through its subsidiary in Singapore. Overall FDI from Singapore has been $94.6 billion in the last two decades, accounting for 20 per cent of all FDI into India. This makes Singapore the 2nd-largest source of FDI into India. Hong Kong pumped in another $4.2 billion during this period. Even the Centre is grappling with exact China-specific FDI via these routes. Jidesh Kumar, Managing Partner , King Stubb & Kasiva, an M&A focused law firm, says, "Usually, investments in India from border states will be structured by creating SPVs in Hong Kong, Singapore, Mauritius, the Netherlands or other jurisdictions to avail tax-treaty benefits under the respective double taxation avoidance agreements (executed by India with these countries)." The biggest Chinese investments have come in the technology sector. Players like Tencent and Alibaba invested in Indian tech start-ups such as Udaan, Delhivery, Swiggy and BigBasket in 2019. The non-tech FDI is sparse.
Even so, just looking at the size of the FDI would be missing the woods for the trees. The other concern which prompted the government to put these investments under the scanner is Chinese firms using lower valuations to strike lucrative deals via the FPI route. "The revision of FDI policy is useful for indigenous entrepreneurs and businesses. It will give a reprieve to businesses that are financially fragile on account of the great lockdown," says Cyril Shroff, Managing Partner, Cyril Amarchand Mangaldas. "This could ensure that the valuations at which Indian businesses receive investments are fair and reasonable."
But the threat is limited here as well. Besides HDFC Ltd, there are only five other companies that have received significant FPI investments from China or Hong Kong. Of these, Hong Kong-based Thai Union Asia Investment Holding Ltd has the largest stake - 8.77 per cent - in shrimp exporting firm Avanti Feeds, while HSBC Pooled Investment Fund has a 3.29 per cent stake in pharma major Glenmark Pharmaceuticals and Hong Kong Victory Investment Co has a 6.32 per cent stake in Kingfa Science and Technology (See Companies With Significant Investment From China)
While it is purportedly aimed at preventing takeovers, the impact of the change in guidelines could be widespread. According to law firm Shardul Amarchand Mangaldas, the changes would impact existing Chinese firms looking to invest more capital, investments from China for greenfield projects as also foreign entities with subsidiaries in India looking to raise capital from overseas.
India is not alone in trying to protect its companies from a potential Chinese invasion either. Many European countries, including Italy, Spain, Germany and France, besides Australia, have recently put similar curbs on opportunistic investments from China (See India in Sync with the World).
"Hostile takeovers are not a country-specific risk and can happen from anywhere in this time of crisis when valuations of companies are down. We need to take precautions from everywhere. China carries a higher risk because of its political setup which is considered to be non-transparent," says Gopal Krishna Agarwal, National Spokesperson (Economic Affairs), Bharatiya Janata Party. "India cannot have the luxury of not having discretion. The financial position will be very critical in the immediate aftermath of Covid and we should not be in a position where we expose our vulnerabilities to China," says Harsh Pant, Director, Studies and Head, Strategic Studies Program, Observer Research Foundation. "China has exposed itself with this crisis and shown its aggressiveness. The world, with India included in it, is wary of it."
At the same time, too much regulation could also prove to be counter-productive. As a growing economy, India needs investments in infrastructure and labour intensive sectors and with the world economy headed towards a recession, China could be one of the few major economies bucking the trend and willing to spend. "China's cumulative investments in India are far more than the total investments of India's other bordering countries. Our investments have driven the development of India's industries such as mobile phone, household electrical appliances, infrastructure and automobile, creating a large number of jobs in India, and promoting mutually beneficial and win-win cooperation," Ji Rong argues. "Where companies choose to invest and operate depends on the country's economic fundamentals and business environment. Facing the economic downturn caused by Covid-19, countries should work together to create a favourable investment environment to speed up the resumption of companies' production and operation."
Agarwal of the BJP agrees, adding India need not follow the path taken by others but chart its own course, as its reality is different. "We need not get entangled in any global warfare and we just need to protect our domestic interests. Others should not use our shoulders to fire at China," he says. "We should also be a bit cautious when dealing with FDI because while we have abundance of labour and raw materials, we are short of capital. So, we also need investments. China is the world's second-largest economy and has the capital. So, it would not be prudent to restrict investments entirely. We need a balance."
Bracing up for Consumer Backlash
"As we are going to mark the 75th anniversary of Independence in 2022, I urge all the youth of this country to use Swadeshi and buy local products in order to give impetus to local produce and generate employment in the country," Prime Minister Narendra Modi said in December 2019 in his regular radio programme Mann ki Baat.
A call to buy made in India goods from none other than the prime minister himself is bound to sway consumer mindset, given his popularity. The bad press China has been receiving across the globe, with criticism of its handling of the pandemic, can only add to that. "The pandemic has unleashed strong feelings about China globally. They are now facing strong headwinds across the world and India is no exception," says Chellaney. Praveen Khandelwal, National Secretary General, Confederation of All India Traders, says, "Even before the lockdown, consumers had started to show their dislike for Chinese goods and would not buy them even if available cheap. This is the best time to put an end to import of non-essential goods like toys from China."
"The cost quality balance of engineering products coming out of India is superior to that of China. That is why Triumph and KTM have allied with us while a company like BMW has allied with TVS. India is going to win on its merit and does not need China to fail for it to succeed. But Indian industry needs its government to support it," says Rajiv Bajaj, Managing Director of Bajaj Auto.
At the other end of the spectrum are social media apps backed by Chinese companies which, apart from being popular, are turning into a nightmare for the government in controlling fake news. Apps like Helo, SHAREit, TikTok and Vigo have penetrated deep into Tier II-III towns and have a huge rural user base with unregulated content. TikTok had in 2019 run into trouble when the Madras High Court banned it for increased crime and inappropriate content. The ban was later lifted.
Though not a Chinese company, the latest platform to get into trouble is video-calling app Zoom, which has emerged as an alternative business calling app during the Covid crisis. Among the other shareholders of Zoom, founded by Chinese-American Eric Yuan, is Hong Kong's richest man Li Ka Shing, founder of the Hutchison Whampoa empire. The Ministry of Home Affairs issued an advisory against using Zoom after security concerns were raised with the company housing its data centre in China, among the 17 data centres it has around the world. Sameer Raje, Head of India, Zoom Video Communications, says the company takes privacy seriously. "Many large global institutions have done exhaustive security reviews of our user, network and data centre layers and continue to use Zoom for most or all of their unified communications needs," says Raje. He says Zoom is in talks with the MHA and is focused on providing information they need to make informed decisions on policies.
There is strong sentiment on social media as well. The day the PBoC raised its stake in HDFC Ltd, the bank was trolled on microblogging site Twitter with people likening this to an attack by China on India's banking system.
Similarly, hashtags like #BoycottChina regularly trend on Twitter in India and some political outfits have also latched on to this. The Swadeshi Jagaran Manch (SJM), an organisation that promotes indigenous goods and has close ties with the government and the RSS, has from time to time exhorted consumers to shun Chinese goods. "After #ChineseVirus, the world has started realising the reality of China beyond cheap goods. This is the time for the globe to unite and practice complete boycott of Chinese goods and capital," Ashwani Mahajan, the National Co-convener of SJM, tweeted on April 21. He has more than 31,000 followers.
This is not the first time a campaign to boycott goods from China has gained currency in India. But the earlier ones have had negligible impact on business in the past. Chinese firms are hoping it will be the same this time as well. "During such crises, there are always some vested interests who want to amplify such kind of negative views. There are some noises but at the end of the day people are smart. We as Indians basically want a good value proposition. So, let the best products and services prevail and let politicians play politics and business guys focus on doing business," says Rajeev Chaba, President and Managing Director, MG Motor. "MG is a quintessential British brand where ownership happens to be Chinese. Our top management is 100 per cent Indian and we have invested Rs 3,000-4000 crore in India. We are no different from a Honda, Toyota or a Ford with strong local manufacturing that is supported by a large set of global suppliers."
Smartphone companies from China that have made even deeper inroads in the market - Xiaomi, Vivo and Oppo are among the top 5 - also say they are as Indian a company as any except for the ownership. "Covid-19 has had a worldwide impact and any region-focused bias would be deemed unnatural. Our focus and priority remains on supporting all customers and minimising disruption. Given our global footprint, we feel we are in a position to handle this well," says Rahul Agarwal, CEO and Managing Director, Lenovo India. Xiaomi says 99 per cent of its smartphones, as well as smart TVs and powerbanks, are made locally and 65 per cent of the value of each phone is sourced from within India.
"Not just this, we have been able to generate employment for over 50,000 people in India across our partners," says a Xiaomi India spokesperson. "We boast of a completely local leadership. We might be headquartered in China but Xiaomi India operates exactly like a local company and we hope our users can see that."
An online survey conducted between late March and early April by Takshashila Institution, a Bangalore-based think tank, highlights the negative perception for China among Indians. With a sample size of nearly 1,300 respondents, a majority 1,156 from India, it found that two-thirds held China responsible for the coronavirus pandemic. Almost the same percentage believed that China's policies towards containing the outbreak were draconian and opaque as the Chinese government tried to cover up the true scale of the crisis. A majority also felt that calling the epidemic a "Chinese virus", words first used by US President Donald Trump, or "Wuhan Virus", was neither unjustified nor racist while 56 per cent felt China was using the crisis to project its power.
This is not great news for Chinese firms operating in India, especially in consumer-centric sectors. China has been a late entrant into the Indian market but in the last five years, its companies have made significant inroads. For example, Chinese firms have cornered more than 50 per cent share in India's growing $8 billion smartphone industry. Similarly, MG Motor, owned by China's largest automotive company SAIC, made a stellar debut in the Indian market with its Hector SUV last year. Should this feeling of antagonism fester among Indian consumers, these firms could be at the receiving end of it. It is compounded by the fact that the government has also been exhorting consumers to buy more from local companies across sectors.
Nevertheless, this has given rivals added ammunition to attack Chinese companies in the market. "I will be lying if I say as a sales guy I will not use this issue to tilt consumers towards me," said a sales executive with a rival Korean firm. "The easiest way for me would be to raise questions about data security. Nobody is sure where the data goes if one is using a Chinese smartphone. So, consumers should take that into account when they make a purchase."
However, Fosun International said while declaring its annual results that it will continue to cultivate existing regional markets, including China, Europe and the United States, as well as emerging markets such as India and Brazil. Fosun is a Chinese conglomerate.
Grip over the Unicorns
Perhaps the more glaring Chinese investments have been in the new economy. Right from fintech companies like Paytm (including subsidiaries), PolicyBazaar, consumer-tech companies like Swiggy, Zomato, BigBasket, edutech players like Byjus, transport companies like Ola, and e-commerce company Snapdeal, leading Chinese funds such as Alibaba, Ant Financial, Tencent, Shunwei Capital, Fosun and others hold sway over the Indian start-up universe. According to IT industry body Nasscom, in FY2020, India housed over 9,000 tech start-ups out of which over 1,600 were in the deep-tech space and 27 were unicorns (valued over a billion dollars). They got over $4 billion funding during FY2020, it says.
With investments in companies that are a treasure trove of sensitive data and otherwise, naturally, a sudden curiosity has arisen over the possible implications of the changes in the FDI policy. With the revised position, says Jidesh Kumar, Managing Partner of King Stubb & Kasiva, at the very outset, government approval will be required for all future investments through SPV if there is a Chinese element which results in a situation of Beneficial Ownership.
However, the larger fear among users is about the humongous data with start-ups and its usage. Arguably, in India, accountability of users' data and mandate to store data locally is more the company's discretion and not mandated by law. It is only when the Personal Data Protection Bill, which is with the standing committee of Parliament, is enacted, will Indians have some control over their data. In a post-data protection regime, fintech companies that provide a variety of services will be under the umbrella of the law. The concept of 'consent managers' will also help regulate user consent sharing with third parties.
Though the current changes do not restrict investments into India by Chinese companies under the FII or FPI route, K. Ganesh, serial entrepreneur and promoter of BigBasket, says, "FDI and any other foreign investment cannot be painted with the same brush". Though the digital colonisation of Indian companies has been an argument for a long time, in the current situation where start-ups and MSMEs are facing a tough time and Indian VCs have a low risk appetite, "We should not end up in a situation where we throw the baby out of the bathwater."
With the current changes in FDI, if a VC or a PE fund has a Chinese LP which falls within the definition of Beneficial Owner, it will now have to seek government approval for investing in Indian companies. Many start-up founders fear this will delay their investments by four to six months.
At a time when funding is slowing down and a global crisis at hand, how can the start-up ecosystem survive without investments from some of the most cash-rich investors? Mohandas Pai, Chairman and Co-founder Aarin Capital, says the move will hurt. "From 2014 onwards, we have received $55-60 billion, out of which $6-8 billion has come from China, with big investments into e-retailing and ecommerce companies," he says. Pai says the government must take steps to help Indian start-ups access long-term capital from India. "India is the only country which has a perverse tax policy against its own citizens," says Pai, pointing out that Indian investors pay more, almost twice, long-term capital gains tax than investors of other countries. However, he says that unless data protection laws are enacted and favourable tax regime and alternative capital avenues are created, not only will India be a digital colony but also lose an industry which is driving employment.
Fixing Trade Deficit
Investments, opportunistic takeovers or data security are not the only issues that plague Sino-India business relations. The most enduring issue is trade imbalance. The two neighbours conduct substantial trade with each other that was worth more than $87 billion in 2018/19 and $72.50 billion during April-January 2019/20. China was India's largest trading partner between fiscals 2014 and 2018 before the US overtook it. But there is also substantial trade with Hong Kong. Bilateral trade with Hong Kong stood at $31 billion in 2018/19 and $23.93 billion during April-January 2019/20. Rajesh Sawhney, serial entrepreneur and co-founder of Inner Chef, points out that while the government wants to protect Indian businesses, the bigger issue is the $60 billion-plus deficit that India has with China compared to $4-5 billion that the Chinese have invested into Indian start-ups. It is, however, heavily skewed in favour of China, which enjoys a massive trade surplus of over $50 billion. With Hong Kong too, the deficit is a sizeable $5 billion. It makes India not dependent on China.
One of the biggest lessons from the pandemic that originated from China's Wuhan province is the need to loosen China's grip on global supply chains. Experts believe this is a good time for India to relook at its policy towards China in its entirety. "When the pandemic started and China was affected, the supply chain got disrupted and for many countries the realisation was they did not have any other source," says Agneshwar Sen, Associate Partner, Tax and Economic Policy (International Trade) EY. "Global supply chains are a dynamic thing. So, countries will look at alternatives and not put all eggs in one basket to avoid a repeat in case of a future calamity."
And India plans to make the most of it. "Now the world is rethinking its strategy of putting all eggs in one basket. A lot of interest is being shown by companies towards India," says Guruprasad Mohapatra, Secretary in the DPIIT. Around 1,000 foreign companies are engaged in discussions at various levels with Indian authorities. At least 300 of these are actively pursuing production plans in sectors such as mobiles, electronics, medical devices, textiles and synthetic fabric, according to top government sources.
Besides, there is a concerted effort to reduce dependence on China for Indian firms. China accounts for almost 18 per cent of India's total merchandise imports. In some sectors like electronics, automotive components, solar equipment and pharmaceuticals, the dependence is big. In solar equipment, for example, China is the source of import for nearly 80 per cent of all solar cells and modules in India. Similarly, a quarter of the automotive components worth over $4 billion in 2018/19 ($2 billion in the first-half of 2019/20) came from China.
Companies such as Tata Motors which want to avail India's FAME II benefits for subsidised electric vehicle production are required to localise up to 40 per cent today. This number will rise to over 60 per cent by April 2021.
The Centre is working on products that could be manufactured locally to cut dependence on China. These are across sectors such as electrical equipment, active pharma ingredients (drug parks policy has been announced), optical fibre, boilers, tiles, sanitary ware, leather, paper board, silk and toys. In toys, imports are as high as 70 per cent. The intention is to raise import duties and encourage local manufacturing. Total imports from China in toys, games and sports equipment were $451.70 million in FY19. In ceramic products, they were $340.75 million compared to $597.60 from the rest of the world.
"Chinese firms have been dumping goods at irrational prices in India," says Abhyuday Jindal. "We'll all need measures to safeguard indigenous industry in the wake of the pandemic. The time couldn't have been more ripe for the government to realise its 'Make in India' promise, and provide stimulus to local manufacturing."
For India, disengaging with China will neither be easy nor in some cases advisable. In many sectors like printed circuit boards or semiconductors or solar modules and cells, India simply does not have the scale to make components competitively enough. "I do not think the supply chain in the automotive sector can be replaced in six months or one year but yes, if people are disenchanted with China for logical or emotional reasons, it will happen," says Rajiv Bajaj.
In the last few years, the government has increased import duties on a number of products to encourage local production that can reduce the deficit with China. In last year's Budget, duties on a range of consumer durable items like air conditioners, CD, DVD, CRT monitors and TV and plasma display panels were raised. This year too, duties on electrical appliances like fans, water heaters and ovens, electric vehicles and compressors for refrigerators and air conditioners were hiked. Electronic items and electrical equipment form the bulk of India's imports from China. Similarly, on solar equipment, a safeguard duty on imports from China was imposed in 2018; it expires in July this year. There is expectation that beyond the curb on investments, India will look at increasing duties on more items from China. "We have been talking about reducing our trade deficit for quite some time now but nothing has come of it. But I think this pandemic will reopen the debate that more needs to be done," says Pant of ORF. "There will be a clear attempt at restructuring the foundations of our manufacturing and innovate so that we are less dependent, particularly in critical sectors."
Reducing the deficit also has its pitfalls for India. No other country has the scale and capacity to supply parts that are being imported from China. Building indigenous factories will also take time.
"I do not foresee takeover anxieties in the renewables sector. There were opportunities in the past too but they didn't fructify and nothing big has changed to suggest they will suddenly start happening now," says Ashish Khanna, MD & CEO, Tata Power Solar and President. Tata Power Renewables. "There was an attempt to curb imports from China with safeguard duties but it was not very successful. We are not in a position to self-sustain and the advantage China has is that they have the full value chain for manufacturing solar panels, modules and cells. They also have the scale that makes them cost effective. For us, till the time we have the full supply chain, any abrupt stoppage (of imports) will harm the industry."
Next up, People's Bank of China's foreign portfolio investor licence is due for renewal in May. Following that, licences of at least a dozen more investors from China, including its sovereign fund, National Social Security Fund and Hong Kong-based East Asia Bank, shall come up for renewal in the next two years.
Their fate will indicate which way this relationship is headed.
(With inputs from Nirbhay Kumar)