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India: A new dawn for Japanese companies?An Economist Intelligence Unit report

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1 © The Economist Intelligence Unit Limited 2015

India: A new dawn for Japanese companies?

Contents

Executive Summary 2

About the research 4

Introduction 5

1) The big picture 7

A young, growing economy 7

India as an export market 8

Japanese FDI in India 9

M&A 11

2) Synergies and opportunities 12

Infrastructure 12

Energy and arms 14

“Make in India” 15

Hitachi: India as global hub 16

Retail and consumer goods 17

3) Challenges ahead 18

Red tape and taxes 18

Logistics 19

HR and cultural issues 20

Kokuyo: Lessons in M&A, from India to the world 22

4) Conclusion 23



Executive Summary

As the second-most-populous country in the world and one of the largest and fastest-growing economies in Asia, India has always offered much to internationally minded Japanese firms. The success of companies like Suzuki and Honda, which formed partnerships with Indian firms so successful their products came to dominate their respective markets, is evidence of this potential. Yet these successes are notable because they have been comparatively rare; it is fair to say that the potential of the overall bilateral trade and investment relationship has been largely—so far—unrealised. India ranks only 20th as a destination for Japanese exports, for instance, and accounts for just 1.5% of Japan’s foreign direct investment. Fewer Japanese businesses operate in India than in Thailand.

The difficulty of doing business in India—dealing with its complex bureaucracy and regulations, numerous jurisdictions, and inadequate infrastructure, among other irritations—has put off many foreign investors. However, the crushing victory in the 2014 general election of Narendra Modi, the reformist and pro-business former chief minister of Gujarat state, was seen as heralding a new dawn. Mr Modi, it was hoped, would usher in investor-friendly reforms and a new focus on infrastructure that would ease the path of foreign investment and fast-track economic growth. Japanese companies should be well-placed to benefit. This paper examines where the opportunities are and what challenges

remain for those companies eager to seize them. Its main findings include:

l India’s demographic profile and economic transition represent great opportunities India’s economy will grow at an average of 7.1% per year to 2020, according to EIU forecasts. It has a youthful population and a rapidly expanding middle class. Moreover, between 2015 and 2030 its urban population will rise by 39% to nearly 600m people. As well as infrastructure needs, such growth implies a massive increase in demand for consumer goods and financial services that Japanese firms should be well positioned to provide, given their experience in emerging markets.

l India needs infrastructure; Japan can finance and build it Japan’s abundance of capital and India’s need for it are a good match. Japan has long experience in channeling long-term, low-cost funds for infrastructure projects in emerging markets. Japanese firms are already playing a major role in several such projects in India, including the US$90bn Delhi-Mumbai Industrial Corridor and a similar project linking Chennai and Bangalore. Japan is also in the running to supply India with high-speed shinkansen passenger trains: a joint feasibility study is underway. Japanese firms such as Hitachi, Toshiba, Mitsubishi and JGC Corporation are also working on “smart cities” within the planned transport corridors.



l Energy is also a core focus, but nuclear cooperation remains sensitive Improving India’s patchy energy infrastructure is a key goal for Mr Modi—with the ambition of achieving 24-hour electricity for all by 2019. Reaching this goal will require estimated investment of US$250bn in the sector. In Mr Modi’s first full budget the government announced plans to build five “ultra mega” power plants of 4,000 megawatts to ease supply problems. India has been courting Japan with regard to nuclear power generation, but diplomatic obstacles to this remain considerable, as India is a declared nuclear-weapons state.

l Japanese firms are taking up the invitation to “make in India” It is telling that while India is Sony’s fourth-largest market globally, it has not made any products in the country since it shut its last facility there in 2004. Recognising the crucial role manufacturing plays in economic growth, Mr Modi wants to raise its share of GDP from 15% to 25-30%, with plans to slash red tape, simplify taxation and offer incentives to firms to “make in India”. These are so far at an early stage, though the prospect of lower costs should be enticing: average wages in India are lower than many comparable economies. Many Japanese firms—including Sony—are reconsidering; Toto, Nidec and Daikin are just some examples of companies that have either opened factories in India in recent months or have made plans to do so.

l Many see the potential of India as hub to reach markets to the west India is appealing as a potential production and distribution hub for markets in the Middle East, Europe and Africa. To take two examples from interviews for this paper, Hitachi plans to make India a “global hub for productisation”, from which to develop products for export to the Middle East and Africa—as well as for sale locally. Kokuyo, a stationery manufacturer,

also sees India as “a major production hub for overseas markets,” and has made acquisitions to bolster its manufacturing capacity with this in mind.

l The challenges of investing in India remain considerable So far, the economic transformation under Mr Modi is more wishful thinking than reality. The World Bank ranks India 134th out of 189 economies in terms of ease of doing business, taking into account factors such as dealing with permits, paying taxes, enforcing contracts and getting electricity. Poor infrastructure, arbitrary tax treatment, lax enforcement of intellectual property laws and complex bureaucracy (especially regarding land acquisition) are particular problems. Mr Modi’s first full budget, announced in February 2015, includes measures to bolster infrastructure spending, simplify taxation and—pending parliamentary approval—ease land-acquisition rules, which may help.

l Success in M&A requires getting over “culture shock” Japanese firms’ record of buying assets in India is not stellar: the ill-fated purchase by pharmaceutical company Daiichi Sankyo in 2008 of Ranbaxy, an Indian maker of generic drugs, is one oft-mentioned failure, as is NTT’s loss-making joint venture with Tata Group. But M&A is picking up: according to the Zephyr M&A database Japanese companies made some 46 acquisitions (including minority stakes and joint ventures) in India in 2014, up from just 23 in the previous year. Interviewees for this paper recommend close control of acquired assets and getting over “cultural gaps” through regular communication. Cultural differences are exacerbated by the relative dearth of personal contact between Japanese and Indian people: only around 7,000 Japanese work in India (as of 2012), compared to 150,000-plus living in China.



EIU and do not necessarily reflect those of the sponsor. The report was written by David Line and edited by Laurel West. Amie Nagano and Takato Mori contributed additional reporting, and translated the report into Japanese. The English text should be regarded as definitive.

This Economist Intelligence Unit report, sponsored by Standard Chartered Bank, is based on in-depth research, data analysis and interviews with a number of senior executives in India and Japan. Our thanks are due to all interviewees for their time and insights. The views expressed in the report are those of the

About the research



areas in which Japanese firms excel. Japanese consumer companies, meanwhile, are aware that with a shrinking and ageing domestic population their future lies abroad: India has a young demographic profile and vast population, a fast-growing economy, and ample urbanisation potential.

A bilateral free-trade agreement, signed in 2011, seemed set to herald a new phase in cross-border trade and investment. Yet economic ties have so far failed to achieve their potential. To be sure, many Japanese brands are well known in India (e.g. Honda and Suzuki, to give just two household names in the automotive sector), and around 1,000 Japanese firms have operations of one kind or another there, according to the Japan External Trade Organisation (JETRO). But to put that in perspective, over 1,400 Japanese firms are registered with the Japanese Chamber of Commerce (JCC) in Thailand while over 2,400 have signed up at the JCC’s Shanghai office.3 All told, India accounts for only around 1% of Japan’s foreign direct investment and 1.2% of its exports. It is also worth noting that previous summit meetings between national leaders of the two countries, such as one between Mr Abe and Mr Modi’s predecessor Manmohan Singh in May 2013, led to grand pronouncements about Japanese investment without heralding any breakthroughs. Indeed, the difficulties

The warm relationship between India’s prime minister, Narendra Modi, and his Japanese counterpart, Shinzo Abe, is the most obvious sign that ties between the two countries are stronger than perhaps ever before. The two leaders began their respective tenures with much in common: solid mandates after crushing electoral victories, a determination to drive economic growth after years of underperformance, and a robustly nationalist political philosophy. Strategically the two countries—separated geographically by China—have much to gain through co-operation. That Mr Modi made an official visit to Japan only a few months after taking office was symbolic of his desire to deepen and strengthen the bilateral relationship.

The two leaders’ personal ties have a long history, cemented during Mr Modi’s tenure as chief minister of Gujarat state. The “Gujarat model” of development he championed—focused on power-sector reforms, infrastructure investment and industrial liberalisation, among other measures1—benefited from investment by Japanese firms, of which more than 60 now operate there.2 It could therefore be seen as a natural step for Japan to play a key role in helping Mr Modi apply his policies on a national scale. India is in desperate need of investment in infrastructure, energy and manufacturing,

Introduction

1 BJP, “Modi’s Gujarat Model”, campaign pamphlet

2 PTI, “40 more Japanese firms to invest in Gujarat: Japan’s envoy”, August 20th 2014

3 JETRO, “Challenges for India-Japan Investment Promotion and Proposals to Both Governments”, September 2013



for Japanese companies of operating in India remain considerable.

Nonetheless there is a feeling that given his pro-business credentials and the success of the “Gujarat model”, Mr Modi’s accession to the premiership marked a new start in the relationship. In an address to business leaders in Tokyo last September he proclaimed that the “environment of disappointment” that had surrounded India’s economy was over, citing the fastest pace of GDP growth in two years of 5.7% year on year in the April-June

quarter. (Full-year GDP results released since suggest India’s economy is now outpacing even China’s, growing 7.5% in 2014 as a whole.4) Mr Abe, meanwhile, promised to double both Japan’s investment and the number of Japanese companies operating in India within five years, targeting ¥3.5trn (US$33.6bn) of private and public financing. Japanese companies should be in prime position to benefit if the two leaders’ hopes are fulfilled. This paper examines where the opportunities are and what challenges remain for Japanese companies eager to seize them.

4 This follows India’s rebasing of official GDP data, making 2011-12 its base year for comparison rather than 2004-05. This arguably inflated the official growth rate.



The big picture1A young, growing economyIndia’s economic potential has never been in doubt. It is the second most populous country in the world and in purchasing-power-parity terms (in nominal US dollars) its economy is larger than that of Japan and third globally behind the US and China. However, at market exchange rates—of greater relevance to would-be exporters, considering they must sell

goods in India and repatriate profits at such rates—it is far smaller (Figure 1). Nevertheless its economy is expected to grow rapidly, at an average of 7.1% per year to 2020 according to EIU forecasts, and despite having very low per-capita income India has a rapidly expanding middle class (Figure 2). Moreover its demographics are favourable, especially when compared to Japan (Figure 3).

2013 GDP, select G20 economies(US$ bn)

0

4,000

8,000

12,000

16,000

South Afri

ca

Argentin

a

Saudi Ara

bia

Turke

y

Indonesia

Mexico

South Korea

Australia

CanadaIn

diaIta

ly

Russia

BrazilUK

France

Germany

JapanChina

Figure 1: Large but poor

Source: EIU

PPP Market e/r



India as an export marketDespite its potential, India is a surprisingly small market for Japanese exporters: it ranks only 20th overall (Figure 4). The main reason is India’s limited purchasing power. Much smaller economies (such as Mexico or the Philippines) rank higher as markets for Japanese exports, partly because of their higher per-capita incomes: US$10,630 in Mexico and US$2,790 in the Philippines, compared to India’s US$1,505.

In terms of composition, India’s US$10.5bn worth of imports from Japan—which account for 2% of its total imports—are idiosyncratic: globally Japan’s biggest export line is cars and other vehicles (which account for 21% of its

US$, constant 2005 prices

Figure 2: Getting richer

Source: EIU

Median household income (LHS) % of households earning > US$3,000 p.a. (RHS)

0

10

20

30

40

50

60

1,500

2,000

2,500

3,000

3,500

4,000

201820172016201520142013201220112010

Share of Japan’s goods exports, 2013(%)

Figure 4: Not heavily featured

Canada

IndonesiaGermany Korea

China

US

ROW

Panama

PhilippinesMexico

India

TaiwanHong Kong

Singapore

Thailand

UK

NetherlandsMalaysiaAustralia

Russia

Vietnam

18.8113.65

18.1

7.95.035.23 5.82

2.65

2.93

2.382.372.131.941.551.531.481.361.351.351.221.20

Source: ITC calculations based on UN COMTRADE statistics

Population by age group(thousands; both sexes)

15-24

25-49

50-64

65+

0-14

Figure 3: Youthful profile

0 100,000 200,000 300,000 400,000 500,000 600,000

351,239363,764

2030 2010

Source: UN World Population Prospects 2012. Projections are based on medium fertility profile



total goods exports), but these struggle to get into the protected Indian market: vehicles make up only 5% of India’s purchases from Japan, and many of the largest Japanese auto firms have production facilities in the country already. There is a much better match between India’s demand for capital equipment as the country industrialises and Japan’s ability to supply it: comfortably the largest single element in India’s imports from Japan is machinery (US$2.9bn worth, 27% of total imports from Japan; Figure 5).

Japan and India signed a bilateral free-trade agreement in 2011, the Comprehensive Economic Partnership Agreement (CEPA), which covers liberalisation of trade in goods (90% of tariffs on India’s side and 97% on Japan’s are to be phased out within 10 years) and more limited provisions covering trade in services, intellectual property, cross-border investment and visa requirements. Within a year of its coming into force in August 2011 the number of Japanese firms operating in India rose 14%, while the country’s exports to India rose from US$9bn in 2010 to US$11bn the year after. The trend has not been maintained, however: by 2012 not many more Japanese firms had set up in India and goods exports fell to US$10.6bn in 2012 and US$8.6bn in 2013. Ironically, India’s free-trade agreements with other nations have been equally as beneficial to Japanese companies: Sony, which used to have a manufacturing facility in India that it shut in phases in 2004, now imports its products to India from overseas factories using FTAs India has signed with other nations.5

Japanese FDI in IndiaThe CEPA was also expected to herald rapid growth in Japan’s foreign direct investment (FDI) into India, but this has not transpired. Japanese direct investment in India, at around US$15bn, is still relatively modest whether compared with Japan’s total FDI (India makes up

India’s imports from Japan, 2013(US$bn and %)

Figure 5: What India wants

Vehicles0.55

Iron and steel1.54

Machinery2.87

Everything else1.35

Rubber and articles thereof0.3

Plastics and articles thereof0.37

Mineral fuels, distillates0.22

Electrical, electronicequipment, 1.16

Ships, boats0.75

Optical, photo, technical, medical,etc apparatus, 0.57

Organic chemicals0.4

Articles of iron or steel0.42

27%13%

15%

7% 11%

5%

5%

4%

4%

4%

3%

2%

Source: ITC calculations based on UN COMTRADE statistics

only 1.5% of the total) or its investment in other Asian destinations (it is not much more than its FDI in the much smaller economies of Taiwan or Malaysia; Figure 6). To be sure, Japan’s investment in India has grown considerably in recent years, from the US$100m-200m range per year in the early 2000s to a high of

5 Economic Times, “Sony mulls setting up a manufacturing plant in India enthused by policies of new government”, August 26th 2014

6 Nikkei, “Daiichi Sankyo to end 6-year Ranbaxy debacle with sale”, April 8th 2014

Japanese FDI stock by country, 2013(US$bn and %)

Figure 6: A yen for India

Philippines, 10.4

Thailand, 35

Brazil, 35.3China

93

Netherlands94.2

US285.8

Everywhere else109.7

Malaysia, 13.3

Taiwan, 13.3

Canada, 14.5

Vietnam, 8.4

Australia61.2

Cayman Is59.6

Singapore, 36

UK, 53.8

Hong Kong, 18.3

Indonesia, 18.4

France, 20

Korea, 25.5

Germany, 16.9India, 15.1

28%11%

9%

9%5%6% 6%

3%3%

3%2%2%2%2%2%1%1%1%1%1%1%



Annual FDI flows from Japan to India(US$m)

Figure 7: Investing abroad

0

1,000

2,000

3,000

4,000

5,000

6,000 India data (via UNCTAD)Japan data (JETRO)

2013201220112010200920082007200620052004

US$5.6bn in 2008 (most of which came from the purchase of Ranbaxy, an Indian pharmaceuticals manufacturer, by Japan’s Daiichi Sankyo, for ¥500bn6). But gains have not been sustained: currently annual FDI from Japan is running around US$2bn a year. Data from the Reserve Bank of India, meanwhile, suggests a doubling of FDI flows from Japan in the year after the CEPA’s introduction, although it also shows that it subsequently fell back (Figure 7).7 Red tape and a poor record on the part of Japanese firms in managing acquisitions in India (explained in more detail in part 3) are partly to blame.

Figure 8: Good prospects(% respondents)

Promising countries over next 10 years Promising countries over next 3 years

Rank Country % Rank Country %

1 India 53.1 1 Indonesia 44.9

2 China 38.6 2 India 43.6

3 Indonesia 37.5 3 Thailand 38.5

4 Brazil 31.7 4 China 37.5

5 Thailand 27.5 5 Vietnam 30.3

6 Vietnam 26.7 6 Brazil 23.4

7 Myanmar 20.8 7 Mexico 17.2

8 Russia 18.1 8 Myanmar 13.1

9 Mexico 13.1 9 Russia 12.3

10 US 13.1 10 US 11.1

Source: JBIC

Japanese acquisitions in India(number of deals)

0

10

20

30

40

50

2014201320122011201020092008

20 20 18

28 2723

46

Figure 9: Buying spree?

NB: Deals completed and assumed completed in given year. Includes minority stakes, increases in stockholdings, joint ventures and acquisitions.

Source: Zephyr, Bureau van Dijk

7 FDI flow data from India, Japan and in third party databases do not necessarily match. Figures in this paragraph are those from the Japan External Trade Organization (JETRO). For comparable data from the Reserve Bank of India (RBI), collated by UNCTAD, see Figure 4. Data from the RBI includes FDI only through official routes and refers to fiscal years beginning in April.



Figure 10: Who’s in? Select Japanese deals in India, 2014

Buyer Target Deal type Industry

Shiroki Corporation Shiroki Technico India Joint venture Automotive parts

FCC Rico Auto Increased stake in JV to 100%

Automotive parts

Nippon Life Insurance Reliance Capital Asset Management

Increased stake to 49% Financial services

Hitachi Zosen ISGEC Hitachi Zosen Joint venture Heavy engineering

Outsourcing Inc Alp Consulting Acquisition Human resources

Tsubakimoto Chain Mahindra Conveyor Systems Acquisition Industrial machinery

Hitachi Systems Micro Clinic India Acquisition IT services

CAC Accel Frontline Acquisition IT services

Kintetsu World Express Gati Joint venture Logistics

Rohto Pharmaceutical Deep Care Health Joint venture Pharma-ceuticals

Toshiba Vijai Electricals – electricity T&D business

Acquisition Power

Toshiba Mitsubishi-Electric Industrial Systems

AEG Power Solutions: Bangalore facility

Acquisition Power

Meidensha Prime Electric Joint venture Power

en-Japan New Era India Consultancy Acquisition Recruitment consulting

Softbank Inmobi Technologies Capital increase Telecommunications

Sources: Zephyr/Bureau van Dijk, press, companies

8 JBIC, “Survey Report on Overseas Business Operations by Japanese Manufacturing Companies”, March 2014

Nevertheless, surveys of Japanese firms show that India remains a favoured investment destination—particularly in the longer term. A 2013 survey of Japanese manufacturers conducted by the Japan Bank for International Cooperation (JBIC), a publicly owned bank that supports Japanese businesses going abroad, showed India ranked first for promising overseas business destinations over the next 10 years and second over the next three years (Figure 8).8

M&AAlthough Japanese companies’ interest in acquiring assets in India—or entering into joint ventures, which is a prerequisite for

entering specific sectors—is heating up, such investment is starting from a comparatively low base and has suffered some high-profile failures (discussed below). The number of completed deals in recent years has been modest: according to the Zephyr M&A database Japanese companies made some 46 acquisitions (including minority stakes and joint ventures) in India in 2014, up from just 23 in the previous year (Figure 9). These included Hitachi Systems’ acquisition of a 76% stake in Micro Clinic India, an IT services company, and the purchase by Meidensha, a capital goods manufacturer, of 23% of Prime Electric, an Indian transformer manufacturer (Figure 10), as well as various other deals.



Synergies and opportunities2InfrastructureJapan has much to offer India—particularly to help it complete desperately needed large-scale infrastructure projects. “Too much debate and corruption has led to a lack of infrastructure like roads, highways, energy and industrial zones; we are lagging behind,” says Sanjeev Sinha, president of Sun and Sands Advisors, a consultancy that specialises in Japan-India business links. “This is exactly where Japan can contribute: it has huge technology [capabilities] and a long-term investment appetite.”

Japan’s abundance of capital and India’s need for it are clearly a good match. Japan has long experience in channeling long-term, low-cost funds for infrastructure projects in emerging markets in the form of official development assistance (ODA) loans, distributed through policy institutions such as the Japan International Cooperation Agency (JICA) and JBIC. JICA figures show a cumulative commitment of ODA loans to India of ¥4.2trn (around US$35.7bn at exchange rates as of mid-January 2015), through more than 240 agreements for various projects such as roads,

metro projects, water supplies, sanitation, power and other infrastructure sectors.9 JBIC’s 2014 annual report showed 832 loans and equity participation commitments to India up to March of that year, worth a combined ¥1.2trn.10

“If you look at the amount [of funds] and the long-term appetite, Japan is number-one in the world [for infrastructure financing],” says Mr Sinha, noting that JBIC offers 40-year loans at low interest rates.

This presents a massive opportunity for Japanese construction, transport and machinery companies—the involvement of which is often a prerequisite for securing the type of funding described above. JICA was involved in the funding of the Delhi Metro, India’s biggest subway system, and will play a major role in several other major infrastructure projects that have been prioritised by the Modi government. These include the US$90bn Delhi-Mumbai Industrial Corridor (DMIC), which includes a raft of proposed developments along a dedicated 1,483km freight railway (Figure 11), and a similar project linking Chennai and Bangalore.

9 JICA, ODA Loan Project Data, available at http://www2.jica.go.jp/en/yen_loan/index.php/module/search

10 JBIC, Annual Report 2014, p94



Figure 11: Delhi-Mumbai Industrial Corridor

JAMMUAND KASHMIR

HIM ACHALPRADESH

PUNJAB

RAJASTHAN

HARYANA

DelhiUTTAR

PRADESH

MADHYA PRADESH

MAHARASHTRA

GOA

KARNATAKA

ORISSA

BIHAR

WESTBENGAL

BHUTAN

SIKKIM

ARUNACHAL PRADESH

ASSAM NAGALAND

ANDHRAPRADESH

TAMIL NADUKERALA

GUJARAT

Ikbalgarh

Mumbai

Ahmedabad

MANIPUR

MIZORAMTRIPURA

MEGHALAYA

Such projects are not necessarily new, but their implementation has proved more difficult than perhaps the Japanese investors envisaged when the initial deals were struck. The DMIC agreement was signed in 2007 but work got bogged down in disagreements between rival political parties running different states along the route. The crushing victory of Mr Modi’s party in the 2014 general election has removed many of these impediments.

“India is about to build its infrastructure from the bare minimum,” says Ichiro Iino, who was until recently the managing director of Hitachi India and is now the company’s chief executive for the Asia-Pacific region. “It’s certainly a land of opportunity. In all fields including

energy, water, transport, and healthcare—and the IT network infrastructure that cuts across these—there is huge potential.” At the end of 2012 Hitachi committed to investing ¥70bn (US$587m) in India, of which 60-70% had been spent by the end of 2014.

Two aspects of infrastructure in particular have attracted a lot of Japanese attention: transport links and smart cities. In 2013 Sojitz, a Japanese conglomerate, signed a ¥110bn contract—the largest ever signed under an ODA loan—to build a 626-km section of the Western Dedicated Freight Corridor in partnership with India’s Larsen & Toubro.11 Separately, much has also been made about the possibility of Japan supplying India with high-speed shinkansen

11 Sojitz press release, “Sojitz Receives the Contract of Civil & Track Works for Western Dedicated Freight Corridor Project in India”, June 10th 2013



passenger trains, particularly since Mr Modi has allowed complete foreign ownership of such projects. There has been little concrete progress on these to date, although a joint feasibility study on a high-speed railway between Mumbai and Ahmedabad has been launched and should be complete by July 2015.12

Roads are another promising area: in 2013 East Nippon Expressways acquired a small stake in an Indian special purpose company set up by the country’s largest operator of public-private partnership (PPP) roads to widen highways in Maharashtra—a trial that will be carefully watched to see if it is successful and replicable.13

Meanwhile Hitachi, Toshiba, Mitsubishi and JGC Corporation have formed a consortium to work on four “smart cities” within the DMIC route (of several that are being planned). These are intended to be self-sustainable habitats with low pollution, efficient energy supplies and state-of-the-art public transportation. Mr Modi, whose election campaign promised 100 new city developments, took the opportunity while visiting Kyoto in September 2014 to depict it as a model for the planned revamping of Varanasi into a “smart heritage city”,14 suggesting Japanese design and technology will be uppermost in planners’ minds.

The scale and speed of urbanisation across

India illustrates the size of the opportunity: according to UN projections, between 2015 and 2030 India’s urban population will rise by 39% to nearly 600m people (Figure 12). As well as infrastructure needs, such growth implies a massive increase in demand for consumer goods and financial services that Japanese firms should be well positioned to provide. Nevertheless, competition from firms in South Korea, Singapore, Germany, the UK and the US is likely to be steep as more urban development plans are rolled out. China, too, aims to increase its presence in the country: while visiting Delhi shortly after Mr Modi returned from Japan, China’s president, Xi Jinping, announced plans to invest US$20bn in India over the next five years.15

Energy and armsIndia’s patchy energy infrastructure is a key focus for Mr Modi—with the ambition of achieving 24-hour electricity for all by 2019. This will require a massive increase in capacity: in November 2014 Piyush Goyal, the minister for power, coal and renewable energy, said India needed investment of US$250bn in the sector to realise this goal. Meanwhile rapid urbanisation, and a commitment to electrify rural regions, will require more investment in transmission and distribution (T&D).

Investment in power generation has been

12 Business Standard, “Japan going whole hog with investment in Indian infrastructure”, January 27th 2014

13 Economic Times, “IL&FS, East Nippon Expressway to jointly work for PPP projects”, Jun 27th 2013

14 IBNLive, “PM Narendra Modi’s plan to turn Varanasi into a ‘smart city’: Will the Kyoto model work?”, September 1st 2014

15 Nikkei, “China to invest $20B in India over next 5 years”, September 19th 2014

India’s urban population

Figure 12: Run to the cities

Source: UN, Department of Economic and Social Affairs, Population Division, World Urbanisation Prospects: The 2014 Revision

Millions (LHS) % (RHS)

200

300

400

500

600

700

800

900

20

25

30

35

40

45

50

55

20502045204020352030202520202015



hamstrung over the years by numerous issues such as acceptable risk levels, and most recently by erratic fuel supplies (in particular owing to controversies over the allocation and exploitation of coal resources, and the inefficiencies of the state-owned supplier, Coal India) but Japanese companies have invested in T&D—including two high-profile deals in 2014 by Toshiba and its partners (Figure 10). Meanwhile, in the first full budget of Mr Modi’s tenure, unveiled on February 28th 2015, the government announced plans to build five “ultra mega” power plants of 4,000 megawatts to ease problems with electricity supply.

It is in the field of nuclear power generation that India is most assiduously courting Japan. Hitachi, which in collaboration with GE has a large nuclear-power generation equipment business, would be one major supplier if diplomatic obstacles can be overcome. These remain considerable: during Mr Modi’s visit last year a highly anticipated civil nuclear agreement between the two countries did not materialise, although both governments did pledge to accelerate negotiations. The issue of nuclear co-operation with India remains a particularly sensitive one in Japan, as India is a declared nuclear-weapons state. The Japanese government wants explicit guarantees from India, which is not a signatory of the nuclear non-proliferation treaty, to limit atomic tests and allow closer inspection of its nuclear facilities.

An equally controversial opportunity—especially given Japan’s fractious diplomatic relations with China—is for Japan to export military equipment to India, something that has only become possible since Mr Abe lifted a long-term ban on such exports in 2013. Discussions on the possible purchase of amphibious aircraft from Japan, specifically the ShinMaywa US-2i, started long before that. During Mr Modi’s Japan trip last year he co-signed defence equipment, technology, and

military co-operation agreements that elevated the relationship between the two countries to a “Special Strategic and Global Partnership”—part of which will involve the sale of 15 planes worth more than US$1.5bn in total.

“Make in India” In theory India should be an attractive opportunity for Japanese companies to establish lower-cost manufacturing bases from which to ship goods to the rest of the world. This has been the foundation of Japanese direct investment in South-east Asia in recent decades—and a trend Mr Modi hopes can be replicated in his country. During a speech on India’s Independence Day (15th August) he invited global companies: “Come, make in India”, and he reiterated that call while in Tokyo the following month, promising that “now a red carpet, not red tape, awaits you”.16 Currently manufacturing makes up around 15% of GDP; Mr Modi wants to raise this to 25-30%.

Certainly the prospect of lower costs should be enticing: average wages in India are lower than many comparable economies—and are projected to stay that way for the short term at least, according to EIU projections (Figure 13). Productivity growth and a continued plentiful supply of new labour, given the country’s

Average manufacturing labour costs per hour(US$, EIU estimates and forecasts)

Figure 13: Pricier, but still cheap

1

2

3

4

5 IndiaThailandChina

2018201720162015201420132012201120102009

Source: EIU

16 NDTV, “Red Carpet, Not Red Tape, Awaits You in India, Says PM Narendra Modi to Japan”, September 2nd 2014



youthful demographics, also have the potential to limit future growth in real wages. However, Japanese firms have so far been reluctant to take advantage of these factors (for reasons examined in more detail below). As mentioned above, to take one example, even though India is Sony’s fourth-largest market globally, it no longer makes any of its products in the country.

But prompted by Mr Modi’s initiatives, the prospect of manufacturing in India is gaining currency among Japanese electronics firms—which have been struggling to match the aggressive pricing of their Korean competitors in the Indian market. A report by India’s Economic Times newspaper quoted Kenichiro Hibi, managing director of Sony’s Indian subsidiary, saying that initiatives allowing foreign manufacturers to sell their products directly online—as well as the prospect of stable economic growth and exchange rates—may well prompt the firm to look again at the possibility of making flat-panel TVs and smartphones

there.17 If it decides to do so Sony would follow Panasonic, Daikin, Sharp and Hitachi in increasing investment in production capacity in the country.

Manufacturers in other sectors are also stepping up their capacity in India to take advantage of expected burgeoning demand. Toto, a manufacturer of sanitary ware, teamed up with trading house Mitsui to begin full-scale production at a state-of-the-art factory in Gujarat, which opened in August 2014,18 while Nidec, a maker of electric motors, announced last June that it would build its first plant in India, for ¥10bn (US$93m), in the Neemrana Industrial Area in Rajasthan—where Daikin has a factory.19 Nidec’s president, Shigenobu Nagamori, later said the company would build around five factories in India.20 Yokohama Rubber, meanwhile, completed a new plant in the country in February this year, while JFE Steel has a joint venture with local steel major JSW in

past two to three years we’ve found that India has strength in designing and producing electrical equipment such as motors and switchgears, the core items supporting the manufacturing industry,” he says. Such technical expertise, married with experience of international standards, makes the partnership of Japanese and Indian skillsets particularly beneficial.

“India has great talent with a flexible and innovative mindset,” Mr Iino explains. “The Indian people are also more used to working with global standards than the Japanese, given the big presence of Western firms in this country. Japanese [companies] tend to be strong in working in an organised manner and producing goods with consistent quality. So I think Japanese and Indian talents complement each other well, presenting immense potential.”

Although Narendra Modi has set his sights on increasing India’s manufacturing capacity, it would be a mistake to see it only as a centre for low-cost production, reckons Ichiro Iino, chief executive for the Asia-Pacific region at Hitachi Group. The company is making India a “global hub for productisation”, that is to develop products there for export to the Middle East and Africa—as well as for sale locally.

“Once you cross the western boundary of Myanmar, it’s wise to assume that you are no longer able to sell the same goods in the same way as you do in Japan and in the rest of South-east Asia,” Mr Iino says. “We can leverage the trust and respect that the Japanese brand and quality receive. But once you are in India, you’d want to look forward to doing things that you couldn’t do in Japan.”

Mr Iino stresses the appeal of the technical skills available to investors in India. “In the

Hitachi: India as global hub

17 See footnote 5

18 Mitusi & Co press release, “Mitsui & Co., TOTO joint venture opens sanitary ware factory in India”, August 20th 2014

19 Globe Newswire, “Nidec to Set Up Its First Manufacturing Foothold in India”, June 4th 2014

20 Nikkei, “Nidec to build five plants in India: President”, June 18th 2014

21 Nikkei, “Japanese investment in India growing, but for how long?”, July 2nd 2014



the latter’s first cold-rolling mill, in Karnataka.21

Many Japanese companies—including Hitachi and Kokuyo, profiled in boxes below—are excited about the prospect of using India as a manufacturing hub from which to ship products elsewhere. One of the most successful Japanese companies in India, Suzuki, is committing to exports by building a plant in Gujarat expressly to service the European and African markets. In January 2015, at an investment summit in Gujarat, the chairman of Suzuki, Osamu Suzuki, told the Nikkei newspaper: “For Japanese companies, India is a gateway to the Middle East, Africa and Europe.”22 But there will be many hurdles—not least logistics and trade facilitation—before this potential can be realised.

Retail and consumer goodsAs mentioned above, the potential for supplying goods and services to India’s rapidly expanding urban, middle-class population is considerable. However, retail remains one of the most protected industries in India. The liberalisation of the sector, while politically sensitive and slow-moving, is proceeding gradually. Since 2012 restrictions have been loosened to allow single-brand stores to establish wholly-owned units, and more opening up is expected during Mr Modi’s tenure.

With India’s apparel market, to take one retail sector, valued at around US$40bn per year and expected to grow 50% by 2020,23 the opportunity is considerable. Japanese firms have been slower than their counterparts overseas (such as Inditex of Spain, Marks &

Spencer of the UK and Benetton of Italy) to take advantage of the recent liberalisation, but Mr Modi’s warm welcome to foreign investment could be the needed incentive for them to dip their toes in the water. In the highest-profile move thus far, Ryohin Keikaku, owner of the Muji brand of household goods, will be the first major Japanese retailer to open in India when it finalises a joint venture agreement with a local partner later this year. It plans to open its first store in Delhi or Mumbai in 2015 or 2016 depending on how swiftly the Indian government approves its investment application.24

Mr Modi also had a meeting with Tadashi Yanai, CEO of Fast Retailing (which owns the Uniqlo brand), in June 2014 and apparently entreated him to expand into India.25 Mr Yanai reportedly told Mr Modi the company would source garments from India.26 Previous reports in early 2013 that the company was about to start a joint venture with India’s Arvind, to establish a US$1bn business in the country, came to nothing (Arvind later announced a joint venture with Uniqlo’s US competitor, Gap, to open 40 stores in India).27

Food is another promising area given projected urbanisation and rising incomes. Japan’s Nikkei newspaper recently reported that Toyo Suisan and Ajinomoto have formed an Indian joint venture to produce instant noodles in Tamil Nadu; Nissin has opened its third instant-noodle plant in India, in Odisha; and Mitsui and Yanmar have formed a JV with India’s Mugrappa Group to make rice-farming machines and combine harvesters.28

22 Nikkei, “India on cusp of breaking out, says Suzuki chief”, January 14th 2015

23 Wall Street Journal, “Arvind to Bring Gap Stores to India”, August 22nd 2014

24 Nikkei, “Muji stores to open in India as country eases restrictions”, September 1st 2014

25 See footnote 21

26 Reuters, “Japan’s Uniqlo may source garments from India”, June 25th 2014

27 Times of India, “Japanese giant Uniqlo set to partner Arvind in India JV”, January 16th 2013

28 See footnote 21



Challenges ahead 3India is not an easy place to do business: the World Bank, in its annual ranking of such issues, rates India 134th out of 189 economies, taking into account factors such as dealing with permits, paying taxes, enforcing contracts and getting electricity.29 But India is far from a homogenous entity. The World Bank also ranks 17 Indian cities by the same criteria. Ludhiana, in the state of Punjab in northern India, ranks first while Kolkata in West Bengal is 17th. To take one indicator, in Ludhiana businesses need 17 procedures to deal with construction permits, taking an average of 143 days (against an OECD average of 13 procedures in 147 days) while in Kolkata they must grapple with 27, taking 258 days.

While it is beyond the scope of this paper to iterate the precise advantages and disadvantages of each location in the country, there are a number of common factors that companies struggle with when doing business there.

Red tape and taxesTaxes and land acquisition are particular problems. “The complex tax system prevalent in India [and] the acquisition of land to establish a factory are major hurdles for Japanese

companies going to India to do business,” says Sandeep Tewari, country head and CEO in Japan for the State Bank of India. JETRO cites complaints by Japanese companies about unequal treatment and uncertainty in how companies will be treated by the tax authorities in different jurisdictions. The prime minister is aiming to tackle such issues, says Mr Tewari, “but it will not happen overnight.” Mr Modi’s government made some initial steps in its first budget, cutting corporate taxes over the next four years to 25% (from around 30% now) and implementing a countrywide goods and services tax by April 2016.

Land acquisition has long been recognised as a hindrance to large-scale investment, even for local businesses, let alone foreign ones. The establishment of special economic zones (SEZs) in which permits and land rights could be more easily acquired was meant to tackle this problem. But it is not a new solution: the first such zone was set up in 1965 and there are more than 190 in operation around the country (as of May 2014).30 This has not led to a significant liberalisation of the business environment in the same way that China’s usage

29 World Bank Group, “Doing Business: Measuring Business Regulations”, available at http://www.doingbusiness.org/rankings

30 Ministry of Commerce & Industry, Special Economic Zones in India website, “Fact Sheet on Special Economic Zones”, January 21st 2015



of similar zones has, but there are hopes Mr Modi’s push for the broader use of such entities may yield faster benefits. Steps taken in the 2015 budget, including an executive order to revise a restrictive 2013 law governing land purchases (eliminating a consent clause and the requirement for social impact assessments to be conducted should the land be used for certain purposes) may help, although this requires the consent of parliament.

Mr Modi’s government has also emphasised the importance of cutting back on the endless regulations that stymie foreign investors. Hiroyuki Ishige, chairman of JETRO, identified bureaucratic red tape as the number-one problem in a recent interview with the Wall Street Journal, saying Japanese companies had complained to him that “when they build a factory in India, they need a separate warehouse to store all the documents for regulatory filings”.31 As part of his simplification drive Mr Modi has scrapped India’s planning commission, which he has accused of excessive centralisation, obstructing other state governments from following the kind of plan he pioneered in Gujarat. Changes to liberalise foreign investment in various sectors are expected, though these are progressing less swiftly than many had hoped when Mr Modi took office.

Given India’s political constitution it might not be realistic to expect dramatic simplification of regulatory jurisdictions, but Japanese investors would be well served by a central repository of information that provides necessary information (for instance about SEZs), claims a 2013 JETRO white paper. The paper makes unflattering comparisons with the situation in Thailand—pointing out that while Thailand’s Board of Investment has two desks in Japan (in Tokyo dating from 1979 and in Osaka from 1995) the Indian government has none.32

The problem is not always of excessive regulation; there are important areas in which

India’s regulations (or at least the enforcement of them) are insufficient, particularly in terms of protecting intellectual property. JETRO’s paper cites numerous instances where Japanese companies have complained that counterfeit and imitation brands operate with impunity and recommends various areas in which improvements are needed. The paper estimates damages from piracy in 2012 were worth as much as 80% of revenues in the IT software industry and 30-40% in the auto parts sector.33

LogisticsWhile there are plenty of opportunities for Japanese construction companies to build roads, bridges, ports, power stations and other vital infrastructure in India, the poor current state of such facilities makes life difficult for businesses in most other industries. JETRO cites complaints from Japanese investors about limited power and water supplies (even in industrial parks), congestion and poor roads that limit truck transport to 300km per day, and innumerable delays in getting approvals for upgrading infrastructure.

Logistics and distribution have been a particular challenge. Mr Sinha of Sun and Sands Advisors cites the example of Lawson convenience stores, which sought his advice when investigating whether to open in India. The political sensitivity of allowing foreign investment in retail (given it is dominated by mom-and-pop stores) meant it was always going to be a speculative exercise. But Lawson’s former president, Takeshi Niinami (who stepped down in May 2014) decided that the poor infrastructure and distribution network—as well as human resources issues—made it a non-starter.

The situation is changing, though, Mr Sinha says. “Distribution and logistics for retail has improved from e-commerce. Flipkart [an online retailer] and other companies have created the impetus to [improve] the logistics industry at the retail level—it’s getting better day by

31 Wall Street Journal Japan RealTime blog, “Japan, India Look to Reenergize Economic Ties”, June 3rd 2014

32 See footnote 3

33 Ibid.



day. Five years ago it was quite backwards, but maybe now Lawson or Uniqlo can consider India as a better opportunity.” Still, it will take time to raise standards. “Logistics will remain a challenge for Japanese companies because they are used to working in an extremely organised environment.”

There are signs that Japanese companies in some sectors are learning to adapt to India’s operating environment. For example, there have been frustrations with delays in getting grand projects such as the DMIC up and running. In part, Mr Sinha contends, this is because Japanese investors “wanted a Master Plan approach for the whole region and to work under that plan”. Given the multiple jurisdictions involved this was always going to be unrealistic. For a similar Bangalore-to-Chennai industrial corridor now being planned, Japanese companies are being much more flexible. “They have not taken a ‘big plan’ approach, which won’t work in India,” says Mr Sinha; rather “they are attracting entrepreneurs and using a PPP [public-private partnership] model rather than government planning.”

The government is certainly aware of the need to invest in infrastructure to make India a more attractive investment destination. In Mr Modi’s first full budget the government said it would double investment in transport, as part of Rs700bn (US$11bn) in extra spending allocated for roads, railways and other infrastructure.34

HR and cultural issuesIndia’s abundant, relatively cheap human capital makes it an ostensibly attractive place to invest. However, it is hardly alone in having a large labour pool: its South Asian neighbours Bangladesh and Myanmar can offer the same. And while there might be an abundance of unskilled labour in India, the price of this is rising steadily: in a 2012 JETRO survey of Japanese companies in India wage increases were the most commonly cited business issue—ahead of even logistics or infrastructure problems (Figure 14).

Tellingly, according to Mr Sinha, the second reason Lawson’s president gave for deciding against an Indian foray was the low quality of available labour. “One of India’s weaknesses is education; it’s good in tech education like physics, sciences, engineering and so on, but there isn’t enough vocati onal education.” This means a lack of available middle managers who might reliably oversee the local operations of Japanese businesses. Meanwhile, cultural differences are exacerbated by the relative dearth of personal contact between Japanese and Indian people: only around 7,000 Japanese work in India (as of 2012), compared to 150,000-plus living in China.35

A lack of mutual understanding has proved to be a problem when Japanese companies buy assets in the country. Indeed, the story of Japanese M&A in India is more famous for its high-profile failures than its successes. These include the purchase by pharmaceutical company Daiichi Sankyo in 2008 of Ranbaxy, an Indian maker of generic drugs. Shortly after the purchase, quality-control problems led to Ranbaxy’s products being banned by the US’s Food and Drug Administration. Daiichi Sankyo was unable to fix problems at Ranbaxy, in part, some analysts speculated, because it never

Figure 14: Reported problems Business issues of Japanese companies in India (% respondents)

India %

1 Wage increase 71.1

2 Difficulty in local procurement of raw materials and parts 66.4

2 Power shortage or blackouts 66.4

4 Competitors’ market shares are growing (cost-wise competition) 63.5

5 Complicated customs clearance procedures 55.6

Source: Survey on Business Conditions of Japanese-Affiliated Firms in Asia and Oceania (2012, JETRO)

34 Wall Street Journal, “India’s Budget Focuses on Infrastructure”, February 28th 2015

35 Statistics Japan dataset, “Japanese Nationals Living Abroad, 1990-2012”, available at http://www.stat.go.jp/data/nenkan/zuhyou/y0215000.xls



had sufficient control of the company—with only one Japanese executive among 10 senior operating officers.36 It ended up offloading its stake in Ranbaxy to an Indian company, Sun Pharmaceuticals, in early 2014, through a stock swap that leaves Daiichi owning 9% of Sun. Another high-profile failure was NTT’s joint venture with Tata Group, signed with much fanfare in 2009, which the Japanese company sold last year having never made a profit.

Such examples, while famous, are arguably no more representative than the success enjoyed by Suzuki—which through its 30-year partnership with Maruti became India’s largest producer of vehicles—or Honda, which parlayed a joint venture with Hero (begun in 1984 and dissolved in 2011) into a market leading position on its own. And as the box below on Kokuyo (which bought India’s Camlin in 2011) illustrates, open communication is the key to overcoming cultural surprises.

36 Nikkei, “Culture clashes threaten quality standards for Japanese companies in India”, April 21st 2014



The company continues to face challenges in managing its Indian business. “Cultural gaps still exist in some areas, not least in the area of compliance,” Mr Sumitani says. “Our challenge is to optimise our existing compliance standards in accordance with local legal frameworks and social conventions. We also organise annual gatherings to discuss these matters with all staff in India and deepen understanding of our compliance practices.”

Despite these issues, Kokuyo remains excited about the Indian market. “Its demographics are qualitatively different from China, given its growing, young population and vibrant middle class,” Mr Sumitani explains. The company’s confidence is reflected in the new manufacturing facility it is building—its largest outside Japan—in Maharashtra, into which its subsidiary operations will be consolidated when it starts fully-fledged production in 2016.

Kokuyo’s enthusiasm for acquiring Indian assets is likewise undiminished. “Our next step would be to develop India as a major production hub for overseas markets, including Asia, the Middle East, Africa and Latin America,” Mr Sumitani says. To this end in 2013 it acquired Riddhi Enterprises, an Indian firm that did not have a domestic brand or distribution network but which specialised in the export of stationery products to overseas markets, mainly Central and South America. “We are planning to expand our presence into new markets in those regions by leveraging Riddhi’s production and distribution infrastructure,” Mr Sumitani says.

Kokuyo, a Japanese manufacturer of stationery, saw great potential in the Indian market when it bought Camlin, a stationery company based in Mumbai, in 2011. But managing the investment has been far from straightforward.

“When we started our business in India about four years ago, we were really surprised by the cultural gaps,” says Tsutomu Sumitani, director and managing officer for Kokuyo Solutions & Technologies. Kokuyo recognised that Camlin had established itself in India as a leading stationery and art material manufacturer, with strong brand equity and a robust distribution network. “But the company needed to improve its product development and design capability as well as cross-departmental communication,” Mr Sumitani says.

In fixing these issues, it wouldn’t work simply to impose the Japanese model that Kokuyo had perfected at home. “One of the keys [to M&A success] is effective localisation of the business model and product development,” he says. “It [may have been] less time-consuming to introduce our existing business model, or products that we have nurtured in Japan. But we cannot make our business grow in India unless our local staff are confident in our business model and products.”

“To overcome differences, it is important to communicate and establish mutual understanding,” he adds. “It is also important to share management know-how and systems freely with the acquired company and ensure speedy decision-making through seamless communication at management level.”

Kokuyo: Lessons in M&A, from India to the world



Conclusion4India has long struggled to reach what many think is its true potential, suffering invidious comparisons with China, its closest parallel in terms of size, which has gone from a relatively closed economy to the world’s biggest in a single generation. The judicious use of foreign investment played a big role in this transformation. India now has a government that appears to recognise this, and Japanese companies should be well positioned to take advantage of its economic liberalisation, not least given the warm relations between the countries’ current leaders—and mutual strategic benefits to bolstering bilateral ties.

There is a difference between effecting the kind of transformation Mr Modi managed in Gujarat state and remoulding the national economy, though. Indeed, the first few months of his tenure have been labelled as fairly disappointing by commentators who expected a more radical pace of change. This was never likely in a land as politically fragmented as India—or one that relies on as massive and slow-moving a bureaucracy—and patience will still be called for. That said, there are plenty of signs that the business

environment in India is changing in positive ways, as investment rules and red tape in various sectors are streamlined and the government devotes more funds to upgrading much-needed infrastructure

Consequently India is increasingly appealing to Japanese firms in various industries. Perhaps the most exciting prospect in the near term is Mr Modi making good on his bid to turn India into a centre of manufacturing. As labour costs in China rise, plenty of multinationals are developing a “China plus one” strategy—or even looking for an alternative focus for their global supply chains. Japanese firms have long cultivated developing economies in South-east Asia for this purpose, and they stand to be able to do so in South Asia—which has great appeal as a gateway to the key markets of Africa and Europe—by following the lead of pioneers like Suzuki and Honda. In the longer term, too, India’s urbanisation and growing domestic consumption—in what is still an excitingly youthful economy—could compensate for dwindling demand amid Japan’s secular decline.

While every effort has been taken to verify the accuracy of this information, The Economist Intelligence Unit Ltd. cannot accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in this report.

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