Japanese investment in India nosedived in 2020. It plunged more than half (54.9 percent) in 2020 against the country’s investment in 2019. No doubt, it is at par with declining Japanese global investment, which tapered in 2020 due to the Covid-19 pandemic.

Nevertheless, the dip in the Japanese investment in India raised eyebrows. This is because major investors like the US, Singapore, UK and the Netherlands raised their investments in India in 2020. Analysts argued about the sudden fall in the Japanese investment, even as the other foreign investors remained upbeat despite the pandemic. This is more surprising considering that Japanese investors were euphoric about India in 2019, according to a survey by Japan External Trade Organization (JETRO).  

Against this backdrop, a moderately slow fall in Japanese investment in China, which should have been at rock bottom after Tokyo incentivized a shift of investment from China, surprised the observers. It dropped by only 7.5 percent in 2020, against the global average fall of 33.5 percent of Japanese investment.

Why did the Japanese euphoria on India disappear? One section of analysts argued that downturn in profitability and losses suffered by Japanese investors in India dented Japanese sentiment. More than 50 percent of Japanese investors surveyed in India projected losses in their operating profits in 2020, according to a JETRO survey. This is the highest among all nations in the world. 

Ironically, the ratio of losses in China was at a low ebb - 19.5 percent. This shows that Japanese investors were not put off by the Japanese government’s discouragement and would like to continue to repose confidence in China’s potential.  

India’s withdrawal from RCEP

Besides the negative sentiment following large-scale losses, India’s withdrawal from Regional Comprehensive Economic Partnership (RCEP) infused a new drag on Japanese sentiment.
Several Japanese subsidiaries in the Association of Southeast Asian Nations (ASEAN) established close tie-ups with Japanese investors in India under the gamut of India- ASEAN FTA. A large part of components, parts and intermediates are imported into India from these subsidiaries under FTA. With India not joining the RCEP last year, Japanese subsidiaries are more likely to divert business interests towards the RCEP member countries. It offers a bigger market and ensures sustainability in duty-free access.

This goes against India’s resurrection of protectionism amid the Covid-19 pandemic and its comparatively smaller market than the trade block. Nearly 400 items are under consideration for a hike in customs duties, according to the Budget 2021-22.

RCEP accounts for 27 percent of global merchandise trade and 30 percent of global Goss Domestic Product (GDP). Its market size by imports is ten times bigger than India. This provides more scope for the Japanese subsidiaries in ASEAN to do profitable business within the block.  Eventually, the new dynamism in global trade, driven by the large multilateral trade block, will attract more Japanese investment in RCEP.

Given the situation, it is clear that the increase in Japanese investment in Thailand and Malaysia during the pandemic was the logical fallout of re-shoring of Japanese investment from China, following the Japanese government’s decision to strategically decouple from China. To this end, India's withdrawal from RCEP resulted in India losing out on the opportunity of re-shoring of Japanese investment from China.      

India’s vast digital market
 
India witnessed a major structural change in foreign investment during the pandemic. Notwithstanding the raging viral disease, FDI in the country went up by over 19 percent in 2020-21. Unperturbed US investors increased investment by over 290 percent in the said fiscal. Other major foreign investors, such as Singapore, the Netherlands and the UK, followed the US footprint. The digital economy emerged as the pivot in the spike in India’s FDI inflows. The US investors were allured by India’s target of a USD 1 trillion digital market by 2025.

Demand for digital services increased rapidly during the Covid-induced lockdown as a means of reducing human contract. India has nearly half a billion internet connections – the second highest in the world - and the second most number of smartphone users, thus emerging as a global leader in digital economy.

Globally, the Japanese race in digital transformation is slower than developed geographies like the US, China, European Union as also S. Korea and even India, according to a McKinsey survey. One of the reasons is the lack of adaptability to digital transformation in Japan. The barriers restricting Japanese challenges for digital transformation were the lack of digital talents and understanding among the senior corporate managers.

The survey found that the cultural entrenchment of the senior managers (such as seniority by age, lifelong employment in one company) deflated the understanding of the benefits of the digital economy. Eventually, the lack of support from the senior managers cast its shadow on digital transformation in Japan, according to the survey.  

US investors stepped into Indian shoes for building a new model of the economy to push Make in India. On the contrary, Japanese investors lagged in pursuing India’s new vision. They continued to rely on the formal economy like the automobile and the electronic sectors. Automobile and electronic industries are import-intensive industries. These industries suffered a backlash with the protectionist moves in the post-Covid period.  

The pandemic dented the automobile industry in India, which is dominated by the Japanese.  In April 2020, not a single car was sold in the country, making history. This resulted in a major fall in operational profit of Japanese companies in India. The sharp decline in auto sales and financial crunch in small and medium scale industries related to auto component industries had a debilitating impact on Japanese investment in India.
 
(The writer is former Adviser, Japan External Trade Organization (JETRO), New Delhi. The views expressed are personal)