China has come on the scene like a booming freight train barreling down the track. It's hard to believe that the magnitude of change associated with 'made in China' has all transpired within little more than two decades. In the aftermath of Mao, the liberal faction of Communist Party leadership managed to open up the country's markets to a distinctive version of state-sponsored capitalism, opening up the flood-gates to a torrent of trade that continues to build.

Now it's India's turn.

Indeed, it is China's example of huge success that is giving momentum to India's intensified efforts to shake off the lingering socialist legacy that has held back economic growth since independence in 1948. While few expect the transformation of Asia's fourth largest economy to be easy, most increasingly consider it inevitable and want to be on the scene to harvest the rewards.

Take General Electric. Under Jack Welch, in whose honor a research center was recently named in Bangalore, the company was among the first in the mid-nineties to see the potential of the country's intellectual capital as a source for IT and business process out-sourcing. But direct investments on the ground fared much less well, most notably a $3 billion power plant in which G.E. partnered with Bechtel that was shut down in 2002 because of politics. Understandably, there was little incentive to go back after being so badly burned.

But this May, C.E.O. Jeffrey Immelt announced the company was returning as an investor after an eight year absence (during the interim it continued to maintain some 30 businesses in-country, ranging from aircraft engines and lighting technologies to financial services). "In the past," he said, "anytime we invested in the people of India, we made a lot of money and anytime we invested in the market of India we lost." Now, however, he proclaimed the situation ripe to directly invest again with energy, healthcare, transportation and infrastructure all high on the list. "We will invest," he proclaimed, "this is the right time. We will do it soon."

Wal-Mart, too, is eager to get a piece of the $180 billion retail market. Made up mostly of small traders and retailers, India's policy has been hostile to the likes of Wal-Mart. But recently the government let it be known--in no small way because of pressure from the Bentonville giant--that it would soon allow foreign direct investment in retail, "hopefully this year" is the prediction of the Prime Minister.

India is back on the U.S. radar screen. The Blackstone Group, the world's richest private equity house, recently declared that India would be its "highest priority" for investment in Asia. "We are impressed with reforms," said Chairman Peter G. Peterson in announcing that the firm was committed to investing $1 billion in transportation and gasoline refining (total U.S. direct investment in India in 2004 was $3.75 billion, with electrical equipment receiving 26%, followed by pharmaceuticals at 10%).

A recent study by the India Brand Equity Foundation concluded that "U.S. companies have taken a long-term view of India that has allowed them to focus on investing in infrastructure, establishing market presence, gaining market share and leveraging India advantages like R&D, intellectual capital, and outsourcing." Pharmaceutical companies were cited in particular, but the study found interest swept across a broad spectrum of sectors. It also noted greater willingness on the part of U.S. companies to transfer technologies and launch new products aimed for India.

India's attraction as a vast emerging market (population 1.1 billion in the 2001 census) has long existed theoretically. Its well-earned reputation for educational excellence (the joke being that India's brightest tech students use M.I.T. as their back-up) and experience as an export hub are deep-seated competitive advantages. What has been lacking until lately, however, has been the political will to embrace capitalism.

The Minister of Commerce & Industry admitted that there was reasons for caution in the past but that investors could rest assured a new regime is now in place. Making a well publicized speech in New York, Shri Kamal Nath proclaimed the national strategy of wooing foreign capital: "What is important is that India has an open system with social and political safety valves, and a regulatory environment that provides comfort, long-term stability and security to the foreign investor."

The China challenge

The bottom line--which American traders can't ignore any more--is that India is too big to not play a larger role in most globalization strategies. Within three decades experts expect it to replace Japan as the world's third-largest economy. And its labor force (and consumer base) will be young, with half of the population under 25 years old (in contrast to China, which is aging faster than any other country largely due to its one child policy).

But India's prospects haven't always been thus.

A curious fact symbolizes the extent to which 'the old' India was under-developed and uncompetitive: a decade ago, according to The Wall Street Journal, the conveyor belts in the port of Mumbai (Bombay) ran in only one direction, downward to unload ships (since there was little product to up-load). The story was the same throughout the transportation system--lack of roads, congested railways, few runways even at major airports.

India's leadership, despite its Socialist heritage, came to realize that things had to change.

Driving the commitment to economic dynamism was the awakening giant on the subcontinent's eastern flank. India's relative isolation and inhospitability to foreign investment was prompting real fears that it would be marginalized (and arguably threatened) by China, which was reaping the globalization benefits of cheap capital and supportive government policies.

The response of the national and regional governments has been policy reforms intended to jump-start a languid economy into dynamism. As Wal-Mart's anticipated entrance into Indian illustrates, key sectors previously off-limits to foreign entities are being opened up to direct foreign investment. These include pharmaceuticals, power, telecommunications, civil aviation, insurance and real estate.

Today there is growing suspicion that the Indian economy is making better use of invested capital than China. Reliable data is hard to come by but William T. Wilson, chief economist for consultants Keystone India, concludes, "China's investment as a share of GDP is twice that of India but it's GDP growth rate has been only 50 percent higher." Translation: India is getting more bang for the buck. Much of the reason has to do with its solid foundation in high tech. Indeed, Silicon Valley owes much of its preeminence to ex-pat Indians, who were trained at elite technical institutions but had to come to the U.S. to find work; now, observers are quick to point out, the flow is reversing as ever growing numbers of Indians return home.

The infusion of these talented cadres is driving Indian tech enterprise up the value chain. Having first drawn notice as a cheap labor pool for Y2K compliance work, India's premier tech companies like Infosys, Wipro and Tata have advanced from outsourced piecework and R&D to where they now produce entire products from scratch.

The metaphor globalist author Thomas Friedman uses to contrast China and India is a highway: "The Chinese highway would be a six-lane, perfectly paved road but with a huge speed bump off in the distance labeled 'Political Reform: how in the word do we get from Communism to a more open society?' ...India, by contrast, is like a highway full of potholes with no sidewalks and half the streetlamps broken. But off in the distance, the road seems to smooth out, and if it does, this country will be a dynamo."

Appearances, however, can be deceptive. The looming question confronting India, as Friedman points out, is whether "that smoother road in the distance a mirage or the real thing?"

Uncertainties

Whether it's a smooth road or a mirage that lies ahead depends on the interplay of several fundamental themes.

Not surprisingly, the political context remains a big uncertainty. Governing coalitions tend to be tenuous, which suggests potential for abrupt and unexpected policy reversals. Regardless of who exercises power, the public finance situation is not strong. The solid growth of exports has enabled currency reserves to increase but public debt remains substantial. Overall, India has been reducing import duties but complex non-tariff barriers remain an obstacle to trade (shipments of foodstuffs, for example, are subject to systematic inspections; pre-packaged goods must bear the maximum retail price on their labels, which includes taxes and transport costs). While direct foreign investment is much easier than before, there still remain sector restrictions (such as the manufacture of some 675 goods) designed to preserve local industry.

On the micro level, Indian companies have improved in their payment behavior, according to the risk insurer Coface's latest assessment, but "the situation nonetheless continues to be marked by insufficient financial transparency and still limited possibilities for recourse in case of non-payment."

The potential 'black hole' in India's economic future is the country's lagging financial systems. This is a critical difference with China. In their study on India's Productivity and Performance recently published in the McKinsey Quarterly, authors Diana Farrell and Aneta Marcheva Key conclude that "China's industrial development is clearly outstripping that of its neighbor not only because of China's head start in economic liberalization but also because of a commonly overlooked factor: India's financial system."

In terms of aggregate financial assets, a measure of an economy's monetization, India's stock is one-sixth of China (China accounts for 4% of the world's financial assets, India less than 1%). In terms of efficiency, the gap narrows since Indian banks are better at avoiding non-performing loans. And its equity market is better developed with four times as many companies listed (additionally, in China most listed enterprises remain significantly state-owned).

Still, after accounting for various factors and noting the on-going reforms in process, the authors conclude that "the bottom line is that India simply has a lot less money circulating in its financial system than one would expect, given the size of its economy." As a result, the ability to finance investment and accumulate physical capital has been hampered ("this factor may explain why China has invested more in heavy industry and manufacturing, while India has had success in the less capital-intensive business-service-outsourcing sector").

Sidebar: Opportunities for U.S. manufacturers in India

Ranked on the basis of estimated Indian imports from the U.S. for 2004, the most promising investment opportunities exist in healthcare services, retailing and biotechnology. Other leaders in terms of relative size include:

• Telecommunications equipment
  
• Education services
  
• Computer and peripherals
  
• Electrical power generation, transmission & distribution equipment
  
• Pollution control equipment
  
• Oil and gas field machinery
  
• Computer engineering software and services
  
• Mining industry equipment
  
• Medical equipment
  
• Process control
  
• Defense industry equipment
  
• Textile machinery
  
• Airport & ground support equipment
  
• Safety and security equipment
  
• Machine tools
  
• Food processing & cold storage equipment
  
• Renewable energy equipment

For more information on each of the best prospect sectors, see the U.S. Commercial Service's "India Country Commercial Guide" online at http://www.buyusainfo.net/docs/x_2109594.pdf.

Sidebar 2: How One American SME Is Entering India

Domes International Inc., based in Mississippi, manufactures dome-shaped fiberglass houses and structures. With a product ideally suited for emerging markets, the company actively pursues global markets. After obtaining a $1.2 million loan from the Overseas Private Investment Corporation for the establishment of a small factory in Ahmedabad, India, Domes International (India) LTD, opened in December, 2003.

World Trade Editorial Director Neil Shister spoke with Steve Pope, Vice President for Sales and Marketing and Director of International Development, about the company's experiences in India thus far.

"I see the potential market for Domes to be much greater overseas and particularly in third world countries than domestically. I have been doing business in India since the mid-nineties and I brought my business associate in from India to show him the houses. He purchased a couple of houses to send back and set them up in the middle of a nice residential section. It created an immediate reaction--we estimate over 100,000 people have visited the site.

"Our sales in India are slow getting started. The biggest reason is the increase in our production costs. Seventy percent of our raw materials is a petroleum-based product and the price we pay has more than doubled since we arrived. Our target market was low-income housing but at the increased production costs that market is no longer viable. We have now shifted our focus to military and high end government buildings.

"It took us almost a year to be approved as a government supplier, and we just received certification this past December. Since then, we've had an unbelievable amount of interest. We are on track to do several million dollars. And, we're poised to do multi-million dollar projects with the military now that we're officially registered.

"The business climate in India is improving quickly. Fifteen years ago it was almost impossible. However, relative to the United States, there's still a tremendous amount of hurdles to overcome. We're a small company and we had to jump through a few hoops. For example, we spent three weeks trying unsuccessfully to open a bank account at three different banks. Finally we went to a friend of our partner and through him we walked into a bank and opened our account in an hour.

"Officials are nice but the common thread seems to be that there's so much bureaucracy involved that no single person or office has a grasp on all of it.

"It can be a big hassle. Being a third-world country, things don't happen as fast or efficiently as in the U.S. But, there's great opportunity over there. Indian labor is fantastic. We are employing between 40 and 50 Indian workers and they are the best we've ever had. The opportunity to work is a blessing and they are so anxious to please and do their job right that they'll go to any length to do it properly.

"In India, you've got to be able to adapt to fit the culture and economic conditions. For example, we've had to change the design of our product there to fit their needs. I'd say be prepared for a long ramp-up time in India. Take whatever budget you've got and double it. But once you get an operation going, once you get all the bugs and the bureaucracy worked out, it can become a very lucrative thing."