India and Japan: The Strategic Agenda

Separated by 6,000 kilometres and the Indian and Pacific oceans, with vast differences in language and culture and China in between, India and Japan would not appear to be natural allies. Despite the historical common bond of Buddhism which originated in India and travelled to Japan as early as the 6th century and political and economic cooperation since the middle of the 20th century when India gained its independence, both remain separated by their differences. Japan’s dependence on Chinese manufacturing, India’s growing dependence on trade with China, both countries’ territorial disputes with China, the growth of intra-Asia trade and particularly the growing pre-eminence of China in that trade has left both India and Japan vulnerable. Their mutual interests in economic and political cooperation are clear and clearly ill-explored. Both countries need to more clearly define their bilateral relationships in the context of their broader regional roles, to protect their interests and to meet their national objectives. However, it would be a mistake to define their relationship in terms of their issues with China. China can be neither ignored nor alienated in this process. The country has much to offer both nations, but that is for another Sign of the Times. The case for an India-Japan strategic partnership with strong cooperation across economic, political, military, and cultural matters is increasingly strong despite their differences.

Japan has begun to explore the potential of India albeit in small steps relative to its engagement in China over the last two decades. Japan is already one of the largest foreign investors in India, its biggest provider of foreign aid, and has attempted to play a bigger role in the automobiles and pharmaceuticals sectors . India’s largest car manufacturer Maruti-Suzuki, with c.40% market share, was originally a government-owned company and is now a subsidiary of the Japanese company. More recently, Japanese investment and technology has been critical in building New Delhi’s state-of-the-art metro system which has entirely transformed the transport infrastructure of the capital. India’s large market and attractive demographics (which compare starkly to Japan’s ageing population and declining workforce) provide Japan with a territory in which it could extend its industrial competitive advantages, deploy its intellectual property and make significant investments. In order for this to be a reality, Japan would need to make sense of India. For Japanese business, India’s surface is so dazzlingly complicated it is alien and closed to their way and so its rules of The two countries are natural infrastructure partners, and some of the greatest infrastructure success stories in India, such as Delhi’s metro system, were financed by Japan and built using Japanese technology. engagement seem opaque. For Indian business, Japan’s surface seems so uniform it is alien and closed to their diversity and so its rules of engagement are equally opaque. If both parties are able to decode the surface, among the differences, they will find common ground in their core cultural concepts such as family, community, respect for elders, loyalty to employees, family-owned businesses, and hierarchy. The differences lie partly in the diversity of behaviour that sprouts from a population in India that grew from 550 million to 1.2 billion in 40 years while Japan’s grew from 100 million to 127 million in the same period of time. The prize for both India and Japan is substantial and there is an imperative to unlocking the opportunity given rising expectations of both countries’ populations. In India, the incoming government will need to deliver on the popular demand that India be returned to a high growth trajectory and that transparent governance be implemented, both of which will need massive changes to almost all aspects of India’s economy and politics. In Japan, Prime Minister Abe’s reforms have begun the process of growth but the major structural issues remain unaddressed and these will either need to be deftly avoided, by finding a platform for growth that is so compelling that internal structural change can be put off for now, or they will need to be taken head-on with all the political complication that goes with it. There are several critical ‘win-win’ opportunities that form the core areas of collaboration between the two. This paper examines eight potential areas of partnership that if fully implemented could boost India’s GDP by c.US$1 trillion (or 10%) over the next three decades while in the process also revitalising Japan’s corporate economy by improving the return on equity of Japanese corporates through a combination of better investment returns and cost savings.

    1. Making Direct Investment into India. Japan is one of the largest foreign investors in the world accounting for US$123 billion or 9% of the world’s total FDI in 2012 . Further, in the past few years Japan has emerged as India’s third largest foreign investor investing a total of US$2.8 billion in 2012 (or just over 2% of Japan’s total overseas spending). However, even this level of participation is insignificant when compared to Japan’s FDI in China which, despite their strained strategic relations, amounted to US$16 billion (or 13% of total Japanese FDI) in 2012. Given that China’s share of Japan’s total overseas investments has started to decline in recent years, there is significant scope for India to potentially attract increased flows from Japan. This will require it to effectively position itself as an ‘alternative to China’ for manufacturing and address concerns around its difficult business environment which continue to effective at overcoming the small trader opposition to foreign direct investment, reducing deter foreign investors. This is no easy task since it requires the new government in India to be bureaucracy, creating a few well-functioning industrial and trading zones and supplying an easier route to solving legal disputes. The simple arithmetic is compelling. If India succeeds in doing this and manages to increase its share of Japanese FDI over the next 15 years to the same share as China currently, the economic impact would be transformative. This would mobilise an additional c.US$160 billion of foreign investment over the next 15 years assuming a gradual increase and up to c.US$300 billion if India can achieve this share by 2020 by accelerating policy reforms and bilateral relationship-building with Japan. This would imply an increase of c.US$30 billion per annum in India’s FDI inflows, which applying current industry multipliers, could result in an incremental GDP of US$90-100 billion per annum (or 1-1.5% higher than current baseline estimates)
    2. Making Institutional Investments into India. In addition to long-term direct investments by strategic players, increasing portfolio investment into India also offers large Japanese institutional fund managers including pension funds, mutual funds, and insurance companies an opportunity to generate excess returns in their portfolios. While Indian equities and the currency are inherently more volatile , they have generally offered significantly higher returns than the Japanese markets. While in local currency terms, the returns on the Japanese market was higher than in India in the first half of 2013, this bull-run was also driven by a sharp depreciation of the Japanese yen which was sharper than even the sharp depreciation of the rupee. Therefore, the Japanese currency adjusted returns of the Indian stock market are significantly higher than the returns on Japanese stocks over the past one, five, and ten year periods. Japan currently does not factor into the top 10 institutional investors in the Indian market . The Japanese stock market has a total capitalisation of c.US$4 trillion much of which is held by large Japanese institutions. Mobilising even a small portion of this capital could significantly help India deepen its capital markets – where most of FII inflows have tended towards the large cap stocks. Aside from mobilising portfolio investments into the equity markets, there is also an opportunity for Japanese private equity and venture capital funds to invest into Indian market to generate attractive relative returns while also building an understanding of operating in India and accessing promising IP and technology amongst India’s entrepreneurs (see point III below).

  1. Converting Intellectual Property into Industrial Strength.Japan currently spends approximately US$180 billion (or 3.0% of its GDP) on research and development annually and has developed industry-leading intellectual property (IP) across a range of sectors. This has enabled Japan to become a global competitive force across industries since the 1980s; at its peak in the 1990s, there were 12 Japanese corporations among the global top 20. However, since the late 1990s, Japan’s position has eroded and at the end of 2013, there were only 2 Japanese corporations among the top 20. Japan’s ability to leverage its IP worldwide appears to be declining despite its on-going investment. In the meantime, others are leveraging their IP well into global markets and India is one of the high potential markets that have been targeted. This has resulted in Japan ceding leadership in a number of its areas of historic leadership such as consumer electronics, mobile devices and semi-conductors to other Asian countries like South Korea and back to the US. India, with its attractive demographic profile, large pool of engineering talent, and more favourable environment for IP protection, has the potential to be a strategic partner to Japanese corporates in IP-led industries including software, high-tech manufacturing, pharmaceuticals and electronics. Such partnerships would offer strong mutual benefits – with India benefitting from increased investment and the creation of high quality jobs, while Japan could leverage India’s talent pool, large market, and low manufacturing costs to scale and monetise its IP globally in areas such as life sciences, clean energy, and advanced robotics among others. Doing so will require India to demonstrate a strong commitment to IP protection and the regulatory and legal patent regime, issues which in the past has slowed the development of IP collaboration between international countries and other natural partners such as China. It will also require India to make its land more available for mass industrial development which in turn is a big issue.
  2. Offshoring Japan’s Cost Structure.Manufacturing continues to be a disproportionately important driver of Japan’s economy representing c.27% of GDP from industry (compared to 19% and 21% for the US and UK respectively). However, Japan still has among the highest labour costs in the world, with manufacturing unit labour costs currently c.30% higher in Japan than the US (see chart). In order to regain competitiveness in its manufacturing sector, Japan needs to aggressively move its high cost structure offshore. Japan’s strategy to date has focused on China, whose own cost advantage is also rapidly eroding ; Japan will therefore need other low-cost manufacturing locations to build and extend its ongoing competitiveness. One prominent example of this is Maruti-Suzuki, India’s largest automobile manufacturer by market share, and a subsidiary of the Japanese automotive company Suzuki . The Indian subsidiary currently accounts for c. 30% of the parent company’s revenues and has operating margins which are c.20% higher and net margins of 5-9% as compared to 1-4% for the parent company. This has allowed the Indian arm of Suzuki to become a cost-competitive exporter of automobiles to rapidly-growing regions such as Africa based on a cost-structure which would be impossible to achieve in Japan. Japan can extend this model much further both in the automotive sector where India is already a critical manufacturing location, as well as in new industries including electronics and industrial machinery. Longer term, the offshoring model can also be extended into service sectors such as financial services and IT services to help make those industries sector globally cost-competitive. India’s hourly manufacturing labour costs are less than 5% of Japanese level. Even if we assume manufacturing productivity in Japan is 5x higher than India , this still implies a 75% cost advantage from offshoring to India. Therefore, if Japan were to offshore 10% of its industrial cost base to India, this would imply annual savings of c.US$40 billion for Japan’s manufacturing sector.
  3. Deepening Trading Relationship. Despite rapid growth recently on the back of a 90+% reduction in Indian export duties, Indian-Japanese bilateral trade is only US$18.5 billion annually or one-third of total India-China trade and one-twentieth of total Japan-China trade. India today is particularly dependent on its skewed trade relationship with China, and its primary exports comprise largely raw materials and unfinished goods while importing a range of capital equipment and finished goods from China. India’s trade profile with Japan is similar, albeit on a much smaller scale. Both countries would benefit by diversifying and growing their bilateral trade, reducing their trade dependence on China, providing a significant boost to both countries’ export sectors (as well as ancillary sectors such as logistics and shipping.), and in India’s case, balancing their current account. Increasing the quality and quantity of trade will require coordinated action by Japan’s large trading houses, which have been a historical focal point of Japan’s integration with the world economy. These trading houses have been an important element of Japan learning the terms of trade and cultures of other countries the world over and so India should pose no real challenge for them once the policy direction is clear. Based on their track records, it would not take much for these groups to become a key conduit in the Japan-India trading relation as the preferred trading partners for large Indian corporates. The seven largest Japanese trading houses and the keiretsu they are a part of currently account for over half of Japan’s exports and two-thirds of its imports . If India can accelerate its trade growth with Japan to similar levels as Japan’s larger trading partners in Asia (China, South Korea, Thailand), then India-Japan trade could increase to similar levels as South Korea and Thailand (c.US$60-90bn of total trade) over the next five years and similar levels to Japan-China trade (over US$300bn) over the next ten to 15 years.
  4. Building Infrastructure. India’s current five year plan envisages a c.US$1 trillion investment requirement for building the country’s physical infrastructure. Despite accelerating the build out over the past 15 years, the infrastructure gap today remains significant. Japan’s government, on the other hand, has a stated goal of tripling exports of infrastructure-related technologies to c.US$300 billion by 2020. In this sense the two countries are natural infrastructure partners, and some of the greatest infrastructure success stories in India, such as Delhi’s metro system, were financed by Japan and built using Japanese technology. The countries have of course recognised the potential and India is already in discussions with Japan for large-scale partnerships including two dedicated freight corridors as well as hydroelectric projects in India’s northeast region. In order to secure these partnerships and build additional ones, Delhi and Tokyo will need to work closely to build ‘win-win’ partnerships with the Japanese conglomerates and technology and financing providers on one hand, and Indian stakeholders including state governments, public sector companies, and construction firms. Aside from helping Japan achieve its stated objectives, increased investment in infrastructure would also have a positive impact on various sectors in India including energy, construction and EPC, transportation, and telecommunications.
  5. Developing Energy, Power and Natural Resource Security. Japan today for all its wealth and development remains a resource poor country, dependent on imports of energy, raw materials, iron ore and food to sustain its economy and population. Currently, oil and gas alone account for c.21% of Japan’s total annual import bill of c.US$800 billion. This makes resource security one of the fastest growing strategic issues facing Japan, both in terms of securing supply of resources from partners as well as in terms of securing the safe delivery of resources (see point VII below). India, though also a net energy importer, has vast reserves of key resource assets including the world’s largest coal reserves, 125 million metric tonnes of proven oil reserves (second only to China in Asia), 27 billion tonnes of iron India and Japan, as two of the largest net importers of fossil-fuels, also have a mutual self-interest in jointly promoting the development and scaling of alternative energy industriesore (third largest in the world), as well as more valuable resource deposits such as uranium and thorium. While India’s exports to Japan today are minimal (as discussed above), India’s resource potential, in terms of food, iron ore or other raw materials is significant. These three categories already represent over 2/3s of total exports to Japan today but are domestic laggards in terms of ore (third largest in the world), as well as more valuable resource deposits such as uranium and thorium. While India’s exports to Japan today are minimal (as discussed above), India’s resource potential, in terms of food, iron ore or other raw materials is significant. These three categories already represent over 2/3s of total exports to Japan today but are domestic laggards in terms of investment and productivity. In a recent Sign of the Times , we laid out a India and Japan, as two of the largest net importers of fossil-fuels, also have a mutual self-interest in jointly promoting the development and scaling of alternative energy industries development roadmap that would increase both the investment into and the output of these critical sectors, allowing India to scale exports over the medium term and establish itself as a critical trading partner into Japan. However, in order to secure these critical trade flows, the two countries will also need to collaborate closely on transportation and logistics, which will require a broader geopolitical partnership. In addition to improving bilateral investment and trade in resources, India and Japan, as two of the largest net importers of fossil-fuels, also have a mutual self-interest in jointly promoting the development and scaling of alternative energy industries. Alternative energy presents yet another opportunity for India to leverage on Japan’s intellectual property and help to scale it, while also leveraging investments to create scaled capacity in India.
  6. Forging Geopolitical Partnership. In terms of their geographic positions in Asia and the world, both India and Japan face three similar issues: (i) Strong economic links to China that are subject to intermittent disruption due to ongoing territorial disputes; (ii) Being aggressively courted by the US as strategic partners as part of its ‘pivot’ to Asia in a bid to offset China’s growing influence; and (iii) Strong bilateral links other south-east Asian countries which neither has been able to leverage into preferred partnerships to date. While both countries are respected, India and Japan have an opportunity to create the most important strategic alliance in Asia in the twenty-first century India and Japan have an opportunity to create the most important strategic alliance in Asia in the twenty-first century neither has built strong strategic alliances in the region. In some ways this failure offers a strong incentive to align interests and build one of Asia’s defining partnerships. The first steps of this can already be seen in recent naval cooperation, the joint bid for the enlargement of the UN Security Council, and a proposal for Japan to manufacture some of its defence equipment in India. However, there is significant scope to expand this aspect of the partnership further for mutual benefit. The challenge for both countries will be to do so without damaging their trade relationship with China which may perceive a desire to “encircle” and “contain” it. In order to achieve this, each country would need to be highly disciplined in not taking the side of the other on strategically sensitive issues related to China such as on territorial issues. If they can successfully navigate this, both will have an opportunity to create, in all likelihood, the most important strategic alliance in Asia in the twenty-first century. This will strengthen their respective roles for the US in their Asia strategy too.

The Positive Impact of the India-Japan Partnership

The cumulative impact of all the measures outlined above could be significant for both countries (see table). Notwithstanding the benefits of a stronger geopolitical partnership, simply increasing collaboration in the areas of trade, investment and IP development could boost India’s GDP by over US$150 billion (c.7.5% of current level) by 2030 while improving Japan’s competitiveness, revitalising its corporate economy and improving return on equity from the currently modest level of 8-9% . For India, the bulk of this impact would come from increased investment – primarily in infrastructure and technology-intensive manufacturing sectors – but with a knock-on impact across the economy. Indeed, in manufacturing alone, stronger collaboration with Japan could allow India to increase the share of industry in GDP from c.25% to over 30% over the next two decades and allow it to emerge as a major rival to China as an outsourced manufacturing destination. In the process, this would create high-quality employment for millions of young Indians and allow it to fully utilise its demographic advantage. For Japan the economic benefit would accrue from an improved return on its invested capital and through a scaling of its intellectual property and could re-invigorate the country’s corporate economy providing its large corporates with an effective way to address the country’s demographic challenge and build their global competitive advantage.

Despite the clear benefits to both countries from significantly stepping up their collaboration, there are challenges which need to be addressed to evolve the right model. This is best illustrated by recent news of two large, high-profile Japanese investments into the Indian market, the US$4.6 billion acquisition of Ranbaxy Laboratories by Daichi The ideal outcome for both countries and the region to ensure peace and widely shared prosperity will be to avoid the emergence of strategic ‘blocs’ of alliances that alienate China and othersSankyo and the US$2.7 billion investment by Docomo into Tata Teleservices, both made in 2008 and currently being unwound at a loss. These two investments alone accounted for approximately half of Japan’s total FDI into India since 2000, and their failure seems to call into question the ability for Japanese investors to generate returns on scaled investments in India. However, it is important to also see the context of the two investments in order to draw the right lessons. Both investments, while large in size and scope, were largely passive from an operating point of view and full management autonomy was left with the Indian operating partners. The failure of these deals often lies in selection, diligence, deal execution and post deal operations, not in the investment hypothesis itself which has in fact been validated through rapid value creation in the sector by other players . Other large Japanese investments such as Maruti-Suzuki and several other joint ventures (prominent examples include Hero Honda, Kansai-Nerolac, among others), as well as various investment through private equity firms have successfully navigated this challenge by having local investment allies and on-the-ground resources to navigate doing business in India and ensure effective management and execution. For the two countries to build their collaboration as outlined above, it is important to learn the right lessons from previous experiences and develop a partnership model that enables both countries to flourish.


The rationale for close Indian-Japanese strategic and collaboration is clear, not least because neither country today has deep alliances (Japan’s defence dependency on the US being a historically grounded exception.) This strategy does not preclude the ties that both countries need with other nations such as Australia and Southeast Asia for natural resources and multi-lateral trade and investment. And of course, both India and Japan will need to continue A successful India-Japan relationship is a critically important endeavour not for just India and Japan but also for America and Europe The enduring peaceful rise of China is more assured when its neighbours are also economically and politically powerful to build a strong relationship with both the US and China, not least if only to ensure that their own strategic cooperation does not alienate the latter. The ideal outcome for both countries and the region to ensure peace and widely shared prosperity will be to avoid the emergence of strategic ‘blocs’ of alliances in favour of an interwoven network of relationships where every potential competitor or strategic rival will also be a partner. Given we live in a time where China has risen peacefully, is the manufacturing centre of the world, is emerging as one of the most effective global acquirers of natural resources, is building the world’s biggest domestic consumer base and is widely seen by American policy analysts as the biggest threat to US geopolitical supremacy, a successful India-Japan relationship is a critically important endeavour not for just India and Japan but also for America and Europe. In addition, China’s factions within its broad political and military leadership also voice their differences on either the need for or the restraint required in the use of force in dealing with their various ongoing territorial disputes. So, in a seeming paradox of logic, the enduring peaceful rise of China is more assured when its neighbours are also economically and politically powerful. The India-Japan relationship will require India, China and Japan to learn to co-exist and work well with America and this is an important ingredient in building a more peaceful world.


1.    From 2000 until 2013, 29% of Japanese FDI into India was in the pharmaceuticals sector and 16% was in automobiles

2.    Source: UNCTAD World Investment Report 2013, Department of Industrial Policy and Promotion

3.    Behind Mauritius and the United States

4.    Cumulative additional foreign investment from Japan over and above baseline estimates (assuming no change in relative shares)

5.    Source: GPC Analysis; assumes industry multipliers of 2.5x and technology multipliers of 3.5x (based on various expert estimates)

6.    India has recently made it easier to implement currency hedging strategies as well increasing the total limits available to Japanese funds in the recently- concluded Prime Ministerial visit to India

7.    A large portion of FII inflow into India is from tax haven countries such as Mauritius, Cyprus, and Luxemburg – therefore it is not possible to ascertain how much of this is funds originating in Japan

8.    Fortune Global 500 rankings 1995 and 2013

9.    (see the article in last month’s Sign China’s Changing Competitiveness to 2025: Far-reaching Economic and Political Implications)

10.    Suzuki is currently the second largest Japanese automobile manufacturer (behind Toyota) and the tenth largest automobile manufacturer globally

11.    Source: US Bureau of Labor Statistics, International Labor Comparisons; data available at

12.    Comparable productivity data for Indian and Japanese manufacturing is not available to ascertain relative unit labour costs so we have applied a simplifying assumption

13.    Currently, China is both India’s and Japan’s largest trading partner

14.    Bilateral trade with China accounts for [ ]% of India’s total foreign trade

15.    Mitsubishi, Mitsui, Sumitomo, Itochu, Marubeni, Toyota and Sojitz

16.    Source: Seeking Alpha, Trading Houses Key to Japan’s Economy, available at

17.    See the March 2014 Sign of the Times: 12% Growth Agenda: A Blueprint for India’s New Government

18.    The constituents of the Tokyo Stock Exchange reported weighted average return of equity of 8.5% in 2013 (Source: CapitalIQ)