India could benefit from the fallout in the U.S.-China trade war, experts told CNBC — but much-needed reforms on land and labor could prove to be a challenge for companies trying to do business there.
Trade tensions between Washington and Beijing have caused some manufacturers to shift production out of China, to avoid higher tariffs.
As a result, Southeast Asian nations, such as Vietnam, have often been cited as winners in the trade shifts. India could be a beneficiary too.
″India could increase its trade footprint in (the) midst of the US-China trade conflict, particularly under categories on which US has imposed tariffs on China," Radhika Rao, an economist at Singapore bank DBS Group, wrote in an August report.
"Apart from trade, diversion in investment flows is an opportunity that India could benefit from, as manufacturers seek alternative origination destinations," Rao added, implying it could attract foreign investments into the country.
India's share of the global export market is relatively small.
Even though Germany's population is nearly 16 times smaller than India's, German exports made up 8.17% of the world's total trade flows in 2017. Comparatively, Indian exports accounted for only 1.68% of world trade that year.
The top three sectors in India that could benefit from the trade war are: pharmaceutical, chemicals and engineering, Rao told CNBC in an email.
India is already competitive in these industries globally and will likely be well-placed to meet further demand in these areas, she noted.
The South Asian nation's pharmaceutical industry supplies over half the world's vaccine demand, and 25% of medicines in the United Kingdom, according to a July 2019 report from the India Brand Equity Foundation (IBEF).
On the engineering side, India was the world's 12th largest producer of machine tools in 2017, a separate IBEF report said. The country also exports more than 60% of its engineering goods to the U.S. and Europe.
The manufacturing sector may benefit too — particularly the textiles, footwear and electronics sectors, said Rajiv Biswas, Asia Pacific chief economist at IHS Markit, in an email.
That's because exports from the U.S. and China will become more expensive as the tariffs kick in, and some manufacturers may move production to other Asian countries — including India.
"India may be able to benefit from this trend over the medium term, with global manufacturers increasingly focused on the rapidly growing Indian domestic consumer market," Biswas said.
For instance, Taiwan's Foxconn — the largest electronics contract manufacturer in the world, which assembles Apple products — moved production into India from China this year. This was to "diversify their manufacturing supply chain away from excessive reliance on Chinese production," said Biswas.
The Indian economy could benefit by $11 billion from these trade shifts, Rao wrote in the report, citing estimates by the United Nations Conference on Trade and Development.
Businesses in India face two key challenges: land laws and labor regulations.
Land laws are the "biggest hurdle" for manufacturing and infrastructure development, said Societe Generale economist Kunal Kundu in a note to CNBC.
Current land laws make it difficult for the private sector to obtain space for manufacturing units, he said.
That's because land ownership is fragmented across several states, and companies need extended periods of time to obtain land, or bypass legal issues that may crop up.
Another problem is that labor laws in India are "extremely complex," noted Kundu. They comprise about 40 acts and companies are required to adhere strictly to all of them. This makes it difficult for manufacturers.
Land and labor reforms are two of the "most important factors of production" needed, according to Kundu.
Hence, he recommended, a national employment policy should be formulated — particularly one that allows manufacturers to make labor redundant during business down cycles.
The lack of proper infrastructure could also be a problem, Nomura economist Sonal Varma told CNBC.
That includes connecting manufacturing plants to proper roads and ports, as well as ensuring that power is available.
The government has been seeking to improve some of these policies, but it will be some time before they can be fully realized. It is also trying to boost infrastructure and foreign investment in India through a multi-billion dollar budget.
Recent policy reforms in August were seen as a step forward for investment. For instance, the government approved 100% foreign investment in coal mining, and eased rules in contract manufacturing and retail.
"India needs to move fast, through innovative policies and clear focus on infrastructure development ... But (a) lot more remains to be done and done urgently," Kundu said.
More changes to existing laws are needed before India can reap the full benefits of these investments to boost the economy.
As India is a big country, a lot of laws are controlled by the state government — not by the central government, Varma said. "The changes need to be not just ... top down from the central government, but also bottom up from different state governments."