The May 6 2025 India-Pakistan conflict has raised questions about the future of South Asia’s regional economic integration. India has stopped all direct and indirect trade with Pakistan, bringing to a halt a $10 billion annual exchange of goods. South Asia as a region of aspiration seems lost for some time. But geographic reality of proximity, common borders and cultural affinity cannot be changed. India is a key destination for the shift of supply chains from China, and the region is the catchment area for these benefits. How then, can the region play its role as the next big trade hub?
There are currently three imperatives for India to become a manufacturing hub. The first is the Trump tariff effect, where India is staring at 26% reciprocal tariffs for exports to the U.S., the world’s biggest, high-income market. A second is Pakistan, whose tepid growth, low productivity and lack of domestic reform is setting back the region, depriving it of the benefits of developing a supply chain ecosystem and ultimately prosperity. Third, China and East Asia’s integration into global supply chains with jobs and unprecedented prosperity offers lessons for others even in global trade policy uncertainty.
This means South Asia leaning to trade more than ever in the new geopolitical context. Indeed, India is stepping up its trade engagement with the world with a flurry of free trade agreements (FTAs). Sri Lanka recently signed an FTA with Thailand and with Singapore. Bangladesh has been discussing FTAs with Asian countries. This indicates a regional desire to develop a supply chain ecosystem required for an ambitious trade agenda.
It is none too soon. Starting June, all of Apple’s iPhones for the U.S. market will be made in India, still cheaper despite the new U.S. tariffs. Samsung, Volvo, Siemens and Amazon have announced they will expand their manufacturing footprint in the country. This is not a sudden shift since the imposition of U.S. tariffs. Multinational companies had already began reducing their dependence on China before Covid-19, and its popularity as a manufacturing source was receding, particularly among Western firms.
This essay, therefore, looks at the prospects for India and rest of South Asia. It tries to answer the following questions:
1. Is India rising as a global manufacturing hub?
2. Is trade diplomacy in high gear at last?
3. What lessons can we learn from China?
4. How can India’s neighbours be lifted?
India’s Role in Global Manufacturing
The disruption of China-centric global supply chains is in motion, with reports indicating that inward Foreign Direct Investment (FDI) has been falling to historic lows for the U.S. and China (Baldwin, Freeman & Theodorakopoulos, 2023). The migration of labour-intensive supply chains from China to lower-cost locations can be attributed to rising wages, domestic supply chain bottlenecks and investor concerns about tighter regulation of foreign companies, coupled with the escalating trade war between Washington and Beijing. Vietnam and Thailand have been big winners in the supply chain shifts. India now is being tapped to become a complementary Asian manufacturing hub to China (Wignaraja, 2023), seen as a reliable alternative destination among the largest global FDI recipients, driven by its rapid economic growth, a large educated labour pool, and huge domestic market (Economic and Social Commission for Asia and the Pacific, 2023).
An influential view most prominently Rajan and Lamba (2024) argue that India’s services sector is the main driver of economic growth in a world of growing globalisation of services. They suggest that India should exploit comparative advantages in labour and increase its role in the domestic economy and global services trade especially those digitally delivered. They conclude that India should invest more in human capital and skills to capitalise on this strength in services. There is some merit in this view as India does have favourable demographics of youthful population and thus ample supplies of low-cost manpower. However, international development history suggests that relying on services development alone may be insufficient for a large economy like India to transform beyond lower middle status and create high-quality jobs. The crucial role of manufacturing development in generating jobs and prosperity is underlined by the East Asian miracle story. This begins with the industrialisation of Japan in the inter-war period, followed by the rise of the four East Asian dragon economies (Korea, Taiwan, Hong Kong and Singapore) in the 1960s and 1970s and China since the 2000s. Looking further back into history, the rise of UK, Germany and the U.S. came on the back of industrial revolutions in the 18th and 19th centuries.
Furthermore, the evidence suggests that manufacturing and supply chain pessimism about India seems to be finally shifting. One indication comes from within the Indian manufacturing sector itself. The Purchasing Managers Index (PMI) summarises if market conditions for manufacturing are expanding, staying the same, or contracting, as viewed by purchasing managers. India’s PMI is well above 50, relatively high compared to the comparator economies including China and Indonesia (ADB, 2025). In addition, there have been significant micro-level investments by global MNCs in India. Prominent among those are Apple which has been ramping up its manufacturing of iPhones in India since 2020, Toyota which has increased its investment by setting up a new plant in Karnataka and Hyundai’s 2024 investment in Maharashtra has upped its capacity and encouraged technological advancement. India’s manufacturing sectors in areas such as automotives, pharmaceuticals, and electronics assembly are already well-established and can benefit from a series of policy initiatives, which have already resulted in a 69% increased FDI equity inflow in the manufacturing sector over the past decade of 2014-24 compared to the previous decade of 2004 -14.
Perhaps most important in uncertain global times has been the visible advancement in India’s defence manufacturing sector, largely due to the Make in India initiative (Ahuja, 2024). In 2023-24, it saw an increase of 174% (CK) over the past decade, and a boost in exports. India’s goal is to become a defence manufacturing hub, with ₹3 lakh crore ($35 billion CK) in defence production by 2029, Start-ups, large domestic companies and multinationals are actively developing a range of products. For example, in 2024, Airbus, in partnership with Tata Advanced Systems, inaugurated a C295 final assembly line complex in Gujarat, for producing military transport aircraft for the domestic market.
An impressive performance has been that of the BrahMos, a long-range supersonic cruise missile developed collaboratively by India’s Defence Research and Development Organisation (DRDO) and Russia’s NPO Mashinostroyeniya. India had already exported the BrahMos to the Philippines in 2024, and in 2025, has been in talks with Vietnam and Indonesia for similar exports. In the 7-8 May 2025 conflict between India and Pakistan, the vastly superior performance of the BrahMos has resulted in increased inquiries for exports and stepped up discussions between India and Russia for advanced versions of the missile.
With this new confidence India needs reforms that promote trade openness, cut the red tape regulations strangling businesses, and facilitate investments in renewable green energy (Das, 2024; World Bank, 2024). Closer policy coordination between the central government and India’s semi-autonomous states is necessary in areas such as attracting foreign direct investment and cross-provincial infrastructure development (such as national highways and high-speed road roads). May there is some merit in revisiting India’s landmark 1991 reforms? Influential commentators like Douglas Irwin (2025) suggest that the political economy of reforms matters. He argues that in 1991 reform-minded technocrats persuaded political leaders to reject what had been a standard response to balance of payments pressure (import repression to avoid a devaluation) and embrace a new approach (exchange rate adjustment and a reduction of import restrictions).
Several other elements now need to coalesce together. Supply chains rely on a multitude of services inputs. In this vein, India’s service sectors (including information and communications technology, financial and professional services, and transport and logistics) are also positioned for growth.
The final goods produced in these factories rely on sophisticated semi-finished goods from abroad which has contributed to growing Indian imports of intermediate goods. Thus, a second indication of India’s global supply chain ascent is its role as a major global intermediate goods importer. In the fourth quarter of 2023, the WTO ranked India as the fifth-largest importer of intermediate goods (see Figure 1) – up from the 10th rank in the second quarter of 2021. In 2023, India was behind top global importers such as China, the U.S., Germany and Hong Kong. The country is now positioned ahead of European developed country importers (the UK, Netherlands, and France) as well as Japan. Few foresaw India’s emergence as a leading global importer of intermediates a decade ago.
Notes: Figures in $billion
Source: World Trade Organisation, 2023
A third indication of India’s role in global supply chains is as an exporter of intermediate goods. Here the data suggest that India and South Asia as a whole are relatively small players in supply chains compared to East Asian or developed economies. Between 2000 and 2023, India’s share of world intermediate goods exports doubled from a modest 0.8% to 1.5 per cent (see Figure 2) Adding the rest of South Asia (an estimated 0.1% of world intermediate goods exports) to India’s share, yields a tiny regional share of only 1.6% in 2023. Meanwhile, China and Hong Kong make up 18.1% of the world share and ASEAN another 8.5%. Though declining, Japan the U.S. and the EU have larger world shares than South Asia.
Furthermore, there are extremely limited regional spillovers from India’s supply chain activities to the rest of South Asia. Intra-regional trade in South Asia at 5% (2017) is amongst the lowest in the world. This makes South Asia one of the world’s most disconnected regions in economic terms. Despite its growing trade volume with the world, India’s trade with its neighbours is between 1.7% and 3.8% of its global trade. India’s largest regional trading partner is Bangladesh, followed by Sri Lanka and Nepal.
Note: *represents estimates
Source: WTO (2023), Wignaraja (2023)
Trade Diplomacy in High Gear
Since 2022, the Modi government has placed renewed emphasis on preferential openings with trading partners through a flurry of bilateral trade deals such as the UAE-India Comprehensive Economic Partnership Agreement and the Australia-India Economic Cooperation and Trade Agreement (ECTA). It has also joined big regional trade frameworks like the Indo-Pacific Economic Framework (IPEF) (Dhar 2022). A trade agreement signed with the UK in May 2025 provides notable gains in services and ambitious market access (Wignaraja, 2025). This will accelerate the ongoing negotiations with the EU to conclude an equally comprehensive high-standard FTA and with the U.S. for a partial Bilateral Trade Agreement. India is a latecomer to Asia’s bandwagon of FTAs but attempting to catch up with East Asia (Kawai and Wignaraja, 2013; Wignaraja, 2022). According to the Asian Development Bank’s Asia Regional Integration Centre database, India has 17 concluded FTAs and another 19 under negotiation (see Table 1). In terms of numbers of concluded FTAs, India is in the same league as leading Southeast Asian countries like Indonesia (19), Malaysia (19), Thailand (16), and Viet Nam (18).
The geopolitical signalling on trade openness in 2025 is important. India is moving to FTAs with the Global North, which has positive implications all around.
First, an India-EU FTA plus an India-UK FTA may support reformed global rule-making on international trade and even perhaps revive the WTO – a stated goal of India.
Second, FTAs are a stepping stone to India’s membership of the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP). The CPTPP, a high standard mega FTA that reduces trade barriers for members and which India declined to join, makes up a large share of world trade. The 12 members, including Japan and the UK, represent 15% of world trade and 15% of world GDP.
The CPTPP includes agendas for services, trade, investment rules, intellectual property rights, government procurement, etc which support the spread of supply chains. Consultations with businesses during FTA negotiations and providing business development services for FTA implementation is essential as trade and investment do not necessarily pick up because an FTA is signed.
As Indian business gains experience and confidence with trading under the trade agreements with the Global North, and as they enable closer economic integration, India can usefully study the economic benefits and costs of CPTPP accession. It provides access to multiple markets in one go, will benefit India from the China+1 movement and boost business for MSMEs which are 40% of India’s exports. This will have resonance in the rest of South Asia, where SMEs are the backbone of these economies, but don’t as yet pull their weight in exports
Source: Asia Regional Integration Center, February 2025
At home, the FTAs will provide the country with a unique opportunity to implement necessary reforms and open up its economy, as it did in 1991. This will, in turn, increase foreign capital, boost skills, encourage R&D- and investment and innovation, – moving the country towards a more competitive and open economy.
So far, India has made the following initiatives to boost manufacturing:
Make in India: Launched in September 2014, with the goal of transforming India into a global design and manufacturing hub. The focus was on ease of doing business, by reforming policies governing business , making them more investor friendly and centring on infrastructure development.
Atmanirbhar Bharat: Launched in May 2020, the Self-Reliant India Campaign focused on reforming seven key sectors especially for ease of business.
Product Linked Incentive (PLI) Scheme: Launched as a continuation of Atmanirbhar Bharat to give financial incentives for higher production and incremental sales to an additional 14 sectors. The goal is to support and grow India’s manufacturing sector.
Lessons from China
Some aspects of China’s industrial policy may be relevant to India, including better targeting of multinationals with which to partner new industrial endeavours that can deliver potential comparative advantages. It requires improved coordination between the central government and state administrations. Equally important is upstream investment in tertiary-level education in science, technology, engineering and mathematics.
However, industrial policy is a controversial area and caution should be exercised before India attempts to copy China’s state interventionist template. Significant risks include government failure and cronyism. It will be prudent to actively engage with think tanks to gain insights into what might work.
Still, India can learn much from China’s experience.
Lesson 1: Promoting export-oriented FDI
Trade liberalisation means an open-door policy toward FDI in manufacturing and facilitating investment at a high level, with competitive incentives and the creation of modern SEZs as public-private partnerships.
Lesson 2: Reducing business hurdles
Digitalisation of taxes, customs fees and business administration is essential. Industrial policy to facilitate the green transition and trade are increasingly used and can bring gains.
Lesson 3: Fostering regional supply chains
India should promote regional supply chains by scaling up the Make in India programme to a Make in South Asia initiative. India can offer fiscal incentives to its manufacturers to spread into Bangladesh and Sri Lanka. The food processing, textiles, apparel and automotive sectors are candidates for regional expansion, given the factories and experience of these neighbours.
Lifting Up India’s Neighbours
Currently, much of South Asia is not a major part of India’s trade story, despite the economic potential of some countries. Thus, it makes economic sense for India to spread the gains from this trade regionally, promoting resilient and cost-effective regional supply chains in South Asia. This will stabilise the region, create jobs, and make its neighbours less vulnerable to the potential risks of Chinese infrastructure investments including debt distress linked to high interest, low return port projects as well as environmental challenges (e.g. deforestation, habitat destruction, water pollution, and increased carbon emissions).
In this spirit, India-Sri Lanka FTA talks could be resumed, with a view to concluding an investment deal, followed by a more comprehensive FTA. Cutting redundant business regulations, stronger investor protections in Sri Lanka are crucial to attracting Indian foreign investors in the country’s ports, logistics, renewable energy, digital economy and tourism ventures. Such ventures generate much-needed foreign exchange and provide Sri Lanka with a path away from indebtedness and towards transformative growth.
A sure way for South Asia to have resilient and cost-effective regional supply chains is for Indian businesses to invest in the region and foster significant local linkages and spillovers for its South Asian partners (Kathuria, Yatawara and Zhu, 2021). This is already happening to a limited extent in Sri Lanka and Bangladesh. The Adani Group, for example, has invested in a joint venture with John Keels Holdings to develop the West Container Terminal in Colombo Port. This project capitalises on Sri Lanka’s favourable geographical location along the main East-West global sea route and transhipment trade to India.
Bangladesh was growing rapidly, with a larger domestic market and cheaper wages than Sri Lanka, until its internal crisis. It had become attractive for Indian FDI in the manufacturing sector. Tata Motors, Hero MotoCorp, Sun Pharma, Godrej, VIP, CEAT Tyres and Aditya Birla Cement all built factories in Bangladesh. A natural corollary would have been Increased private investment in consumer-oriented sectors and start-ups focused on fintech, healthcare and agritech to develop a local ecosystem with access to seed funding and technology transfer from India. But, these potential developments are now on hold due to political developments.
India-Sri Lanka: a model for South Asian Cooperation
The joint statement released after Prime Minister Narendra Modi’s visit to Colombo in April 2025 and Sri Lanka’s President Anura Kumara Dissanayake’s visit to New Delhi in December 2024 highlighted India’s pledge to help Sri Lanka become an energy hub, enhance India-Sri Lanka defence cooperation and boost education, health and technology exchanges and encourage Indian FDI in Sri Lanka.
It is clear that India recognises that Sri Lanka can be a premier partner in making South Asia a progressive economic region in an uncertain global economy. Sri Lanka has been South Asia’s highest GDP per capita economy, reaching a peak of $4,388 in 2017, a productive, medium and small enterprises machine. Its fall, in five years, to $3,3431 per capita, was a blow to a country accustomed to a good life. This is what Dissanayake has vowed to reverse. He has confirmed that Sri Lanka will continue with its 17th IMF programme but with increased social spending to reduce high poverty. He is improving governance by adopting anti-corruption measures, digitising the government and modernising agriculture.
The bilateral agreements with India help the new continue these efforts and change the focus of the relationship from aid to trade. India has agreed to help Sri Lanka in the digitalisation of its public services, a model which India has pioneered, and which will help achieve some of the promises NPP made for targeted social protection and anti-corruption. A Memorandum of Understanding (MoU) was signed during PM Modi’s visit to Colombo in April 2025 with Sri Lanka to establish a high-voltage direct current (HVDC) connection for importing and exporting power. A tri-partite agreement between India, UAE and Sri Lanka to develop Trincomalee into an energy hub is a model that can be replicated in other sectors.
It’s a promising start that can elevate the bilateral to make it like the close cooperation visible between Thailand, Cambodia and Lao People’s Democratic Republic, for instance, in the Greater Mekong sub-region.
New Delhi and Colombo can consider piloting a regional PLI scheme in Sri Lanka similar to the Government of India’s efforts to build domestic capabilities in sophisticated manufacturing industries including solar panels, electric vehicles and electronics components. A limited extension of the domestic PLI scheme to Indian businesses to make solar panels in Sri Lanka will limit the risks of overseas investment and build regional supply chains in the neighbourhood – a key goal for India’s China+1 strategy.
Such enhanced cooperation with Sri Lanka is almost a necessity. India is facing a hostile neighbourhood in 2025. Ties with Bangladesh are strained; debt-distressed Maldives reluctantly accepted a short-term liquidity inflow of an RBI swap after China cooled about its request for aid. Nepal’s PM K.P. Sharma Oli just signed a framework agreement with China to implement the Belt & Road Initiative’s infrastructure projects. Struggling economically under Taliban rule, Afghanistan risks becoming a regional centre for narcotics trade and illegal migration, as does Myanmar to India’s East. Relations with Pakistan remain in cold storage.
These issues concern both India and Sri Lanka. An economic partnership in South Asia that works can become a model for others, enhance India’s Neighbourhood First Policy and India’s status as a regional power.
Conclusions
The slowdown of the Chinese economy, and the shift, particularly by MNCs, from China to other more competitive locations has opened up business opportunities for latecomers to supply chains in the developing world. The available evidence suggests that Southeast Asia and some South Asian countries like India, Sri Lanka, Bangladesh, could be beneficiaries of the supply chain shift, particularly in labour-intensive segments.
The shift is underpinned by geopolitics as also the availability of skilled and relatively low-cost labour and a large middle class. However, these carry constraints: Southeast Asia does not offer scale, and South Asia which can, is a latecomer to trade-led regionalism, therefore constrained by policy barriers and infrastructure gaps.
Three policy implications stem from the analysis in this paper on enhancing the role of India and the rest of South Asia in global supply chains. First, openness to trade and FDI inflows is fundamental entering and deepening a country’s positioning in global and regional supply chains. Perhaps the Trump reciprocal tariffs should be seen as an opportunity for South Asia to undertake comprehensive trade and FDI reforms, cut red tape and digitise business procedures to make the ease of doing business easier and reduce corruption vulnerabilities. It may be prudent to revisit the case for ‘big bang’ comprehensive reforms as gradual, incremental reforms have had a mixed experience.
Second, countries should invest in trade-related infrastructure (such as transhipment ports, trade-related logistics services and port-road network connectivity) to significantly reduce trade costs. In this vein, improving the performance of Special Economic Zones (SEZs) to attract foreign and domestic investors and clustering of business activities is useful as trade and investment reforms may take time.
Third, concluding deep free trade agreements with India’s neighbours like Sri Lanka would help to reduce regional trade barriers and provide for regional rules-based trade amidst global uncertainty. In this vein, India should explore limited time-bound fiscal and financial incentives to promote regionalisation of supply chains in India’s neighbourhood like its own PLI scheme.
Ganeshan Wignaraja is Professorial Fellow for Trade and Economics.
This article was first published in July-August 2025 issue of India Foundation Journal.