Indian companies aren’t investing. The cost of money is too high; in its latest policy announcement on December 18, the Reserve Bank of India (RBI) maintained its benchmark repo rate (the rate at which the RBI lends to banks) at 8%. This was despite the official GDP forecast for 2012-2013 falling to 5.7%-5.9%, the lowest in a decade. Lower interest rates are necessary to induce companies to borrow money for investment purposes.

Big ticket foreign investments like Walmart and IKEA are still waiting for clearer rules. Besides, though foreign direct investment in multi-brand retail and aviation has been approved by both houses of Parliament, there is still considerable local opposition. No company wants to enter the country to find its stores attacked by political parties, as happened earlier with KFC.

So is the India manufacturing story – described by McKinsey & Co as a US$1 trillion opportunity by 2025 – running out of steam? Not really. While the big companies are putting projects on hold, smaller players are filling the gap.

There has been a subtle change in the purpose of these projects, however. Until recently, India was looked upon as an outsourcing base for items as diverse as auto components and fabrics. Today, the focus is more on the domestic market.

“Local manufacturing and local services are the best way to cater to the Indian market,” says Piyush Shah, managing director of Hitachi Hi-Rel Power Electronics. Hitachi, a Japanese global electronics major, has opened a new factory in Gujarat at an investment of US$11 million. This is part of Hitachi’s US$1 billion investment plan in India.

The URB Group, one of Europe’s biggest manufacturers of bearings, has announced its first manufacturing foray in India (in Rajasthan) at an investment of US$66 million. This will be its first factory outside Europe (the others are in Romania, Turkey and Hungary). URB has had a marketing presence in India since 1982. “We will be able to sell our bearings at much lower prices to manufacturing companies in several sectors,” says Harun Adiguzel, president of URB India.

Amway India, a direct-selling FMCG (fast-moving consumer goods) company, plans to set up its first manufacturing facility in Tamil Nadu at a cost of US$100 million. The company has been sourcing some 97% of its needs from third party contract manufacturers until now.

Focusing on the domestic market means that products have to be localized. To use a very basic example, electrical devices have to be configured to a 220 volt input instead of the 110 volts that is the norm in some other countries. When the Indian market wasn’t very important, foreign companies expected consumers to buy a step down adapter to be able to use the foreign model in India. Now products are being made specifically for India.

This is the other big driver in the invest-in-India movement. “India is a very diverse market in terms of consumer choices and preferences,” says Krishan Sachdev, managing director of Carrier Midea India. “This makes product localization an integral part for a consumer brand like ours. A local manufacturing facility gives us the flexibility for new product development and to quickly respond to the market dynamics. Besides, localization also helps with cost economies and reduces exposure to [foreign exchange] fluctuations.” Carrier Media is a joint venture between U.S.-based Carrier Corp. and the China-based Midea Group. It recently inaugurated a new manufacturing facility in Haryana with an investment of around US$100 million over a five- to six-year period.

Panasonic India has a similar focus on localization. “[We want to integrate] Indian expertise into our product design and manufacturing processes,” said Daizo Ito, president of the Indian subsidiary of the Japanese MNC, in a recent press statement. Panasonic has opened a technopark in Haryana to manufacture air-conditioners, washing machines and certain industrial products. The investment planned in this facility is around US$200 million.

Export remains a long-term ambition, however. At URB, 70% of the production will be for domestic use and the remaining 30% for export. The target is to take this to 50:50. Panasonic is looking at exporting 5% of its production by 2013 and 20% by 2015. “Lower cost of production and the ability to provide best-in-class quality is also putting India in the forefront of export markets,” notes Shah of Hitachi.

The export strategy comes in a new form. India is being regarded as a local manufacturing hub. Panasonic India will target the Middle East and Africa. Shah is looking at Southeast Asia, Africa and the Middle East. URB is a little more ambitious: It is eyeing the European and the U.S. markets as well. (The others already have bases in the West.)

Export is the icing on the cake. The domestic market remains the key driver for the foreign investments in manufacturing. “With the emerging middle class, increased disposable incomes and low level of product penetration, India holds very strong growth prospects,” says Sachdev of Carrier.

Kumar Kandaswami, senior director at Deloitte India, gives a macro view. “The per capita consumption in India is low,” he says. “There is a lot of headroom for growth. For instance, while India has about 10 cars per 1,000 [people], China has over 50. As increasing numbers of people come into the zone of employment and consumption, demand will be further fuelled. Going [forward], consumption-driven manufacturing looks strong. In Europe, demand is dwindling, and in the West there’s a slowdown. Companies are now focusing on regions where demand exists; they want to localize and make themselves responsive and relevant by setting up manufacturing units to cater to these regions.”