Dragon vs elephant

Jiabaos visit

No matter whether India has  already ‘emerged’ (as Obama declares) or is merely ‘emerging,’ there is no doubt that there is now a huge business interest in the $1.3 trillion Indian market growing at a phenomenal rate of 8 per cent plus. The visits by the British prime minister, the US president, the French president, now the Chinese premier, to be followed by the Russian president — all within the year 2010 — is a big testimony to that.

The significance of the current visit by the ‘communist’ Chinese premier Wen Jiabao accompanied by some 400-member business delegation (which has a striking similarity to the ‘capitalist’ US president’s visit with the top US business CEOs) has to be understood against the backdrop of the current economic landscape of the world. The economies of the western world (US, EU and Japan) are showing little promise of going back to their pre-recession growth rates in the foreseeable future and resentment against Chinese economic policies (specially undervalued yuan) is growing in the West.

So, China is trying to gradually move away from its export-led growth strategy built on selling manufactured goods (mainly) to the western world with the help of high savings, low wages and undervalued yuan to a model which has to allow rising wages, higher domestic consumption, a more market-determined exchange rate, more sales to non-western markets through exports and setting up production-cum-servicing facilities abroad.

As a result, China is now looking to engage more with the emerging economies in Asia and Africa which are growing faster than western economies (providing alternative markets for Chinese goods), offer cheaper production locations and are important sources of crucial natural resources (agricultural land, minerals, energy) which the fast growing overpopulated Chinese economy will need more and more to sustain itself.

China has already built up a huge foreign exchange reserve of some $2.5 trillion — most of it held in US government bonds offering a very low return due to both low US interest rate and declining US dollar. China is no longer keen to accumulate more dollar funds. Chinese high savings (more than 50 per cent of GDP) kept mostly in Chinese banks is searching for better and safer investment avenues.

India’s plan to invest some $1 trillion in infrastructure in the 12th 5-year Plan offers Chinese banks (mostly state-owned) huge opportunities to invest in India, financing purchase of equipment by Indian companies (a typical example is the $8.3 billion agreement between Reliance Power buying equipment from Shanghai Electric Power Company and construction projects.

Chinese construction firms typically insist on bringing their own labour which provides jobs to Chinese workers. All these are making India an attractive economic proposition for Chinese business and financial institutions.

Self-interest

Despite various political irritants like lingering old border disputes, new claims over Arunachal Pradesh, stapled visa for residents of Jammu and Kashmir, Chinese military and construction activities in PoK (interestingly, Wen’s India visit will be immediately followed by a visit to Pakistan — in sharp contrast to Obama’s visit to India not followed by one to Pakistan) the pragmatic Chinese leaders have no problem in engaging economically with India so long as it serves its interest.

In fact, China has already replaced the USA as the largest trading partner of India. India-China bilateral merchandise trade is more than $42 billion in 2009-10 as against less than $13 billion in 2004-05 and less than $2 billion in 1999-2000.

The major problem from India’s side is the rising trade deficit with China which stands at more than $19 billion in 2009-10 as against only $1.5 billion in 2004-05. Some trade theorists may suggest that India should not be too concerned with the bilateral trade deficit so long as it has manageable multilateral trade balance and the trade deficit with China may simply reflect the current pattern of comparative advantage.

However, most Indian business people and the Indian government are not willing to buy that. Their major argument is that Indian firms have been very successful in exporting in areas like IT, pharma and processed meat products to highly competitive western markets but has not been able to penetrate the Chinese market. This is evidence of the existence of various non-tariff barriers in China against Indian exporters. To ally these concerns, Wen has specifically promised to open up the Chinese market in IT, pharmaceutical and agro-products for Indian business.

Another area of concern is the very low level of bilateral FDI flows. Chinese FDI into India is a meagre $52 million. Increasingly, the Chinese are realising that without manufacturing and servicing facilities near the market, Chinese firms will not be able to sell their heavy equipment and durable consumer goods in a big way. So, the Chinese may very well agree to set up more manufacturing and servicing facilities in India (providing jobs to Indian workers) in its self interest and as a quid pro quo would allow more Indian companies to set up production facilities in China.

Given that the Indian companies (like Reliance Power) is able to get equipment at significantly lower price from China along with financing at a low interest rate and longer maturity, the increasing economic exchange between the dragon and the elephant has the potential to be a win-win for both. However, to realise the potential, India needs to a hard bargainer.

(The writer is a former professor of economics at IIM, Calcutta)