India’s $99B trade deficit with China calls for gradual decoupling. Dr Ajay Dua outlines how to pivot with BRICS, Quad & local innovation.
With its vast resource endowment and notable efficiencies in sourcing, production, distribution, and trade, China has accumulated trade surpluses with numerous countries. Through assiduous and methodical efforts in import substitution and export promotion, a handful of them may over time, be able to reduce their trade deficits, and possibly their dependence on inflows from it of investment and financial aid. However, their vulnerability to economic shocks and growth deceleration is likely to persist as long as China retains the ability to weaponize trade and financing.
China has repeatedly demonstrated a willingness to deploy both tools liberally in pursuit of its geopolitical and strategic interests. China’s capability to undertake such strategic manipulations stems from its well-conceived and effectively executed policies aimed at exploiting economic dependencies. Since the early 1980s, when Deng Xiaoping made the deliberate decision to steer China away from a closed, state-run economy toward a market-base, yet statecontrolled model, the country’s financial and military capabilities have steadily expanded.
Selectively letting in foreign capital, technology, and showing scant respect for the international regime of intellectual property rights, came in handy to achieve all-round progress. By leveraging its huge population and market size, within just three decades of the policy shift, China had developed the biggest manufacturing base, accounting for 30% of global manufacturing, turned itself into the largest trading- nation with 37% of GDP originating there, and emerged as the second-largest economy, next in size only to the USA, and way ahead of all others.
Initially upon gaining independence, India and China facing similar challenges, had cooperated in geo-political issues. The bonhomie was rather shortlived. By 1959, China decided to fulfil its inexhaustible urge to expand borders and had marched into adjacent Tibet—a move that brought it directly to India’s northern frontier. Thereafter, it pressed for a revision of the bilateral international border defined by the 1914 McMahon Line, based on the watershed principle. To buttress its new claim of sovereignty in November 1962, its army intruded deep into Indian territory in Arunachal Pradesh (then NEFA), reaching as far as Tezpur in mid-Assam. In eastern Ladakh, it occupied Aksai Chin. Following the so-called China–Pakistan Border Treaty of March 1963, the Shaksgam Valley in Pakistan-occupied Kashmir (POK) came to be ceded to China.
Through this, it positioned itself as a stakeholder in the Kashmir dispute between India and Pakistan, and has since supported Pakistan on Kashmir at all international platforms, especially the UN Security Council. The resultant heightened rivalry and contestation, however, has not come in the way of their pursuit of transactional commercial interests. By 2023-24, bilateral trade between them had reached a staggering US $135 billion or 18% of India’s merchandise trade. Overwhelmingly in favour of China, its annual exports hover around $110-115 billion, in comparison to the Indian exports of $15 to $20 billion. The bilateral Indian trade deficit had ballooned to $99.21 billion and might continue to widen with India’s import increase outpacing exports. Indian exports to China have declined from 42.3% of Chinese exports to India, twenty years ago, to just 11.2%. China has entrenched itself as India’s default supplier for both everyday products and critical industrial inputs. It currently meets 97% of India’s imports of erythromycin, 88% of all antibiotics, 97% of silicon wafers for electronics and semiconductors, 86% of flat panel display modules, 67% of printed circuit boards, 37% of memory chips, and 41% of microprocessors. In consumer electronics, it accounts for 81% of laptops and tablets, 59% of smartphone components, and 52% of their parts. Similarly, 83% of solar cells, 79% of solar panels, and 75% of lithium-ion batteries used in electric vehicles and energy storage systems come from China. In machinery and industrial goods, Chinese exposure ranges between 85% and 92% of all imports, while for chemicals and plastics, the shares stand at 41% and 38%, respectively. The measly Indian exports to China currently consist primarily of iron ore, light naphtha, p-xylene, shrimps, castor oil, rice and sugar. To maintain the extant differential, the Chinese have been restricting market access through higher tariffs and enforcing nontariff barriers.
Amongst the recent impositions upon India are: licenses for export of rare earths in many of which China holds a virtual monopoly; not permitting the dispatch of tunnel boring machines for the Ahmedabad-Mumbai highspeed rail link; curbing the export of DAP for farm application before sowing; and delaying the mandatory customs inspections of Indian shrimps, sugar, and rice, while preferring their imports from Pakistan and Bangladesh. Peeved by the increase in Indian mobile handset and component production, it has withdrawn Chinese skilled supervisors from the Indian facilities of Apple (USA) and Foxconn, the large Taiwanese contract manufacturer, thereby disrupting production lines. On the bright side, China has not been a significant FDI investor or a donor of development aid to India. Its aggregate equity investment since 2005 is US $3.2 billion—marginally higher than $2.5 billion invested by Indian entities in China. The slow inflow, averaging $160 million per annum, is attributable partly to India’s security concerns over investments from the Mainland and Hong Kong, which have heightened since the Galwan intrusion in 2020. There is wariness at opening up India’s large and expanding market to the Chinese. FDI proposals bringing unique technologies, know-how, or product innovations, and incorporating a program of phased indigenization are being permitted.
The manufacturing of low to medium technology imports - ranging from textile and agricultural machinery to compressors, building hardware, bearings, motors, nuts, bolts, and even stationery - is amenable to production in India. Once the Indian import policy is firmly established, a nationwide reverse-engineering initiative for such products, needs to be launched. Sector-specific industrial labs must be set up by the government to deconstruct commonly imported items and develop standardized, open-access blueprints. MSMEs, along with startups with proven track record, must be facilitated to begin niche production. Thereafter, aggregation in production to secure the benefits of mass production can be initiated. Such assistance may be made available for a longer duration than currently provided under the PLI scheme for 14 identified products. Initially, it may also include the provision of high-tech common facilities and an assured purchase arrangement. Sustained assistance would incentivize deep manufacturing and not merely shallow assembly.
Components and intermediates must be manufactured locally, as successfully done in Japan and South Korea. Robust and vertically integrated ecosystems for manufacturing, call for sustained investment by both the State and the private sector in R&D, infrastructure, and talent-building. To reduce vulnerability, this becomes essential in sensitive segments such as power equipment, telecom networks, fintech infrastructure, and critical logistics. To counter the Chinese dominance in minerals, especially rare earths, India should consider offering, ab initio, deposit-bearing nations a stake in the entire value chain from exploration to mining and refining. The growing acceptance of India in the Global South, earlier in Africa and now even in Latin America, can be hastened by such a noncolonial approach. Accompanied by “soft aid” in the form of support for setting up schools, skilling centres, primary healthcare facilities, water treatment plants, and distributed power station would help minimize the reservations of local people. Instead of adopting the Big Brother attitude often conveyed by the Chinese in their Belt and Road Initiative and other projects, India would do well to make its aid process participatory and making the host nations feel they have a skin in the game. All such efforts of pivoting away from China have the potential to lower the dependence. But China-proofing quickly does not appear to be a feasible proposition.
China’s current GDP is five times India’s and is backed by a large factor endowment. Even with the Dragon’s annual GDP growth slowing to 3%, and India maintaining a 6% growth rate, a back-of-the-envelope calculation suggests that after 25 years, China’s national product would be three times larger. The gap in per capita income, currently about 500% higher, would remain around four times. By the middle of the current century, the two countries are unlikely to have achieved global parity in strategic or geopolitical matters. With such structural advantages continuing to favour China, India must adopt a realistic approach and reconcile itself to a gradual, long-term process of decoupling. Alongside, the endeavours at constant diversification of trade and reducing dependence on China wherever techno-economically feasible, the Indian initiatives have to be aligned with those of other countries facing a similar challenge and dilemma. Its Quad membership can be strategically leveraged, as the other three members, USA, Japan, and Australia, also run trade deficits with China and share a common interest in checking its growing influence in the Indo-Pacific region.
The objectives of this grouping, despite China’s sneering references to it as the “Asian NATO,” have expanded in the last few years and now include building economic strength and resilience among member countries. Last week, the Quad Foreign Ministers had set up a new Critical Minerals Initiative by collaborating to secure and diversify critical mineral supply chains. In February last, Prime Minister Modi and President Trump had agreed to undertake R&D and investments across the entire critical minerals value chain. Replicating efforts in other industries viz semiconductors, AI, robotics and more, through leveraging each member’s comparative advantages—USA and Japan’s high technical and financial strength, Australia’s mineral diversity, and India’s skill base and market size—can help counter Chinese advancements. BRICS, though only an association, is another forum for collective action. Its 11 member nations and 10 partner members together account for half of world’s population, 40% of global GDP, and 20% of global trade.
They can leverage their strengths for greater economic cooperation and achieving rapid progress in developing new supply chains. No doubt, since decisions are made by consensus, China cannot be expected to allow the passage of proposals that adversely impact its interests. However, as a loud protagonist of WTO’s rule based and free trade, it cannot be seen as objecting to collective efforts which aim at achieving them. In fact, with Trump’s threat of an additional tariff against the BRICS, the members might be able to persuade China to refrain from deploying any unfair practices against the fellow members. A joint understanding among the five original members to scale up mutual trade from the current $1 trillion to $2 trillion by 2030, through minimal tariffs and a shared commitment to free trade, should be on the agenda of the next BRICS summit to be hosted by India. A billion-dollar question is whether India should propose to China to consider a bilateral trade pact. China’s demonstrated statecraft of manipulating Indian trade to create volatility might be kept in check if the two neighbours commit to a long-term economic relation. Such an agreement holds the potential to cool tensions along their shared borders and expedite the resolution of the territorial dispute. An additional incidental benefit for India would be the boost to its manufacturing and exports at a time when the share of goods in its Gross Value Added (GVA) is falling despite a host of efforts.
Dr Ajay Dua, a development economist, is an ex-Union Secretary, Commerce and Industry.
