Balancing LAC tension with economic strategy — How India can walk the tightrope against China

Customs Act allows Modi govt to prohibit imports from China. But the law's compatibility with WTO norms brings legal hurdles. That's where Atmanirbhar Abhiyan comes in.

Representational image | Bloomberg

While India and China engage to ease out border tensions, the bitter Line of Actual Control standoff has understandably triggered calls for a boycott of Chinese goods and services on the economic front. Amid emotional calls for stopping all kinds of imports from China, the Narendra Modi government banned 59 Chinese apps citing national security concerns.

Navigating these choppy waters of fraught relationships while securing India’s economic and security interests demands a comprehensive assessment of the country’s economic and strategic reliance on its trading partners, especially China.

The skewed nature of trade with China 

Let’s first examine the numbers. What is the nature of trade between the two countries and what’s the extent of India’s dependency on its northern neighbour?

About 10 per cent of India’s overall trade is with China, making it our second-largest trading partner. The India-China bilateral trade, which was $1.8 billion in FY2000, has jumped to $81 billion in FY2020.

The lopsided nature of India’s trade with China and our huge import dependency on our neighbour is well documented. India’s trade deficit with China has grown from a mere $0.6 billion in FY01 to $49 billion in FY20. India’s exports to China in FY20 were $16 billion compared to imports of $65 billion, nearly one-fourth. China currently accounts for 14 per cent of India’s overall imports and 20 per cent of our non-oil imports. Thirty per cent of India’s overall trade deficit is accounted for by China.

A rising trade deficit per se may not be as problematic as the quality of trade between the two nations. India’s top exports to China include ores and slag, mineral fuels, organic chemicals, fish and some electric machinery. However, three categories dominate 62 per cent overall imports from China – organic chemicals, electric machinery and equipment, and machinery and mechanical appliances.

These also happen to be India’s top import categories accounting for almost a quarter of its total import bill. China dominates in these categories with 40 per cent, 39 per cent and 30 per cent share in imports, respectively. Telephone and mobile handset automatic data processing machines, diodes, transistors and semiconductor devices, electric transformers, air vacuum pumps, electronic integrated circuits from the bulk of imports in machinery and electric equipment. Imports of active pharmaceutical ingredients (within organic chemicals) from China account for almost 70 per cent of our overall API imports.

Apart from these three dominant categories, imports, where China has more than 50 per cent share, include furniture, industrial textiles, footwear, ceramic, toys, knitted fabrics, leather articles and handbags, base metals, apparel and clothing, silk, umbrellas, headgears and sports equipment. These numbers sketch the striking asymmetry of dependence between the two economic powerhouses.

Chinese market distortions well known, need to be addressed

There is enough evidence on underpricing and dumping of Chinese imports into various markets, including India. As per World Trade Organization (WTO) data, China has the maximum number of anti-dumping cases against it (a total of 1,033 since 1995) followed by South Korea at a distant second with cases on 289 products. Just in the last two years, dumping has been proven against China for more than 100 products. This again is the highest against any country.

China’s market-distorting practices with respect to prices and resource allocation is well documented. In a study titled, On significant distortions in the economy of the People’s Republic of China for the purposes of trade defence investigations, the European Union Commission found significant cost-cutting distortions in China across various factors of production – land, capital, energy, raw materials and labour – which give the Chinese producers a significant edge over their global peers. Moreover, substantial government intervention in sectors such as steel, aluminium, chemical and ceramic exacerbate these distortions and amplify disadvantages of trading partners.

The study reports, “typical instruments used are market access controls, project examination and approvals, land supply approvals, loan approvals, various forms of financial support, industrial guidance catalogues, and licensing & Government procurement”. The report terms the Chinese industrial policy demonstrably interventionist with no perceptible signs of change in the near-future.

Similarly, various studies conducted by the US Department of Commerce have concluded that China is a non-market economy where costs do not reflect market values. Non-market based resource allocations have, over time, led to the creation of overcapacities in many sectors.

Further, subsidised loans to industry, provision of land at less than adequate remuneration (LTAR), raw material and electricity at LTAR, income tax credits for purchasing equipment, export buyers credit, export loans, value added tax (VAT) rebates for exports, etc. because instruments used by the Chinese state have added to the distortion.

Moreover, China’s competition (anti-trust) authority and practices have also been under scanner. The 2019 US Investment Climate report claims that anti-trust enforcement in China favours local companies and there is an “inherent anti-monopoly law bias against foreign companies”.

USTR’s Section 301 investigation in 2017 concluded that China indulges in unreasonable and discriminatory actions that pressed for technology transfer from foreign companies to domestic ones through modes of joint venture requirements, foreign equity limitations, administrative review and licensing processes further limiting US trade and commerce.

All in all, China’s unfair market practices have led to overcapacities, market dominance and huge trade surpluses with other countries.

A calibrated approach towards reducing import dependence

PM Modi’s vision for ‘vocal for local’ will need both — a calibrated approach to import substitution, and a root cause analysis of reasons for over-dependence on China in certain categories of imports.

The government along with industry associations should chalk out a list of essential and non-essential items being imported from China. There should be a concerted effort to first reduce non-essential item imports by sourcing it elsewhere.

For both essential as well as non-essential items, it is important to understand whether the imported items are not being sourced locally either due to ‘capability’ issue or ‘scalability’ issue.] If it’s the latter, find out whether price undercutting by China has forced the local producers to scale back production over the years. For example, as per the Indian Electrical and Electronics Manufacturers’ Association (IEEMA), out of 58 equipment used in power infrastructure, there is sufficient domestic capacity for all products except four. However, the majority of the power equipment is still imported, especially from China.

The Modi government must also find out whether local producers are not able to compete only against China or other trading partners as well to gauge the reasons behind competitive disadvantage. A comprehensive analysis needs to be done with respect to taxes, duties or other levies, which are escalating costs of production for local producers.

As highlighted in the authors’ previous article, the government has identified a few champion sectors, where India has inherent scaling-up potential, which can be capitalised in the medium term. Capability building by fast-tracking reforms to create domestic value chains can help these sectors become ‘atmanirbhar’ (self-reliant) and hence reduce dependence on imports eventually.

At the same time, integrating more with regional and global value chains (for sectors where the possibility of scaling up is limited) for good quality and price competitive imports is inevitable. Here, the trade policy needs to focus on comprehensive and deep bilateral Free Trade Agreements (FTAs) with maximum trade complementarities and high utilisation ratio.

A possible instrument for trade action against China in short run

What are some immediate options available for India? Can India really boycott Chinese goods or single out China by raising import duties against it? It’s not that simple.

As per the WTO’s most-favoured nation principle, member countries cannot usually discriminate among their trading partners. Simply put, India cannot impose higher import duty only against China and not its other trade partners. However, WTO does grant exceptions in special cases like security concerns (Article XXI GATT) and safeguarding the balance of payments crisis (Article XII).

Indian laws prohibit imports from a particular country by way of provisions in the Customs Act (Section11(2)f), which gives the government of India the power to prohibit imports of any product to prevent injury to the economy. However, its compatibility with WTO norms involves legal complexities. In such cases, the matter gets referred to the dispute settlement body of the WTO and the decision has to be withdrawn if the authority rules otherwise.

Prudent exercising of this option could be a game-changer for India. Recently, the UK banned Huawei from entering its 5G network system citing ‘national security’ concerns. Given the current climate of concerns regarding Chinese surveillance world over, India must proactively consider exercising the ‘national security’ clause to safeguard its security interests.

At the same time, measures such as disallowing global tenders below Rs 200 crore in government procurement need to be further calibrated to push our MSME sector forward. Often, arbitrary eligibility criteria are set forth for these tenders that eliminate the participation of nascent and innovative companies. For example, clauses that require a minimum number of years of experience for providing a certain product automatically stifles the participation of any new company in the tendering process. The concerned ministries must ensure that such bottlenecks are done away with.

These companies could also be provided benefits in the form of tax credits, which are now becoming a dominant instrument for boosting innovation. Similarly, a public procurement order that now gives preference to suppliers with over 50 per cent or more local content should also be followed without any biases.

While India engages with China through diplomatic and military channels, it must devise a balanced economic strategy that respects the principles of comparative advantage and free trade without compromising on its security interests. This is a tightrope to walk.

The Atmanirbhar Bharat Abhiyan is a well-intentioned step that provides domestic producers with an opportunity to revive animal spirits and work towards a high-value addition economy. India Inc. on its part, needs to seize this opportunity by making sure that ‘Made in India’ is the best that is offered to the Indian consumer.

V.K Saraswat is member, NITI Aayog; Prachi Priya is a Mumbai-based economist; and Aniruddha (Twitter: @ani_econ) is a PhD student at Johns Hopkins University. Views are personal.