Why India’s complete economic disengagement from China is unrealistic

If India hopes to implement infra projects in the neighbourhood to restrain China, it will have to create management groups to support diplomats on the ground.

File photo of PM Narendra Modi and Chinese President Xi Jinping | Graham Crouch/Bloomberg

The near collapse of frameworks for strategic relations with China and the newly protectionist impulse of the ‘Make in India’ initiative has placed new demands on New Delhi’s economic diplomacy with Beijing. While India has for some time been wary of Chinese economic influence and practices, the recent military stand-off in the Ladakh sector of the border has resulted in swift policy decisions and sharp rhetoric on the feasibility of the current state of Chinese presence in the Indian economy. This is evident in India’s refusal to join the China-dominated Regional Comprehensive Economic Partnership (RCEP), the blocking of Chinese apps in India and the intense discussions around decoupling from China-controlled supply chains. Strategic concerns over China’s economic embrace and its tendency to use economic advantages to leverage its political and security objectives have emerged in the last decade. This means that India needs to develop policy and diplomatic processes to constrain negative strategic fallouts without bucking the trend of China’s economic trajectory.

Decoupling from China

China’s deeply embedded global supply chains, its undeniable economic recovery after the shock of COVID-19, its significance for global economic recovery, and its presence in the Indian infrastructure, manufacturing, digital and real estate sectors indicate that decoupling may not be an easy option, despite fears over China’s weaponisation of commercial relations.

China’s success in establishing regional economic institutions and its ability to split the Trans-Atlantic consensus over engagement with it also attests to its continued significance to major economies around the world and the obstacles in diversifying investments and trade away from Chinese supply chains. In this context, India’s complete economic disengagement from China is unrealistic and, given that it only exercises relative marginal economic influence globally, India is unlikely to find many economic partners willing to move comprehensively away from Chinese supply chains despite the signing of the Supply Chain Resilience Initiative (SCRI) with Japan and Australia. The RCEP, with 15 members aboard including those in the Asia-Pacific who have pledged to create more resilient supply chains, runs against this, at least in the short or medium term. The more recent China–European Union (EU) agreement on investments is also an endorsement of the value of the Chinese market.

The EU’s position on decoupling from Chinese or other supply chains is more nuanced than the dominant discourse emanating from the US and echoed by the SCRI signatories. While the need to maintain its leadership in future technology is critical to EU economies, member states are more realistic in acknowledging “mutual technology dependency” with other economies as “mutually reinforcing.”

Concerns around restructuring global supply chains arise from the choice of sectors, the efficiency costs for firms (the initial drive to create supply chains), whether domestic policy changes can be made swiftly enough to make restructuring feasible and whether new regulatory frameworks can be put in place to avoid further economic disruptions. The SCRI may, at the end of the day, remain a strategic statement but one that could be repositioned to argue for better management of global value chains (GVCs), especially with regards to evident choke points — such as short supplies of active ingredients for pharmaceuticals from China on which Indian companies depend or the automobile sector’s dependency on parts from China — as Chinese factories shut down during the pandemic.

Existing regulatory mechanisms also militate against strategic decoupling. For example, despite the Indian government’s restrictions on Chinese companies last year, the exemptions given to multilateral agencies like the Asian Development Bank (ADB), the Asian Infrastructure and Investment Bank and the World Bank from procurement restrictions still provide Chinese companies access to infrastructure projects in India. As a member of multilateral financial institutions, India cannot easily discriminate against Chinese companies without violating the rules of these institutions. This applies to restrictions on companies that have contracts for infrastructure projects, such as China Railway Tunnel Group Co. Ltd, Continental Engineering Corp., SJEC Corp., China Harbour Engineering Co. Ltd in Mumbai and the Shanghai Tunnel Engineering Co., which won the contract for an underground stretch of the Delhi-Meerut Regional Rapid Transit System.

Also, if, as projected, an ambitious infrastructure investment initiative in India is expected to shut out competitive Chinese companies, it may result in pushing up the price of investments and hurting the Indian economy rather than giving it real advantages. Since Prime Minister Narendra Modi’s first incumbency in 2014, Chinese businesses and investment firms have seen the Indian market as an opportunity (see Tables 1, 2 and 3) and many of China’s leading firms in infrastructure manufacturing, digital processes, renewable energy and real estate have established a presence in India. Around 800 Chinese companies are said to be operating in India’s domestic market according to Invest India, the Indian government’s investment promotion and facilitation agency.

Chinese firms in India

A brief survey of Chinese companies in India also indicates that they have no intention of relocating their businesses and manufacturing units. The fact that many Chinese companies will stay on in India after recent tensions between the two countries requires the development of rational and transparent protocols with security oversight, which adhere to global best practices. Concerns over Chinese companies linked to the People’s Liberation Army raise strategic issues and India, like the rest of the world, has put a number of these firms on the restricted list, highlighting concerns over transparency. The EU’s gold standard on transparency and reciprocity would be a good practice to follow.

Implications of moving away from Chinese supply chains

Many leading Indian companies with a presence in China also find the Chinese market lucrative and will also be hard hit by restrictions. Despite this, a relative shift from supply chains in China could help India access other markets and develop strengths in domestic manufacturing. But this will require a concerted effort by the government to implement reforms to support inward investment and manufacturing. The government has been cautiously optimistic that the country’s economic recovery by mid-2021 may be faster than anticipated, even though a closer look at the performance of the economy over the last few years and especially during COVID-19 does not indicate a recovery, at least until 2023.

Despite the Indian economy confronting a near recession for the past few years and the economic shocks of the COVID-19 pandemic, domestic reforms and external geopolitical concerns may still give it an advantage over other markets in attracting investments and interest from developed economies also seeking to divert from China and from traditional markets, as with the UK post-Brexit. Global construction activity is expected to increase nearly 35 percent to US$ 5.8 trillion by 2030 — with two-thirds of the growth anchored in China, the US, India and Indonesia. India’s increasing partnership with the US, also concerned about over-reliance on Chinese supply chains, and the potential gains from the possibilities created by Brexit might provide opportunities that nimble economic diplomacy could seal.

The reinvention of the ‘Make in India’ initiative as ‘Atmanirbhar Bharat Abhiyan’ could also provide the much needed financial and regulatory support that strategic sectors in the domestic economy need to grow. But these changes will not be sufficient to decouple completely from Chinese supply chains, given the already deep and extensive involvement of Chinese enterprises in many sectors in India and the fact that many potential partners outside China either have Chinese financing or have partnered with Chinese firms.

Challenges to Chinese economy

As with all economies in 2020, the Chinese economy also faces challenges at home and abroad, which provide some wiggle room, both for renegotiating economic relations and diversifying from Chinese companies. Given the increased attack on Chinese supply chains in 2020, China is also reflecting on the need to focus on its domestic economy. Although China’s 14th Five Year Plan, announced at the Fifth Plenum of the Chinese Communist Party in October 2020, and likely to be ratified at the end of the Two Sessions meeting in March 2021, outlines policies for a multipolar geoeconomic world, the document points to an inward turn in policy. It is less upbeat about its engagement with the global economy amid trade wars and the pushback to its technology enterprises, calling for a new model of growth that focuses on domestic technology innovations, domestic investment and consumption and ‘dual circulation,’ the last a euphemism for a balance between external investments and exports and domestic development.

The Belt and Road Initiative (BRI), Chinese President Xi Jinping’s signature project, seems to have suffered from the challenges of a contracting economy, protectionist policies by economies along the BRI and Beijing’s rethink on lending policies. Implementation of projects on the BRI has slowed down and funding is down by 29 percent from 2019 levels, according to Beijing’s commerce ministry. From January to October 2020, the value of contracts shrank by 17.5 percent over the same period in the previous year. As COVID-19 took its toll on BRI countries that received loans from China, at least 12 states sought to renegotiate financing worth US$ 28 billion, and about US$ 94 billion loaned has come under renegotiation last year. As China changes its lending policies for BRI initiatives, there are indications that it is also rethinking its financial commitments to the China-Pakistan Economic Corridor (CPEC) despite signing an US$ 11 billion deal in the middle of 2020. Consequently, Islamabad is considering a bill to open up CPEC projects to joint ventures with countries other than China. The prospects for China shutting out other countries from the region has become that much weaker.

Recalibrating India-China engagement

Attempts to modify India’s economic engagements with China will not be easy in a highly competitive global economic environment where bottom-line considerations prevail. Beyond the initial protectionist reactions, India needs to work towards establishing clear economic and political objectives in its economic engagement with China. Compartmentalising the political and the economic is no longer an option. These views have been expressed since 2003 by the Ministry of External Affairs (MEA) but have rarely been acted on. In common with the world’s economies, India’s objective of negotiating a level playing field in trade, investments and services in China will be foremost. Preventing an overreliance on Chinese supply chains and China’s entry into strategic domestic sectors, given that the ownership of Chinese enterprises is often in doubt, will remain heightened concerns. Beyond the bilateral engagement, competition from China in the South Asian region and economic dominance in the Indo-Pacific will matter, as will maritime security in the Indo-Pacific to safeguard energy and resource corridors and needs. The COVID-19 experience has added a new urgency to ensuring access to artificial intelligence, 5G and digital technologies beyond the current reliance on Chinese technology firms in India. Economic diplomacy with other partners will only positively balance the Chinese presence in these sectors. Finally, Indian objectives must include the more strategic and long-term issue of how the global economy will be shaped in multilateral institutions and across inter-governmental agencies over the next two or three decades and the span of time it takes for new technologies to change an existing economic paradigm.

In practice, ensuring these objectives are met means that Indian policymakers must move away from the existing framework of negotiations to one that actively acknowledges the impact of new agendas in trade relations. This is especially true for economic engagement with China, given the direction of Chinese investments in India. Hence, moving away from a focus almost entirely on tariffs, rules of origin and trade deficits to national laws on quality standards, complementarities with anti-corruption norms in contracts and green requirements, which have a greater impact on access to markets, will enable a reconfiguration of trade relations. In the long-term, India will also need to view trade as intrinsic to its pattern of growth and its global partnerships. This speaks to a more strategic view of economic engagement with China, putting aside the somewhat tactical approach of the last few decades. For India’s economic diplomacy to be successful in meeting its objectives with China, it needs to be calibrated at multiple levels, the bilateral being only one of these. The regional and multilateral matter as much. A strategic approach to economic diplomacy is most likely to leverage bilateral economic relations with China.

The complexity of the task calls for a change in the way India has conducted economic diplomacy when it comes to China. While Indian diplomats have been adept at representing India at multilateral forums and inter-governmental bodies, the pullout from the RCEP at the last minute indicates a lack of broader inputs from industry and experts on trade policy. India has the necessary institutions to channel a shift in policy. Some of these need to be reoriented, such as the high-level strategic dialogue on economic relations between the two countries and the capacity of its embassies, commercial attachés, and domestic trade and industry associations. Others, like multilateral institutions in which India has a presence, are handy instruments for redefining agendas, while still others like science, technology and medical research institutions should be critical partners in evolving regional and global models of cooperation and exchange to fill the dire development needs that COVID-19 has exposed.

Nature of India’s economic diplomacy

Currently India’s economic diplomacy with China is conducted through the strategic economic dialogue (SED) through its embassy in Beijing and industry associations. These work in consultation with each other, some from the sidelines of more formal SED meetings. Since its inception in 2010, the SED has focused on India’s growing trade deficit with China and efforts to close the gap by discussions on diversifying into investments in infrastructure and India’s competitive sectors like pharmaceuticals. Despite six rounds of the SED, persistent problems with the bilateral engagement have remained. Market access for Indian firms and commodities in China is limited, given the state’s ownership of the local economy. Little headway has been made on proposals on collaborative ventures with Chinese enterprises, market access for pharmaceuticals and, what the minutes of SED meetings euphemistically term, “bilateral practical cooperation.” The programme of the SED, by its own account, remains limited to official joint working groups on various sectors and rarely goes beyond announcements.

This framework rarely recognises that the Chinese government or its state-owned enterprises are no longer the only, or even prime, investors and players in the Indian market. Since at least 2014, China’s private sector has been far more active in India. On the Indian side, traders, corporates and technology companies have been the most enthusiastic enablers of Chinese trade and investment in India. Additionally, more localised associations and interest groups across many states in India have greater investments in the economic relationship. Hence, defining the direction of the India-China economic story entirely through the SED lens may ultimately be misleading. India’s economic diplomacy with China should, therefore, include those who are likely to define these interests more clearly. The inclusion of these interests from outside government and at the level of the states can only support the work of understaffed departments at the nodal ministries for economic diplomacy, the MEA and the Ministry of Commerce and Industry. The MEA is the smallest of all establishments among BRICS nations, has no transparent process of policy planning, and is rarely successful in reaching out to domestic actors in the process of planning projects. This attitude of parsimony reflects even in Indian industry associations like the Confederation of Indian Industry, which has not moved beyond establishing a small office in Shanghai, its only interface with Chinese industry.

As India enters a period of negotiating issues like cybersecurity and data privacy with China, domain knowledge, which officials with a bent for generalist expertise rarely have, becomes important. Adding to this the more realistic understanding of the practices in data control across major economies will ensure that knowledgeable negotiators do not view China as the chief culprit but establish a dialogue with it on the need for a standard policy that will apply to all countries, including the US, which has been less than cooperative on data controls. The diplomatic space needs to be crowded with a host of actors involved in data security issues, including regulators, consumers and civil society groups, which have an unbiased and realistic assessment of the issues involved. The pertinent government ministries need to retain and use personnel with an in-depth knowledge of these issues. This must be a sustained exercise. More, the need for expertise and domain knowledge increases in light of the next big development in the digital and cyber sector — data centres — where India is increasingly becoming the investment destination. Changes to the organisation and structure of the MEA were first suggested in 2009 but it was only in 2015 that the first consultants were hired at junior positions and in 2020 that the MEA got its first internal revamp.

India’s economic diplomacy with leading technology powers has greater strategic import for the India-China relationship when viewed from the perspective of accessing technology to build capacity against China’s growing sea and land dominance. Recent expectations are that the Quadrilateral Security Dialogue — comprising the US, Japan, Australia and India, and many of whom have borne the brunt of China’s economic coercion and are looking to diversify from Chinese supply chains — will include an economic agenda that feeds into these interests.

India’s shaping of the multilateral order

India’s economic diplomacy should leverage its strengths in the region and in multilateral institutions in the face of China’s influence and claims to leadership. If India hopes to implement infrastructure projects in the neighbourhood to restrain Chinese presence, it will have to create management groups and technical personnel to support diplomats on the ground. This is especially true for the ailing Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation and International North–South Transport Corridor initiatives. A project-focused approach is imperative to ensure implementation, which has been missing until now. Many of these projects will create the goodwill India needs if it is not to be locked out of trade and resource needs in China’s ever growing economic corridors. China now has six resource corridors in Asia and at least three in Africa, covering many countries that have an increasing dependency on Chinese loans and infrastructure technology. Indian diplomats need to ensure that the arrangements made are not biased against India’s access to these regions.

Globally, recent years have been a period of existential challenge for multilateral institutions. The US and the UK, the founders of the liberal multilateral system, have tended to ignore and even attack it. Despite supporting multilateralism, developing nations have demanded reforms. The World Trade Organisation has been stymied by the lockdown of its arbitration mechanism and the failure of its negotiation mechanism, its raison d’etre. The World Health Organisation, which should have been central to the management of the COVID-19 pandemic, has been overtaken by “vaccine nationalism” and private pharma companies, despite establishing the COVAX facility. Rich nations repeated behaviour from the time of the swine flu by making advance purchase agreements for the greater bulk of vaccines with pharmaceutical companies such as Pfizer.

Economic protectionism has endangered the concept of cooperation on which multilateral institutions are built. This was never so apparent as at the 2019 BRICS meet where each member country highlighted individual economic woes and seemed to be speaking at cross purposes, with no insights provided on the global economic crisis. However, if this is a moment of challenge for the multilateral order, it may be to India’s interest not to let the leadership of that order fall to China. Indian diplomacy must address the future of this order and the way it can shape it to its interests.

More pertinently, this might also be a moment to view the global order from the chasms revealed by COVID-19. The global order failed, as did the notion of interdependencies so central to the neoclassical framework. As one study notes, the issue of supply chains was not just an issue of strategic interests. Firms with cross-country supply chains did not contribute to meet the challenge of COVID-19. Shutdowns of industries and social lockdowns disrupted GVCs. Scarcities of medical equipment and accessories saw an increase in market competition and national procurement policies, affecting supplies to poor countries. In April 2020, the United Nations stepped in to create a supply chain for COVID-19 related materials.

Amid the pandemic, many countries’ reliance on Chinese supply chains were disrupted, forcing them to diversify but mostly in support of domestic producers. Japan moved US$ 26 billion investments out of China, although not necessarily back to Japan, and allocated US$ 2.2 billion to support its domestic industries; the US invoked the Defense Production Act, 1950 to expand production in the US; and Canada, Brazil, Italy, South Korea and Russia gave state aid to producers to increase production. This was, in all likelihood, a momentary response to immediate and critical needs and does not indicate that the impulse towards globalisation has completely soured. But it does mean that any further impetus to globalisation must take into account not just elements of growth but also those of livelihood. India must draw upon its intellectual capital to formulate a global development plan to this end.

Conclusion

Given the economic and strategic challenges with China, India has begun to articulate its position on the bilateral economic relations more sharply. It has voiced many of the anxieties over the issues related to dependencies, a skewed trade relationship and the entry of Chinese firms into strategic sectors. It has also announced the setting up of an India Strategic Trade Agency, which will presumably take a more strategic view of this relationship. Less obvious is the development of a plan for concerted economic diplomacy to renegotiate the relationship, expand the country’s interests into areas where Chinese influence can be constrained and where India can secure advantages that ensure its strategic interests in relation to China.

Madhu Bhalla was professor in Chinese studies at the Department of East Asian Studies, Delhi University. She has held a visiting fellowship at the Fudan University, Shanghai, and has been a visiting scholar at the University of Sichuan at Chengdu. Views are personal.

The article first appeared in the Observer Research Foundation website.