1China and India today represent Asia’s two largest and most dynamic societies which are emerging as new trend setters in international relations. Especially, with their annual GDP growth rates standing respectively at 9.1% and 8.5% for 2003 and at 9.5% and 6.9% for 2004, China and India have since come to be recognised as the fastest growing economies. According to World Bank estimates, and assessed on the basis of purchasing power parity, China and India have already become respectively the second and fourth largest economies of the world surpassing developed countries1.

3Thanks, however, to their colonial and cold war legacies, their economic success had, for a long time, remained a mutually exclusive exercise thus slowing down its pace of progress and its global impact. It is only rather recently that their political initiatives at confidence-building began to expand their areas of mutual co-operation, which now remains premised on their new mantra of mutual accommodation and mutual benefit2. Their bilateral trade has since come to be recognised as the most reliable as also the most agreeable instrument of China-India rapprochement. Their long-term potential as trade partners, however, remains yet to be fully explored and exploited and their political equations remain yet vulnerable to their problematic legacies3.

5The context of China-India bilateral trade itself—bilateral as well as regional and global—has been changing rapidly. At the bilateral level, this is self-evident in the way their rapidly growing trade partnership has provided a great boost to their ongoing political confidence-building. In the wake of their diplomatic stand-off following India’s nuclear tests of May 1998, their bilateral trade was the first to bounce back to its normal pace4. However, this boom in their bilateral trade could not have been possible in absence of bold political initiatives yet, in recent years, it is the role of their business communities that has become far more influential in determining the tone and tenor of their political interactions.

6Their recent signing of the April 2005 “general parameters” agreement for their boundary settlement, their opening of a third border trade route through Sikkim in June 2003, and now their discussions for evolving a China-India Free Trade Area (FTA) remain some of the examples which have been accompanied by a reduction in forces deployment on their border and revival of several cottage industries among border communities in remote and inaccessible regions5. Apparently, policy-makers from both sides have begun to increasingly focus on the social and political spin-offs of their bilateral trade. The last five years have witnessed China-India trade quadruple and the expectation that it will reach US$30 billion by 2010 appears increasingly credible6.

7However, for both China and India, their rise to stardom is no without its share of pitfalls, puzzles and challenges. Much of the aforementioned success remains particularly true of China with India slightly behind. India’s Prime Minister Manmohan Singh is seen as an architect of India’s economic reforms and opening up7. However, even without government initiatives, several sectors in India have picked up momentum and will continue to grow helping New Delhi to catch up with Peking. For example, the number of skilled professionals from India are growing at enormous speed. They mainly work in the software industry, and Chinese enthusiasm for India’s information technology sector clearly recognises this new trend8.

8Nothing compares to the China-India bilateral trade when it comes to evaluating the positive trends in post-1962 China-India relations. Starting with an extremely slow pace with an annual turnover of only a few million dollars, and then staying on the margins for much of the 1980s, their trade has gradually come to occupy the centre stage of their interaction. The target of reaching US$20 billion in bilateral trade by 2008—set by the two prime ministers in their meeting in Delhi in April 2005—is now expected to be reached before end of 2005. Similarly, the target of US$30 billon of bilateral trade set for 2010 is now expected to be reached by 20089. At least in the short-run, their current institutional arrangements and enthusiasm augurs very well for their continued trade boom, which can contribute a great deal to their growing confidence one in the other and their evolving long-term strategic partnership10.

10Positive trends in the bilateral trade have been particularly shaped by the economic reforms on both sides and the consequent search for new business partners. As a result of this, their complicated politico-strategic equations, that had continued to slow the rising enthusiasm, have come to be underplayed and marginalised. To cite some examples of China using trade as its diplomatic tool, its trade with other problematic neighbours like Japan and South Korea has increased respectively from US$16.8 billon and US$0.7 billion for 1990 to a whopping US$99.6 billion and US$36.2 billion for 2002, making them each other’s most valued trade partners. China’s combined trade with Japan and South Korea reached US$212 billion for 200411. For the same period, China’s bilateral trade with India grew from US$0.2 billion for 1990 to US$5 billion for 2002, though it has increased much faster since then reaching US$7.6 billion for 2003 and US$13.6 billion for 2004.

11Viewed in the context of South Asia, China’s trade with India have witnessed impressive increases defying all suspicions about China’s special relationship with Pakistan or China’s encirclement of India (see Figure 2). To highlight some other strong fundamentals that promise to sustain their current trade boom, while China continues to enjoy a huge favourable balance of trade vis-à-vis most other smaller states of the South Asian region, it is only the China-India trade that has remained to be China’s most balanced trade in South Asia and often the balance has been in favour of India. This clearly reflects strong mutual stakes which promise to sustain this trade boom at least in the short term (see Figure 3). Indeed, the two seem to be becoming increasingly relaxed about their bilateral ties and are now thinking of building joint strategies towards their regional and global initiatives. No-one today talks of a China-India clash in South-East Asia where both have built flourishing engagement without any mutual friction or scepticism. While so far they have not allowed this to become a major stumbling block yet their intensifying search for energy sources abroad is lately seen as one area that could post a serious challenge for their economic engagement12.

14Thirdly, it is the dynamism of their economies and societies, especially their young populations and increasingly skilled manpower, that are going to be their critical asset. In absolute terms, as proportion of their total trade or even in terms of per capita trade this may present a dismal picture, yet trends in the growth rate of China-India trade show strong potential and have important political implications. However, even in terms of its share in their total foreign trade, while India accounts for little more than 1% in China’s total foreign trade, China now accounts for over 5% of India’s total foreign trade which creates substantial stakes for mutual co-operation13.

15Finally, their foreign exchange reserves provide perhaps the easiest layman’s indicator of their international economic standing. China’s foreign exchange reserves, which stood at mere US$1.6 billion for 1978, had exceeded US$659 billion by March 200514. These may not be huge figures compared to those of Japan at US$843 billion yet they are when compared to India’s US$142 billion15. The same also remains true of their foreign direct investment (FDI) inflows where China and India are often projected as either poles apart or competing against each other. However, both have again continued to sustain growth simultaneously without any major friction. Their FDI remains perhaps the strongest mover of their foreign trade and especially in case of China it has come to be known as the main locomotive for their economic success.

16Unlike India, FDI makes China a global player. In 2000, in cumulative terms, China was world’s fifth-largest recipient of FDI, after the United States (US$1.3 trillion), the United Kingdom (US$497 billion), Benelux Economic Union states (US$482 billion) and Germany (US$480 billion). But for 2004, China was to clock the second largest FDI inflow of US$62 billion―next only to the United States which makes these FDI inflows the most critical as also most visible indicator of its sustained and rapid economic development16. Even India is expected to emerge as the next hot spot for FDI inflows. Amongst others, the UNCTAD-DITE Global Investments Prospects Assessment 2004, estimates for 2004-2007 put China and India at the top two ranks followed by the US as third17. This, however, remains rather ambitious, especially for India. Even for China, while it is expected to continue to leapfrog, it is likely to stay at its second position and may not surpass the US for a very long time.

17But there are indicators that FDI inflows to China (even India) will continue unhindered. For example, China today accounts for over 10% of US foreign trade destinations and China owns $167 billion of US securities issued by the Federal Government18. During the year 2000, the total US corporate revenue generated from China was $7.2 billion, compared to $4.6 billion from Mexico, $3.5 billion from Singapore, and $1.85 billion from Brazil19. Though China faced some phases when FDI had gone down yet it has gradually witnessed rise from $2.7 billion for 1984 to $62 billion by 2004, largely staying within the range of $45 to $ 60 billion on an average year20.

18By comparison, India’s FDI has been generally sluggish and, for the early 1990s India’s contracted FDI stood at $0.15 billion for 1991, $0.23 billion for 1992, $0.57 billion for 1993, $0.95 billion for 1994, and $1.96 billion for 199521. But from there, India’s FDI has experiences some acceleration and rose to $3.4 billon for 2002 and $4.3 billion for 2003; and some experts also question calculation methods and suspect underplaying of India’s FDI statistics22. For year 2004, India’s FDI was estimated to exceed a rather impressive US$8 billion23. And, given this new enthusiasm of the United Progressive Alliance, the government has been talking of absorbing an FDI of US$15 billion for 2005 and US$30 billion for 2007 to reach a total of US$150 billion of fresh FDI in next ten years24.

19Among the reasons cited to explain India lagging behind, is the argument that China had decided to open up to FDI back in 1979 and created special economic zones (SEZs) in coastal regions that had the clear advantage of geographical proximity to Hong Kong—the hub of capital investment in Asia—, and that China had the added advantage of its political system, cheap labour and special incentives for foreign investors as for its armed forces which were to become major players in China’s opening up experiments25. Also important is overseas Chinese contributions. Non-resident Indians and overseas Chinese have been distinct categories in FDI inflows into their respective homelands. Beginning only from the early 1990s, while non-resident Indians do contribute a little to India’s FDI, overseas Chinese are known to present a unique example by contributing over two-thirds of the whopping inflows of FDI into China26.

20As regards an evolving overall institutional framework for their bilateral trade, the China-India Joint Working Group for the Boundary Question (JWG) remains the most generic and potent forum for all issues and sets the overall tenor of China-India relations. More specifically, the two also have a JWG for Trade and Commerce which is supported by a Joint Business Council that represents business interests, in particular of the non-state sector. They also have a JWG for Science and Technology that focuses more on research and development sectors. In operative terms, much of the norms and regulations for clearing road-blocks and evolving the new legal framework for trade are facilitated by their regular meetings. Besides, using such opportunities as Summits, many more agreements have been signed between individual Departments and Ministries from both sides27.

21Among some more exciting institutional frameworks, China and India have recently launched discussions to evolve a bilateral free trade area (FTA) agreement. This indicates their desire to go beyond the World Trade Organisation framework and mutually reduce tariffs even further as also to remove non-tariff barriers28. Indeed, in their meeting over March 21st-22nd 2004, the senior officials from China and India had launched the first round of discussions for signing a FTA agreement and a comprehensive economic co-operation agreement in Peking. The idea was further followed up during Premier Wen Jiabao’s visit to India over April 9th-12th 2005. However, unlike their government, some Chinese experts continue to have strong misgivings. To quote one well-known expert on South Asia, “Although a FTA between China and India will be hard to achieve in the short term, its significance in forming a multi-party regional free trade system is apparent, given the huge population and size of the two countries”29. Another Chinese expert believes that the stronger trade ties and complimentary economic structures cannot ensure the quick establishment of a FTA between the two countries”30. India has its own reservations and, that cheap Chinese goods are flooding Indian markets has been a source of concern among India’s business community as well31.

22In international relations, finance capital transfers have been a rather recent phenomenon compared to the trading of goods and services. But mutual investments always reflect greater mutual confidence and provide a great boost to bilateral trade, especially in the long-run. And this is especially true when it comes to China-India bilateral trade. However, as of now, the United States stands out as the largest investor, accounting for about 21% of India’s total FDI inflows. Mauritius follows with a 12% share, but it is really a conduit for investors from various countries, including the United States, because of a special tax treaty with India which grants exemption from Indian taxes for Mauritius-based companies. The United Kingdom is then the third largest investor in India followed by the Republic of Korea, Japan and the non-resident Indians who now account for about 4% of India’s total FDI inflows32.

23China’s export expansion in certain sectors has had a direct impact on similar exports from and investment into labour-abundant India33. Yet, there are sectors where China and India have entered into joint ventures and they today hold joint stakes in Kazakh oil firms and Sudan’s oilfields. The first China-India joint venture—between India’s Mideast Integrated Steel Limited and China Metallurgical Import Export Corporation—was commissioned in Orissa way back in January 199334.

26The reality, however, has been changing rapidly in last few years. India’s Ranabaxy pharmaceuticals and National Institute for Information Technology (NIIT), today clearly dominates China’s pharmaceuticals and IT education. There have also been several other smaller and less known initiatives in IT education. India’s Tata Group, one of largest conglomerates in Asia, plans to increase its investment from US$2 million to US$5 million in China’s software sector and has also been in discussion about joint-venture projects in other sectors like automobiles and steel35. China’s home electrical appliance makers Guangdong province-based Konka and India’s Tata Consultancy Limited (TCL) have also established joint ventures in India. China’s Konka though halted its manufacturing in India due to the allegedly restrictive policies and it was reported to have deep difference with its Indian partners36. But again, during the June 2003 visit by Prime Minister Vajpayee, China had pledged to invest US$500 million in India’s infrastructure sector37.

28Trends in trade surplus can be another important indicator of the impact of nuclear tests on bilateral trade ties. Beginning from the early 1990s, while India had enjoyed a trade surplus during 1992, 1993 and 1996, the trade surplus was with China during 1994, 1995, 1997. In fact, according to experts, the China-India trade was known to experience fluctuations even within each year as India generally enjoyed a trade surplus during the first half of the year while in China this trend was reversed during the last few months, every time. For 1997, for example, during the first eight months of 1997, there was a trade surplus in favour of India of US$40 million. Very suddenly, China’s exports experienced faster growth resulting in China having a trade surplus of US$53 million by November which dropped to US$36 million by the end of December38. But no such trend was seen during 1998 when the trade surplus with China reached its peak of US$110 million though this rectified itself in 1999.

29All that we had were the symbolic cancellation of China Commodity Fair in Mumbai during August-September 1998 and China’s visibly low-profile presence during New Delhi’s India International Trade Fair during November 1998. This did create scepticism among businessmen on both sides. Academic exchanges were the second important sector to return to normal, not letting political polemics overshadow positive economic initiatives. In addition, when seen in the larger context of China’s negative growth rates in their annual trade with Asia, even the low positive growth in Sino-Indian bilateral trade for 1998 trade inks was seen to bode very well for Sino-Indian ties39.

31Indeed, the growth rate of China-India trade had already started slowing down from an average of 78% for the first eight years of the 1990s, by about 30% per year during the mid-1990s. It had further slid to 5.2% for 1997. Seen against the backdrop of the East Asian financial crisis of late 1990s, China’s exports had also witnessed a general decline. China’s exports to its major trade partners like Japan and South Korea as also its closest ally Pakistan, sent a very positive message to India’s policy-makers. Even during those difficult months of the summer of 1998, India signed agreements for five joint ventures (two in China and three in Hong Kong) during 1998 involving an investment of US$8 million and other six joint ventures (one in China and five in Hong Kong) during 1999 involving investment of US$1.9 million40.

32China’s overall exports which were expected to grow at a respectable 9% (from its heady 20% growth during 1997) grew only by 0.5% for 1998 and imports actually fell by –1.5%. China’s exports to even its more stable Asian partners had plunged sharply―South Korea by 31.3 %, Hong Kong by 11.5% and Japan by 6.7%. Against this scenario, Chinese exports to India grew by a respectable 8.9%. In 1998—the year of India’s nuclear tests—India’s share of China’s international trade actually increased to 0.59% from 0.56% for 199741. It has since risen to 0.9% of China’s overall foreign trade for 2003 and to 1.1% for 2004. India’s nuclear tests and other political rhetoric have had only a limited impact on China-India bilateral trade. Their trade relations have had a much stronger positive impact and facilitated their political turnaround which has potential for strong fundamentals for their trade relations.

33Although India’s software is becoming famous and is attracting attention in most debate on China-India trade, given the labour-intensive nature their economies, both will have to be exceptionally innovative to sustain the current boom in their trade relations. No doubt, the two have so far handled their economic engagement deftly enough but their rise to capture global resources and markets is very likely to increasingly complicate their equations. For instance, in view of their rapidly rising demand for energy, recent months have seen China and India beginning to undercut each other in seeking control and stakes in various oilfields and oil firms42. Strands of possible economic competition do exist, and the chances of their bilateral trade emerging as a stimulant for an eventual political stand-off cannot be completely ruled out. This means that this second phase of their bonhomie remains as yet pretty fragile.

34To be sure, China today aspires to match India’s success as an exporter of software and Taiwan’s as an exporter of hardware. If India has the advantage of language, China produces three times the number of engineers as India, and Chinese companies like Legend are proving serious competition to other brands and occupy 26% of China’s market. China’s nascent private sector has already emerged as the most promising and potent driving force in China’s economic opening-up exercise. During 1989-1997, China’s private enterprises grew in number from 90,581 to 960,726 firms, which amounts to an annual increase of 34.3%. The workforce has increased from 1.64 million to 13.49 million, an annual increase of 30.1% and their capital has increased from 8.4 billion yuan to 514 billion yuan, an increase of 67.2%43. None of these can be ignored as paper tigers and will provide both several new challenges and opportunities for China-India trade relations.