Two Big Asian Rivals Start a ‘Beautiful Friendship’

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Although largely reported as a fence-mending exercise in the wake of recent Sino-Indian border incidents, the Chinese Prime Minster Li Keqiang's visit to India last week was mostly about trade and finance between the two countries representing one-fifth of the world economy and a prodigious market of about 2.5 billion people.

The talk of mutual trust and consultation mechanisms was very much in the air, but the economy was on everybody's mind. While welcoming his Chinese guest in searing 46 degree Celsius heat, Prime Minister Manmohan Singh knew that in a few days he would be standing next to his boss, the governing Congress Party leader Sonia Gandhi, waving a copy of his Report to the People – a sort of manifesto before next year's general elections - where India's declining economic growth is mainly ascribed to the euro area's recession and a sluggish U.S. economy.

It is a good bet that Mr. Singh suspected that Indian voters might think otherwise. A dispiriting thought no doubt at the time when the Congress Party is bidding for a third five-year term to lead the world's largest democracy. Not so much because, predictably, the opposition Bharatiya Janata Party (BJP) promptly dismissed the idea that India's flagging growth was a result of weak export demand. No, Mr. Singh surely expected that the BJP would put the blame squarely on the government's mismanagement of the economy.

But the next blow was shattering: An opinion poll released last week showed that, if elections were held now, 31 percent of respondents would vote for BJP, while the Congress Party would get only 20 percent of the vote.

The weak economy will make it very tough to turn this situation around in the months ahead, even if there are no further desertions of the coalition partners and no major corruption scandals. Indeed, facing binding policy constraints of high inflation and budget and external deficits, it will be quite a challenge to stabilize the economy around its current 5 percent growth rate.

And the path from there to India's estimated growth potential of 8 percent will be even more difficult if there is a reversal of large capital inflows on growing speculations about less accommodative monetary policies in the United States and similar policy corrections in Japan. Markets are already signaling these events. Reversals of capital flows have also been foreshadowed in recent warnings by the Reserve Bank of India.

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How Can Trade With China Help?

Capital outflows, or even slowing inflows of foreign savings, would put an end to India's further credit easing to stimulate domestic demand, because the financing of India's large trade deficits (6-7 percent of the gross domestic product) would require rising interest rates.

That is the economic environment in which Mr. Li's visit to India was taking place. And the question is: What role could a China guanxi (connection) play? There are several possibilities.

First, China could – and should - quickly deliver on its promise to buy more to reduce its huge trade surplus with India. In 2011-2012, India's trade deficit with China was one-fifth of its total trade gap. The fact that Indian exports to China had picked up considerably (growing 25 percent in 2011-2012) over the past three years is proof that there is a broadening range of Indian goods and services of interest to Chinese companies and consumers.

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Second, China could buy more of India's assets. That would be an appropriate quid pro quo for India's large purchases of Chinese exports – and a way of supporting India's domestic demand that underlies imports from China. A sort of Bill Clinton's old message to Japan about trading with America: "If you don't buy, you won't sell."

Third, and perhaps the most important, China could balance out its huge trade surplus with India by stepping up its direct investments. Mr. Singh invited these investments – particularly in infrastructure and manufacturing – during his talks with Mr. Li last week. Clearly, such investments could build on multi-billion dollar contracts signed in the area of renewable energy, infrastructure, electrical energy and iron industry during last November's Second India-China Strategic Economic Dialogue in Delhi.

Beginning of a 'Beautiful Friendship?'

The big question is: Will rivalry and old enmities get in the way of the enormous potential of Sino-Indian economic ties?

I don't think so. The political and strategic relationship between the two countries has changed, despite irritants presented by 15 unsuccessful rounds of border talks – seemingly intractable legacies of colonial times. Throughout this arduous and literally uncharted negotiating process, Beijing and Delhi have been steadfast in pledging peaceful solutions to disentangle their real estate problems. They are probably reminded of the fact that it took 40 years for Russia and China to solve the issues along their 4,300 km border, and that solutions became easier as the two countries' relations continued to improve.

Things seem to be moving in the same direction between China and India. Apparently good atmospherics during Mr. Li's visit last week, intensive dialogue at highest government levels, and the resumption of joint military exercises are showing that relations have moved on from sporadic and ad hoc platforms of the past. The fact that Mr. Singh told the media that "we have also discussed the possibility of infrastructure development to link India's north eastern region with Bangladesh, Myanmar, China and other countries in the Southeast Asian region" is a clear indication of more confident and stable ties. This is a far cry from publicly vented anger, suspicions and strategic misgivings at a mere mention of similar access routes to China only a few years ago.

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I also believe that the evolving and increasingly more structured BRICS (Brazil, Russia, India, China, South Africa) relationships are providing a suitable forum to anchor Sino-Indian interests on a common agenda transcending purely bilateral issues. Largely ignored by most analysts, BRICS projects - such as the group's currently negotiated development bank (an Indian idea), along with security and strategic initiatives in Central and North-East Asia and in Africa - have the potential to foster closer Beijing-Delhi ties.

That is probably what Mr. Li had in mind when he talked about Beijing's determination to take its relations with India to "new heights of strategic growth," reiterating the metaphor of a "handshake across the Himalayas."

Responding to that, India's soft-spoken and scholarly prime minister talked about India and China as "civilizational neighbors who have lived in peace through the ages." And, saying that he accepted Mr. Li's "gracious invitation to visit China at the earliest opportunity," it all sounded like Humphrey Bogart's final line from the movie Casablanca: "Louie, I think this is the beginning of a beautiful friendship."

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.