Is 'Chindia' Asia's new dream team?

Chinese Premier Li Keqiang meets with Indian Vice President Shri Mohammad Hamid Ansari at the Great Hall of the People in Beijing on June 28, 2014.
Wang Zhao | AFP | Getty Images
Chinese Premier Li Keqiang meets with Indian Vice President Shri Mohammad Hamid Ansari at the Great Hall of the People in Beijing on June 28, 2014.

After a number of false starts in recent years, it seems that India Prime Minister Narendra Modi's landslide election victory and a strong mandate have finally opened the way to a broad strategic partnership between Beijing and New Delhi.

Closer economic and political ties with China have been an important part of Mr. Modi's election program. He wants India to catch up and compete with China and, in order to do that, he advocates the need for "skills, scope and speed."

So far, he seems to have got the speed right. China and India have quickly moved to establish wide-ranging consultations on bilateral issues. China's Prime Minister Li Keqiang was the first foreign leader to place a congratulatory call after Mr. Modi's election, expressing Beijing's desire to set up a "robust partnership" with India. The Chinese Foreign Minister Wang Yi followed with a visit to Delhi, and India's Vice President Hamid Ansari made a five-day trip to China where memoranda were signed about Chinese companies' plans to build industrial parks in India.

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The China-India summit meeting in Fortaleza, Brazil, on July 14, 2014 (on the eve of BRIC's two-day meeting) is the first in a number of forthcoming summits scheduled for this year. According to Indian media, that first encounter has been quite successful; it lasted 80 minutes – double the originally allotted time – prompting the Indian leader to tweet that he "had a very fruitful meeting with Chinese President Mr. Xi Jinping. We discussed a wide range of issues."

The sensitive border and trade problems topped the agenda. And in a new sign that the two countries are really moving closer, Mr. Xi invited Mr. Modi to attend the summit of APEC nations (of which India is not a member) next November in China, and to step up the participation in the Shanghai Cooperation Organization (SCO), where India currently has the observer status.

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Beijing's invitation for India's deeper engagement with the SCO is of particular importance. That is an old idea strongly advocated by Russia (the SCO's founding member) but, so far, systematically blocked by China. If, as seems likely, India does become the new SCO member during the organization's next summit in Ufa, Russia, in July 2015 that would indeed take its relationship with China to the level of strategic partnership.

Border problems and trade imbalances

Serious difficulties in attempting to find a mutually acceptable settlement for a 2520 miles (4056 km) frontier has been a major stumbling block between the two countries ever since India's independence in 1947. Technical discussions have been going on for decades. They will continue. The difference is that these discussions are now coupled with the leaders' firm pledge to find a peaceful solution.

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More important, perhaps, is the agreement not to allow the border issue to stand in the way of closer economic and political ties. These are seen as confidence building measures that should facilitate difficult territorial compromises.

Trade imbalances are also a serious problem. The bilateral trade last year came in at $65.47 billion, with India's trade deficit amounting to $31.42 billion. A similar outcome is likely this year. According to China's customs data, the trade volume in the first four months is running at an annual rate of $66 billion, and the Indian trade gap is narrowing to about $20 billion.

Delhi and Beijing agree that this trade imbalance is "unsustainable." Solutions are sought in greater Chinese direct investments in India, exports of India's services (mainly tourism) and a more liberal access of Indian pharmaceutical companies to China's market.

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In the course of Fortaleza summit, Mr. Xi suggested infrastructure investments in modernizing India's railroads and roads. Chinese companies are already working on industrial parks in several locations.

Interestingly, a number of Indian states have been actively promoting their building sites and conditions to Chinese investors. That is a huge change compared with often indifferent or even hostile attitude of Indian local authorities toward foreign direct investments in the past. This could be an early sign of Mr. Modi's hands-on management style. He was the chief minister of the state of Gujarat for 12 years. During that time, Gujarat's economy grew at an average annual rate of about 10 percent, partly because it actively and successfully courted direct investments.

Stabilizing the economy

India has also some work to do to balance the economy. The projected central government's budget deficit of 4.1 percent of gross domestic product (GDP) for the current fiscal year will probably lead to some decline of the consolidated public sector deficit, which averaged 7.3 percent of GDP over the last three years. That would leave more domestic savings to finance productive investments; it would also decrease India's dependence on foreign fund inflows to support current consumption and business capital outlays.

Inflation at 7.3 percent in June is a significant progress compared to 10 percent a year earlier, but it is still too high for a stable and strengthening output the country needs to provide jobs for an estimated one million people entering labor markets each month.

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A stable exchange rate and real short-term interest rates of 1.3 percent suggest a roughly neutral monetary policy. As things now stand, there is no need for additional credit tightening to fight inflation, because a substantial part of inflation pressures stems from poor infrastructure (apparently one-third of food supplies are spoiled before they reach the market) and weather-related problems. The rainfall has improved in recent weeks, and a normal monsoon season is expected next month. That should help the farm output and keep the food prices down.

Investment thoughts

Since the beginning of the year, India's equity price gains (23.4 percent) are by far the highest in Asia-Pacific and are among the highest in the world.

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There is no doubt some "Modi effect" there. Investors correctly see a hopeful beginning of a new administration determined to tackle the huge developmental challenges that could unlock India's enormous growth potential.

Partnership with China can be instrumental in this task. In particular, Chinese infrastructure investments could raise India's economic efficiency and help accelerate the country's growth while relieving upward supply side pressures on costs and prices.

Will that happen? I believe chances are better than even that it could. The key reason is that the two countries seem to have decided to abandon old suspicions and prejudices, and that they realize that their economic and political interests are now more in tune than at any time in recent history.

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.

Follow the author on Twitter @msiglobal9