Column: Can India bridge its trade deficit with China

Updated: Jul 15 2014, 07:43am hrs
At nearly $70 billion, China is today Indias largest trading partner. More striking is the fact that India has a large and growing trade deficit with China. In FY13, India recorded the largest bilateral trade deficit of a whopping $39.4 billion. This has raised concerns among Indian policymakerslargely related to what constitutes this deficit and how this deficit can be bridged.

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Trade data shows that Indias major exports are cotton, copper and iron ore which account for 51% of its total exports to China. Major imports from China comprise mechanical and electrical machinery and their parts and organic chemicals accounting for 44 % of total imports.

A more insightful inference can be drawn if we classify traded items into raw materials, intermediate goods, capital goods and consumer goods. Raw materials and intermediate goods were 89% of our exports and 83% of our imports comprised capital goods and intermediate goods.

More importantly, Indias exports are largely resource-intensive and non-fuel primary commodities while imports are basically high- or medium-skill and technology intensive commodities. How concerned should we be about the huge imports Clearly, intermediate and capital goods at competitive rates are essential for our manufacturing sector and would contribute to the industrialisation process. An interesting observation is that consumer goods comprise only 15% of total imports. This sets to rest the concern that many analysts have raised regarding Indian consumer goods sector being affected by a surge in imports from China.

Can India increase its exports to bridge the trade deficit Indias exports to China have been dominated by primary commodities. However, the composition in the last few years has changed. In 2008-2009, iron ore exports were the single-largest item, accounting for 60% of our exports. Indias response was to impose export restrictions on iron ore in the form of duties. In the subsequent years, iron ore exports have fallen but there has been an increase in the exports of copper items, leading to a rise in its share in Indias export basket to China from 1% in FY09 to 15% in FY13.

Thus, unless India diversifies its export basket, it is unlikely that it will be able to bridge its trade deficit with China through raising exports. One way to reduce Indias overall deficit is by expanding Indias export basket in manufactured products. Investment from China will not only bring in capital inflows but would also provide the much needed impetus to the manufacturing sector. Unlike trade, levels of investment between India and China remain relatively low. Total FDI inflows between April 2000 and February 2014 were a mere $396 million, accounting for less than 1% of the total FDI inflows received by India during the period. Of this, $251 million flowed in the last two years, indicating the potential synergies that can be realised between the two countries.

What is not understood very well is why FDI inflows from China are low. In the past, India has had a restriction on inward investment flows from three countriesSri Lanka, Bangladesh and Pakistanwhich were removed by 2012. Even though China has never been on the negative list for inward FDI, it is not too clear whether there is a non-transparent policy that inhibits FDI inflows from China. Another factor that may be inhibiting FDI from China is that it has been linking obtaining work permits to larger investment flows, drawing the reluctance of the Indian government. Evidence seems to suggest that Chinese prefer to use their own labour in investment projects than the local workers of the host country. Chinas Go Global Policy, meant to encourage more investment abroad, preceded a rise in the number of Chinese workers overseas. China had 812,000 workers abroad at the end of 2011, double of what it was in 2002.

In view of these problems, the recent signing of a memorandum of understanding to set up Chinese Industrial Parks in India is a welcome step. The MoU is aimed at attracting Chinese investments in India and providing an enabling environment for Chinese companies to invest in industrial parks and zones.

To have a sustained inflow of FDI from China, the governments on both sides should address the barriers that have restricted these flows so far. Not only would FDI bring benefits such as technical know-how, jobs, and higher productivity, but would also rejuvenate the manufacturing sector that would help India increase its exports and lower its trade deficit in the coming years.

Nisha Taneja & Samridhi Bimal

Taneja is professor and Bimal, researcher, ICRIER