Press Release

S K Mohanty ¹

1. Introduction

China has emerged as India’s largest trading partner after it replaced the United States in March 2008 (GoI, 2008). When India initiated its comprehensive reforms in 1991, the level of bilateral trade between the two countries was insignificant as the trade basket was restricted to a limited number of products. However within a short period, China has become India’s single most important trading partner even though India’s bilateral trade deficit with China reached an unsustainable level of US$ 39.1 billion in 2012 (IMF, 2013b). Policy makers will have to find ways to manage this huge deficit given that India can neither afford to limit its economic engagement with China nor continue with such a huge bilateral trade asymmetry for a long period of time.

China has been on a high growth trajectory for more than three decades, and even maintained a sustainable rate of growth at more than 9 per cent per annum during the period 2002-10. The rate of domestic expansion has been robust since its accession to the WTO in 2001. As is evident from statistics, the main drivers of China’s economic growth have been its export and a subsequent expansion of the domestic sector, accompanied by its import surge. During the above reference period, China’s export share in the world economy increased from 3.4 per cent to 10.4 per cent, while its imports rose from 4.4 per cent to 9.1 per cent, respectively. The global economy started recovering from recession in 2010, but with the deepening of the financial situation in Europe once again entered the danger zone and remained there until the third quarter of 2012. The global situation continued to remain fragile in 2013, and its adverse impact was felt in most of the emerging countries that included China and India. Although it suffered from global downturn, China has been strategising to take advantage from the expected recovery of the global economy.

In this context, it is significant that China’s external sector growth is mostly propelled by manufacturing exports. Technology is an important factor for both production and exports as technology-embodied FDI and the domestic innovation system have contributed to the growth of product development for exports, often with the import of related services (Fu and Balasubramayam, 2005). With the changing industrial structure of the country, a large portion of Chinese exports istending towards high-tech exports. This trend coupled with mass production will sustain its high growth momentum for long (Mohanty and Chaturvedi, 2006). Further, with the Most Favoured Nation (MFN) and ‘market economy’ status, China is likely to dominate the global market with its aggressive promotion of exports.

However, sustained economic growth over a period of time has led to a rise in labour productivity and the domestic wage rates. With qualitative improvement in the labour force, the domestic sector is gradually shifting towards more knowledge-intensive industries. In the process, China has started losing its cost advantage in several sectors that span the primary, resource-intensive as well as labour-intensive industries (WTO, 2012). There are possibilities that some of these industries are likely to be shifted out of China and re-located in other countries including India but it remains to be seen whether India is gearing up for such a role! The implications of the Chinese trade strategy needs to be examined in the context of India’s trade options.

As China emerges as the largest trading partner of India, there are many bilateral issues that require close scrutiny. India’s bilateral trade gap is increasing along with its overall trade gap with the rest of the world. It is important to examine to what extent is this bilateral trade imbalance contributing to the overall trade imbalance of India. An important challenge for policy is the need to sustain the present level of trade between the two countries while narrowing the existing bilateral trade gap.

Equally important is a comparative analysis of the tariff policies of both countries because of their increased engagement with the world economy through their participation in various Regional Trading Agreements (RTAs) in Asia and in other parts of the world. Furthermore, reform processes in tariff policies in both countries are again, linked to their external sector performances. Relative external sector performance in both countries requires further investigation in the light of ongoing trade policy reforms.

The Global Value Chain (GVC) has emerged as an important vehicle of trade in the global economy. While during the 1950s and 1960s, the usage of this trade process was mostly in the domain of developed countries, , it is an important source of trade engagement between North-South and South-South in recent years. Global value chain remains relatively an unexplored policy option with India. However, China and India are becoming important players in such activities for both developed and developing countries particularly in their engagement with the United States and the European Union. Is it possible to leverage this advantage vis-à-vis China?

There is presently global debate on the revaluation of the Chinese renminbi and the growing global imbalances. The implication of a revaluation of the renminbi on the export prospects of India is crucial for its trade with the rest of the world. Moreover, India’s trade is increasingly becoming ‘Asia Centric’, while its association with various RTAs has expanded during the last two and half decades. In this process, ties with SAARC and ASEAN have gained prominence for India in South and East Asia. Strategies by Indian policy makers can link the increasing profile of India with the countries that are part of the East Asia Summit (EAS) Process. These are pressing issues that need special consideration.

This study examines some of these issues as follows: Section 2 presents some broad macroeconomic developments both in India and China while a trade policy review of China in the context of India’s economic interest is discussed in Section 3. The bilateral trade relationship between India and China is analysed in Section 4; Section 5 examines tariff regimes in both the countries; Section 6 focuses on the trade potential existing in partner countries; Section 7 examines patterns of engagement of India and China in the Global Value Chain; Section 8 examines the implication of a revaluation of the renminbi on India’s market access in third countries; Section 9 examines the engagement of India and China in different regional trading arrangements and the implications of this for India. The conclusions and policy recommendations are presented in the last section.

2. Macro-economic Developments and the Outlook

As India and China are the two fastest growing countries of the world, the possibility of an economic rapprochement among them to seize the synergies² of their development is an interesting issue for discussion. Both the countries have witnessed transitions in their economic policies during the last two to three decades, and the irreversible nature of economic liberalisation has enabled each nation to integrate with the world economy. While analysing the existing patterns of their trade and the sectoral complementarities for further economic engagement, the comparative macroeconomic performance of both economies may be examined in recent years. The robustness of these economies may be seen from their macroeconomic performances.

2.1 Sustaining High Growth

China has increasingly attracted the attention of the global economic community during the last three decades due to its excellent track record in maintaining a high growth rate unparallel in the annals of the world economy³. Since 1980, it has been maintaining an average GDP growth of about 9 per cent per annum and has taken major strides in elevating large sections of its population above the poverty line. During the period of global buoyancy which spanned fom2003 to 2007, its GDP growth rate accelerated to more than 11.6 per cent per year, while its highest growth rate in recent time was recorded in 2007⁴ (see Table 2.1). The reoccurrence of the Global Financial Crisis in 2008 tapered global economic activities substantially. However, Chinese high growth profile was adversely affected with the persistence of a global economic downturn. Real GDP growth rate weakened sharply from 9.6 per cent in 2008 to 7.7 per cent in 2012, casting aspersions about the growth prospects of the country in future. In the Post-Asian Financial Crisis period, the external sector has emerged as the key source of China’s growth, and its exports and imports grew at the rate of 28.1 per cent and 25.4 per cent, respectively during 2003-08 and declined significantly during 2009-10. According to the Ministry of Commerce of China (MoCC, 2011), trade in services, which grew at a modest rate earlier, has registered a high growth in the recent years.⁵ Foreign direct investment added up to $378 billion cumulatively with about $108 billion in 2008. Rising current account surpluses combined with strong capital flows brought the net international reserves to about $1.55 trillion in 2007, surpassing those of Japan in the present decade. However, external sector performance was adversely affected during the period of recession.

The resilient Chinese economy dealt with intermittent occurrences of external shocks in recent years. It has effectively coped with shocks for example like the Asian Financial Crisis; the SARs epidemic; several major natural disasters including floods and earthquake, and the current episode of global recession, among others.

During the financial crisis of 1997-98 and 2008-12, the Chinese authorities evaded adjusting the exchange rate regime to reduce the pressure of crisis and instead launched a major Keynesian programme of reflation (estimated to have injected stimulus packages of about $1 trillion during ‘Asian Crisis’ and $0.6 billion⁶ during the present crisis to boost domestic demand) to keep up the growth momentum of the economy. Succumbing to international pressure, China has agreed to make appropriate corrections in the exchange rate.⁷ The prudent management of Chinese economic policies and other factors has led to a resurgence of the growth rate in 2010 butthe growth momentum was subdued until 2012. The IMF projection of Chinese growth rate has expressed pessimism in the medium term.

Among others, the demographic dividend remains one of the most important factors, determining the growth prospects of China in the next two decades. Growth prospects areaffected by the population structure because the dependency ratio, which is represented by relative size of the labour force to the total population, is the major yardstick of level of output. A rising share of workers in the population in China indicates that participation rate is properly accounted for in the production process. With declining fertility rate, there will be reduction in both population growth and dependency rate, leading to rise in the working age ratio. In case of India and China, increasing working age ratio would contribute to higher per capita income growth, or demographic dividend.

Various studies have indicated that China has passed through a phase of demographic restructuring, and demographic dividend has a major contribution to the recent growth profile of the country. The demographic dividend will continue for some time before it turns out to be adverse in the form of ‘demographic tax’. Chinese peak population will be 1.5 billion in 2032 before declining (Wolf, et al, 2011). The empirical analysis of Cai and Wang (2005) concluded that demographic dividend of China would cease to exist by 2015. ADB (2011) projected that China is expected to receive benefit of demographic dividend until 2020, and will incur ‘demographic tax’ in the 2020s. The prediction about erosion of Chinese demographic dividend in the next decade, particularly before reaching the status of a developed country, could be due to several reasons including rapidly aging population, rising dependency ratios, rising health costs for the elderly, sharp gender imbalances, etc (Wolf, et al, 2011). On the contrary, India is likely to gain from the demographic dividend. According to Aiyar and Mody (2011), India started receiving demographic dividend since 1980s, and it would contribute at about 2 percentage points per annum to India’s per capita GDP growth over the next two decades. It would not only address the issue of income convergence among Indian states but also focus on balanced growth of the regions. The working age population in China is expected to decline in the next decade where it is likely to rise in India. With the existing demographic character, India’s growth profile could outpace China’s for a considerable time (Economist, 2010). The level of demographic dividends in India and China are dependent upon the successful implementation of a range of policy choices during the period of transformation (Golley and Tyers, 2012).

Growth momentum of the Indian economy⁸ has been susceptive to the global business cycles (see Table 2.1). During the periods 2001-02 and 2008-12, India’s growth performance was limping as compared to the years of buoyancy in the global economy. Average GDP growth declined to 6.5 per cent during 2008-12from 9.5 per cent during 2005-07. The speed of recovery in India was slow in comparison to China, though both countries revived from the global recession in 2010. With a rebounding of the economy, India could post a robust GDP growth of 10.1 per cent in 2010, allowing per capita income to rise from $1159 in 2009 to $1432 in 2010. The per capita income, however, has stagnated at $ 1501 in 2012. During the last decade, India’s share in World Gross Product has increased from 4.0 per cent in 2003 to 5.7 per cent in 2011, but remained stagnant in 2012. Simultaneously, performances of exports and imports are yet to pick up in recent years.

However, the surge in the external sector performance of India is considerable below its potential. Strong inflationary pressure grappled the Indian economy during 2008-12, leading to a surfacing of numerous macro-economic imbalances in the domestic economy. Until 2005, India’s rate of inflation was under the permissible macro-economic ceiling of 5 per cent. With the onslaught of recession in 2008,the current account imbalance as a percentage of GDP went up to -4.8 per cent in 2012 from -1.0 per cent in 2006. In value terms, current imbalance grew from $15.7 billion in 2007 to $88.2 billion 2012, registering an unsustainable rise of CAD during the period 2007-12. Therefore, India’s recovery in 2010 was transitory in nature and the economy was not resilient enough to withstand the second episode of the global ‘double-dip’ recession.

2.2 Sources of Domestic Growth

The global debate on the choice of an appropriate development strategy has been changing radically during the last few decades. In the mid-seventies, there was a policy switch towards an export-led growth (ELG) strategy in several countries including in Asia. Constraints relating to the ELG strategy surfaced predominantly during the Asian crisis, and there was strong motivation to move to a Domestic Demand-Led Growth (DDLG) strategy in order to maintain high growth while keeping the economy resilient to the intermittent occurrences of external shocks⁹. Considering the advantages and disadvantages of both the approaches, India and China have been pursuing these strategies simultaneously to optimise their growth potentials from the constantly changing global and domestic situations. With global buoyancy, the ELG strategy receives priority, while the DDLG strategy dominates in the domestic policy during global recession.

The ELG strategy is focused on re-orienting the structure of domestic production to promote exports. Based on the neoclassical principles of ‘efficient allocation of resources’ between sectors, it is envisaged that exports would act as the engine of growth. In the changed policy environment, with exports firmly in the saddle, domestic demand was stimulated, and this process, in turn, encouraged savings and capital formation to expand with exports and economic growth. In the framework of the ELG strategy which is consistent with the principles of the ‘Washington Consensus’, exports gradually emerged as the growth simulator for the economy. The growing demand from the export sector, paved the way for introducing new and efficient technologies in exporting firms to meet the required quality and standards of various products. The spill over effects of technological up-gradation in select export sectors were felt in the rest of the economy. With a strong undercurrent of exports in the domestic economy and continuous investment in the exporting sectors, the supply potential of the economy in the tradable sectors increased over time. This, in turn, strengthened the import capabilities of the countries to support their increased need of the export sector.

During the post-war period, within the developing world some of the currently more advanced countries known as the ‘Asian Tiger’ were almost at a similar level of development as that of India. The rapid growth of these economies over a period of more than two decades brought another dimension to the ELG strategy as a development paradigm. Asia witnessed a ‘growth miracle’ in these countries during the period from 1970 to mid-1990s. However, the development gap between these and the rest of the developing countries widened. A key factor for the phenomenal growth of these fast growing economies has been the ‘export boom’ following adoption of the Export Led Growth strategy, which has effectively integrated these economies into the global economy. This strategy allowed development to transmit through the external sector channel, and export took the lead in shaping the growth process through a restructuring of the domestic production structure. Experiencing the positive effects of the ELG, many countries from Latin America have also adopted a similar strategy (Herzer, 2006).

However, as an aftermath of the ‘Asian Financial Crisis’, the ‘High Growth Profile’ of the ELG regime as a credible strategy for enhancing growth and economic welfare was called into question, and its efficacy came under the scanner. Inconsistent performances of some of the sectors during the period of crisis raised doubts about the relevance of export-led growth as a growth stimulating strategy for the developing countries (Felipe, 2003). This called for a new development paradigm, which would insulate developing countries from the possibility of economic crises because of external shocks. In the post-crisis period, a gradual switching of policies towards Domestic Demand-Led Growth strategy yielded positive results and placed the developing economy back on the path of sustained high growth¹⁰.

Under the Domestic Demand-Driven Growth hypothesis, expansion in the components of domestic demand would lead to an increase in economic growth. Some of the factors contributing to domestic demand are private investment, government expenditure, consumption, etc. This hypothesis emphasises that GDP growth can be made sustainable with deep internal market demand. Therefore, growth in output can be triggered by growth of aggregate demand. The central focus of the approach would be to enhance the production capacity to comply with effective demand.

There are merits in both approaches to steering an economy to maintain steady growth over a long period. It is often discussed in the literature that these approaches are not either/or and competitive in nature. In many cases, they are rather complementary, even though they appear to be competitive. It is frequently seen in the literature that empirical evidences do not support the dominance of any of these approaches in a country/region because they contribute differently in diverse situations. It is the prerogative of a country to choose its future development paradigm to guide its growth process, particularly, one that will take it to a high growth trajectory.

The current literature provides sufficient evidence to show that the export-led growth strategy is not likely to sustain growth (Palley, 2011) because of the changing global situation. Now protectionism in the global trading arena has returned with a vengeance and the space of export activities has somewhat narrowed. The situation will be more complex for those countries, which are middle-income countries, aspiring to a high-income country level status. For accommodating the national priority of sustained growth within the framework of global norms (i.e., commitments to climate change, global standards, global governance, etc.), the new development paradigm suggests maximising domestic effective demand with Domestic Demand-Led Growth.

A critical examination of the development strategies of India and China indicates that these consist of a combination of both ELG and DDLG in recent years, particularly after the ‘Asian Financial Crisis’ (Mohanty and Chaturvedi, 2006; Li and Zhang, 2008; Mohanty and Arockiasamy, 2010). During the period of global recession, development policies are more inclined towards DDLG to maintain high GDP growth rate. During the phase of global recovery, export is pushed as a major driver of growth with an emphasis on Globally Dynamic Products (Mohanty, 2009).

Review of Literature

The Export-Led growth hypothesis has been dominating the development literature for the last four decades. Several studies examined the relationship between exports and growth in the 1970s and 1980s. Many of these studies (see for example, Michaely, 1977; Heller & Porter, 1978; Tyler, 1981; Feder, 1983; Kavoussi, 1984; Ram, 1987, Mohanty and Chaturvedi, 2006; Wah, 2004; Wong, 2007 and 2008) have supported the assertion that export growth has a strong association with growth of real output. Moreover, causation between the two variables is not established with certainty among different cross-section of countries and at different points of time. During the last several decades, such relationships were examined in the framework of time-series and in a cross-section of countries.

Several studies have (see for example, Jung and Marshall, 1985; Hsiao, 1987; Bahmani-Oskooee, et al., 1991; Dodaro, 1993 and Love, 1994; Love and Chandra 2005) used different time-series approaches to lend support to the export-led hypothesis. Their results are not conclusive in supporting the hypothesis, but rather mixed in nature. Taking a large set of 87 countries, Dodaro (1993) examined the causality between export growth and causality. Results of the study found weak support for the hypothesis that export growth promotes GDP growth. Using the Granger causality, Jung and Marshall (1985) found that the export-led growth hypothesis is supported by 10 percent of the sample in the cross-country analysis. The results of the study by Bahmani-Oskooee et al. (1991), combining Granger causality with Akaike’s Final Prediction Error (FPE) were to some agreement with the export-led-growth hypothesis, although the evidence is inconclusive. Using a similar methodology, with Johansen’s multivariate approach to cointegration, Love and Chandra (2005) examined the hypothesis of an export-led growth hypothesis for Bangladesh. The findings suggest that the direction of both long- and short-term causality is from income to export and therefore country inward trade strategy of development discriminated against export.

In several countries, both ELG and DDLG are pursued simultaneously in order to insulate the domestic economy from the adverse impacts of global business cycles. Several studies have observed that empirical findings do not strongly support the export-led growth stance and this is because of the missing impact of DDLG misspecification in the model. In many other cases, both development paradigms are empirically found to be important in contributing to growth, meaning thereby a simultaneous pursuit of these two strategies to optimise national welfare. Lin and Li (2002) examined contribution of the external sector to GDP growth to examine efficacy of export-led growth in China. They proposed a new methodology to estimate the direct and indirect contribution of exports to GDP growth. Their results indicate that a 10 percent increase in export growth would lead to 1 percent growth in GDP in the 1990s.

In a recent paper, Mohanty (2012a) examined the possibility of maintaining a sustained high growth performance in India while simultaneously pursuing both ELG and DDLG strategies. Since India falls in the Low Middle Income Country Group, it has a large number of products with export competitiveness globally. Time Series analysis with the VECM model reveals that both strategies have a significant long-term relationship with income. If India’s medium-term growth performance were sustainable, India’s trade integration with ASEAN would be strengthened with either ELG or by a combination of both strategies. India’s interest could be to pursue both strategies alternatively to maintain sustained high growth until its export competitiveness is fully realised.

In the case of China, a study by Tang and Selvanathan (2008) suggested that FDI had not only compensated a shortage of capital but also induced high economic growth through domestic investment. Therefore, FDI encouraged the relevance of the DDLG strategy in China.

Wah (2004) tried to examine the specific paradigm of development that contributed to the high growth phase of the Malaysian economy during the period 1961-2000. During the high growth period, export remained an important factor in the economic transformation of the economy. However, various studies examining the export-led hypothesis in Malaysia found weak support for this hypothesis in the long run, and this could be because of exclusion of various factors relating to domestic demand in the models. Results support the domestic demand hypothesis in the long run, but the export-led hypothesis was not supported by the empirical findings. In another study, Wong (2008) examined the relevance of development stance of some of the South East Asian countries, particularly ASEAN-5, during and after the ‘Asian Economic Crisis’. The regional overview indicated that there was bilateral Granger causality between exports and economic growth, and private consumption and economic growth. The empirical findings could not suggest that the crisis in the region was due to export-led growth. The broad conclusion of the study is that sustained economic growth requires steady growth in the exports and domestic demand. A similar hypothesis was examined by Wong (2007) for some Middle East countries including Bahrain, Iran, Oman, Qatar, Saudi Arabia, Syria and Jordan, and found that sustainability of economic growth went hand in hand with growth of both exports and domestic demand. However, the results were less conclusive to support any development strategy responsible for sustained economic growth in the Middle East region.

An overview of the current literature highlights the role of both exports and domestic demand to put economic growth on a high growth trajectory in a sustainable manner. The exact sequencing of policies and their impact on the growth prospects of a country are empirical issues, which can be examined in case of India and China.

Growth Accounting Approach

From the above discussion it is relevant that both India and China are maintaining high growth over a long period despite turbulences at the level of both the domestic and global economy. The resilience of these economies has been the outcome of the policy priorities associated with alternative development strategies, which vary from time to time in order to catch up with different economic situations. An exercise is to examine the contribution of domestic demand and the external sector to aggregate growth in both countries follows. It may be interesting to note that the relative contribution of both the components (i.e., domestic demand and external sector) vary with the changing global situations. The computations of growth decomposition are based on the procedures developed by Felipe and Lim (2005).

GDP growth in the year t is explained by the following macroeconomic identity:

The same formula applies to other components of demand.

It is hypothesised that contribution of domestic demand, such as consumption, investment and government expenditure is expected to be significant during global recession whereas the external sector contribution should be robust during the period of global buoyancy. As the global economy passed through different phases of the business cycle, both countries continued to maintain high growth performances during the last two decades due to a suitable interplay of both ELG and DDLG strategies.

Analysis for Growth Decomposition: China and India

China has simultaneously pursued export-led and domestic demand-led growth policies to place the economy on a high growth trajectory in a sustainable manner. The investment-led domestic demand and the export sector have been the drivers of growth for the Chinese economy. The experiences of developing countries suggest that both export-led growth and domestic demand-driven growth have positive as well as negative effects on economic growth; and neither of these appears to be appropriate to be pursued in isolation. In recent years, the contributions of both the strategies to overall GDP growth in China follow the behaviour pattern of the global business cycle, thus, it insulated the high growth momentum in these countries from the adverse effects of exogenous shocks. Simultaneous pursuance of both these strategies of domestic demand and export-led growth can ensure consistently high growth irrespective of the nature of the global business cycle.

During the last few years, exports have been expanding rapidly in real terms and the impact of exports on employment has been profound (Mohanty and Chaturvedi, 2006), thus contributing towards the alleviation of poverty. Exports have generated substantial employment opportunities due to sustained demand for industrial products in the global market.

The impact of the global business cycle on domestic economic growth has been different for various elements in the income identity during different phases of the cycle. A growth decomposition analysis for the Chinese economy indicates that contributions of domestic demand and exports to overall growth have been different across various phases of the global business cycle, but their combined contribution to growth has been significant and consistent during the last decade. During the period 2001-03, the global economy grew at an average rate of 2.9 per cent during the economic downturn and increased to 4.9 per cent on an average annually during the global buoyancy of 2004-07. The world economy was struck by recession in a major way twice recently in the form of ‘Asian Economic Crisis’ during 1997-98 and then since 2008, with a marginal improvement in 2010 before relapsing into crisis.

The growth performance of the Chinese economy was adversely affected during these two phases of the global business cycle, and the contribution of domestic demand and the export sector to GDP growth followed a definite pattern during these two phases. The contribution of domestic demand to growth was significantly high during recession and declined considerably during the period of economic boom. A reversed trend is apparent for the export sector in its contribution to growth. Decline in the contribution of a growth factor is compensated by another growth-inducing factor in one episode of the business cycle, leading to restoration of the overall growth rate of Chinese economy maintained at a high level.

Growth decomposition for China is estimated for the period 1991-2011 using equation (1) and (2). For examining the contribution of different sectors to growth in different phases of the global business cycle, we have referred to fdifferent time periods in the analysis as presented in Table 2.2. The empirical results indicate that during the phase of recession (i.e., 1996-99), the contribution of the external sector to overall GDP growth was 3.7 per cent per annum on an average and went up to 21.9 per cent per annum to the GDP growth during buoyancy (i.e., 2004-07). It is observed that the contribution of exports to GDP growth during recession declined from 24.6 per cent in 2007 to -82.0 per cent in 2009, and the loss of external demand was adequately compensated by domestic demand, mostly by consumption and investment.

Among the drivers of domestic demand, the most important source of growth was investment which grew at a double digit rate during the present decade. The decomposition results show that 36.5 per cent of GDP growth came from investment as against 21.9 per cent from net exports during 2004-07. Buoyancy returned to the world economy during 2004-07, and global demand picked up. With the changing phase of the global business cycle, exports of China surged and so also its contribution to growth. The share of exports to GDP growth jumped to nearly 62.7 per cent per annum and contribution of investment reduced to 36.5 per cent on an average during 2004-07. On account of strong complementarities between the export-led growth and domestic demand-led growth, mostly led by the investment factor, Chinese overall growth performance was unhindered substantially during the decade. The Chinese economy grew at an average rate of 9.4 per cent during the global downturn and maintained an average growth rate of 12.1 per cent during the global boom (2004-07).

The high investment rate in the country was more than fully supported by an increase in domestic savings, which increased from 35.5 per cent of GDP in 2001 to 53 per cent in 2007 and led to a substantial current account surplus. Such high rates of domestic savings obtain from a number of peculiar characteristics of the Chinese economy and also from the high savings of state-owned enterprises which are not required to pay dividends to the government. While foreign direct investment has assisted growth, more than 50 per cent of investment consisted of self-financing by enterprises including that made by state-owned enterprises. Foreign direct investment was none the less substantial and the bulk of it was directed to manufacturing as a platform for export: foreign invested enterprises (FIEs) based in China conducted a substantial part of China’s foreign trade, undertaking more than half of manufactured exports. FDI served as a platform, enabling China to manufacture products that met world-market specifications with regards to quality, design, and technological content.

It is important to note that the growth prospects of the Chinese economy is likely to remain robust in the medium term due to a simultaneous pursuance of export-led growth and demand-led growth by the Chinese government. As domestic growth is likely to remain strong irrespective of the global business cycle, the domestic demand for imports will be strong, taking into account the import profile of the economy in the present decade. The predictability of the Chinese import behaviour in the medium term is an opportunity for India to develop a strategy to access the Chinese market. While opening up of the economy to trade and FDI have resulted in the emergence of a significant private sector, public ownership remains a key feature of the economy, especially for services. The major enterprises, for example the banking sector, are mostly in the public sector and government continues to exert a strong influence on trade and investment (Girardin, 1997). Government-to-government relations thus remain crucial for China’s trading partners including India.

China is dependent on the external sector, but the contribution of this to GDP has started declining. This is evident from the falling share of domestic demand in GDP. Although the contribution of net exports to GDP has gone up substantially during 2002-04, the Chinese economy is largely characterised by the dominance of domestic economic activities. Similar trends exist for India.

The external sector in China constituted more than 20 per cent of its GDP growth during global buoyancy (2004-07). During 2002-08, export contribution remained significantly higher than imports and other components of demand. However, contribution of exports remained negative (-64.4 per cent in 2009), leading to net negative contribution to growth during global crisis (2008-09). This shows a declining relevance of ELG in case of China.

China is passing through a phase of rapid structural change, leading to growing imbalances in its current account position. As reported by the IMF (2012c), country’s international reserves increased from $615 billion in 2004 to $3.2 trillion at the end of 2012. Surging of Chinese international reserves over a period has been construed as the key reason for the continuation of the recent episode of global imbalance. China has been experiencing current account surplus (CAS) since the early 1990s, even during the period of ‘Asian financial crisis in the mid-1990s. The nature of current account surplus has undergone radical change over the years. As a percentage of GDP, CAS reached its peak of 10% in 2007, and started declining (Cline, 2012) in the following years. Various reasons are provided in the literature to explain secular failing of Chinese CAS ratio including robust import demand against declining terms of trade (IMF, 2012c), widening resource gap (EAF, 2012), and real appreciation of exchange rate (Cline, 2012; Cline and William, 2011), etc among others.

While Chinese consumption as a share of GDP has been growing steadily, savings ratio graph is moving towards a phase of plateau and then falling off significantly from its present level of 50 per cent of GDP. There are some tendencies towards surge in the consumption behaviour in the country. China’s private consumption has been growing within the range of 8-9 per cent per annum during the last two decades, and this has been fuelled by growing demand for consumer durables. Falling savings ratio, rising consumption and pressure on investment have a combine effect on widening of domestic resource gap, which will put pressure on China’s current account balance (EAF, 2012). China is likely to witness robust import growth because of surging private consumption and investment demand in the medium term. Indications of secular worsening of the country’s terms of trade would have a lasting impact on its adverse export performance. Divergence between imports and exports may have long-term implications for its current account balance (IMF, 2012c). Recent empirical studies¹¹ (Cline, 2012; Cline and William, 2011) suggest that a key reason for decline in the share of CAS in GDP is substantial real appreciation of the exchange rate. Other factors contributing to this process include world oil prices, slower world growth and an erosion in the capital services accounts but these are secondary factors as compared to appreciation of Yuan.

The present trend indicates that there will be a lasting decline in the Chinese current account surplus in the medium term. IMF (2012a) projects that CAS as a share of GDP will be 2.3 percent in 2012 and 2.5 per cent in 2013. Cline (2012) observes that CAS ratio would be in the range of 2-4 per cent of GDP over next six years. There are several counterfactual results showing expected CAS ratio in 2017. Results of Cline and William (2011) suggest that it would be 5.4 percent whereas IMF (2012a) predicted at 4.3% in 2017. Cline (2012) has predicted CAS ratio in a range of ±2 per cent of GDP in 2007, depending upon exchange rate policy of the government. However, through various channels, the current account surplus is going to dip in the medium term.

Both India and China have shown divergent growth paths though there are many commonalities between them. During global buoyancy or recession, priorities in development strategies (i.e., ELG and DDLG) have been similar, but the countries differ in terms of their drivers of growth. It is interesting to note that while in China the ELG strategy is facing increasing challenges, in India it is still being considered as relevant as a credible development strategy. During the global boom, growth performances were significant in both the countries. While India was growing at a rate of 9.0 per cent in average during 2004-07, China posted an average growth rate of 12.1 per cent per annum. During the recent episode of global recession, India’s average growth performance slowed down to 6.5 per cent whereas it declined to 9.4 per cent in average for China during 2008-09. It is important to examine the growth drivers in both countries during different phases of the global business cycle.

India’s growth records during its two decades of reforms are presented in Table 2.3. Domestic demand during the ‘Asian Financial Crisis’ was significant. In comparison with China, consumption and government expenditure remained major driver of domestic demand during the global recession (1996-99). During global buoyancy (2004-07), GDP growth in India was fuelled equally by consumption and investment. The contribution of consumption to overall growth in India was much stronger than it was for China during the same period. Investment as an instrument to support the growth momentum in India has been fragile during the period of global boom. Over the years, in India, export sector contribution to growth has been improving starting with the ‘Asian Economic Crisis’. During the recent episode of global recession, domestic demand-led growth had been the major policy to maintain high growth, and consumption was the single largest contributor to growth during 2008-09 (181.5 per cent). Government expenditure also played an important role during recession to maintain an overall growth performance. However, the export sector has been consolidating its contribution to growth despite enlargement of the current account deficit in recent years.

Despite broad similarities in the overall economic structure, there exist stark differences in the composition of domestic demand in the two economies. While GDP growth in both economies remained consumption-led in the 1990s, the role of investment in domestic demand improved for China in 2000-09. On the other hand, India continued to maintain a high level of dependence on private consumption marking a 7.4 per cent rise from 54.8 per cent in 1991-2000 to 62.2 per cent in 2000-09.

Compared to China, the share of investment in GDP was lower for India during the period 2000-03. In subsequent years, the share of investment of both the countries was more or less comparable varying around 35 per cent. For instance, the average contribution of investment to GDP was found to be 48 per cent during 2002-07 whereas it hovered around 40 per cent in China.

The relative share of government consumption declined in both the countries during the last decade. It dropped from 13 per cent to 12 per cent in China and from 11 per cent to 10 per cent in India over the period of two decades between 1991-2000 and 2000-12.

To sum up, it can be concluded that the present level of external exposure for India and China is quite consistent with the medium-term growth potential of the two economies. Alternatively, it suggests that the downside risk of double-dip recession was strong for India whereas it could be lesser for China due to strong economic fundamentals. In view of weak external demand, both the countries have some leeway in pursuing domestic demand-based economic policies during the crisis period.

2.3 Outlook for Macroeconomic Situation

According to the IMF (2012a), recovery in China has been stronger than it was predicted earlier on account of the picking up of business activities and financial market in 2010. Resumption of the economy with a high growth rate was expected as an outcome of the macro-economic policies along with high capital inflows. GDP growth rate increased to a double digit figure in 2010 and declined significantly to 7.7 per cent in 2012. It is projected to decline further to 7.3 in 2014. Other reports including the ADB (2012) and ESCAP (2012) have predicted similar trends in real GDP growth rate¹² in the medium term. The Chinese Ministry of Commerce (2011) has reported robust domestic growth in 2010 on account of the cascading effects of policy stimulus made earlier. However the recent forecasts indicate about marginal weakening in the growth prospects of China between 2013 and 2017 (IMF, 2013a).

As expected, the Chinese external sector picked up fast in 2010 and 2011 according to the ADB (2012). With the modest recovery of the world economy, Chinese exports grew at a rate of 13 per cent and imports by 13.5 per cent in 2010 due to a robust domestic demand, higher global prices for oil and rising prices of primary commodities. Though world output growth declined from 5.1 per cent in 2010 to 3.8 per cent in 2011 (IMF, 2012b). Chinese exports and imports growth rates were robust during the corresponding period. The Chinese Ministry of Commerce (2011) forecasted a robust growth of the Chinese external sector on account of an expected boom in the domestic economy as well as due to recovery of the developing countries. In 2010, exports grew at the rate of 31.4 per cent and imports by 39.1 per cent amidst persistence of multiple international problems including continuation of the global financial crisis; increasing sovereign debt risks in some countries; persistence of protectionist measures; and domestic concerns like rising inflationary pressure, occurrences of intermittent natural disasters, fast rising of housing prices in urban cities, latent risks in fiscal and financial sectors, etc. Although the pace of Chinese overall exports and imports growth rates slowed down in 2012 in comparison with the previous year, the levels of growth rates were robust. The Chinese government took a strong commitment that the macro policies were effectively managed to ‘enhance quality and efficiency of economic growth, strengthening and targeting flexibility of macroeconomic policies and strive for a steady and faster economic development.’ There is now a growing consensus that China may become the largest economy in the world, pushing the US economy to the second position by 2020¹³.

2.4 Some Areas of Concern

While the performance of China has been exceptional, for bilateral trade there are, of course, many areas of concern, some of which have special significance for India. First, China is experiencing large and increasing inequalities within the economy. Several regions close to India (especially in South West China) are among the laggards in development. There are several government initiated special programmes to help the under-developed regions, which include public investment as well as preferential treatment for FDI in these areas¹⁴. These regions border on India, so they may be of special interest to India in terms of trade as well as investment policy.

Second, as noted above, growth in investment has been very high, perhaps excessive from a prudential point of view. There are major risks pertaining to the poor quality and viability of investments. There are various government efforts to rein in investment and to stimulate consumption. So far success in these efforts has been modest. In case investment slows down, it may have implications for India’s exports of iron ore and other raw materials.

The third issue is that raised by the exchange rate policy of China. The country has followed a policy of pegging the renminbi or yuan to the US dollar for more than a decade. Between 2000 and 2005, the renminbi was allowed to trade against the dollar within a narrow range of 8.276-8.280 and has not been allowed to appreciate in synchronisation with the gradual accumulation of foreign exchange reserves and a growing trade surplus. The Chinese trade surplus to the world increased significantly. The trade surplus with the US has been even larger. As the US dollar has tended to depreciate in the recent years with respect to the world’s major currencies, a pegged exchange rate has led to depreciation of the Chinese currency. An artificially depreciated exchange rate can provide broad-based protection from imports and can be of special help to exports. With the large and continuing trade surplus of China with the US, there are pressures from the latter on China to appreciate its exchange rate to actual level. China accordingly, relaxed the exchange rate regime in August 2005 when government suspended the policy of gradual appreciation in late 2008 through early 2009, the renewed tie of the renminbi to the dollar resulted in appreciation of real effective exchange rate. However, Chinese authorities removed fixed tie to dollar in mid 2010 and allowed to appreciate gradually.¹⁵

During the last few years, India’s competitiveness has suffered from a sharp appreciation of Indian rupee vis-à-vis the dollar. So far China has been resisting a major appreciation of the renminbi or the floating of the currency. However, if China does revalue the renminbi in relation to the US$ in a major way or agrees to float the currency leading to significant appreciation of the same, it should result in a relative strengthening of competitiveness of India’s goods vis-à-vis China. The expectation is that China will allow the renminbi to appreciate in a very gradual manner rather than revaluing it suddenly.

Fourth, there are concerns relating to a weak financial sector in China which is reeling under the heavy burden of non-performing assets (NPA) estimated to be upto 50 per cent. The government keeps bailing out the banks and financial sector (Wang, 2007; Lu, Feng and Yao, 2009). NPAs have accumulated over the years in the form of subsidised credits extended generously to the state-owned enterprises (SOEs) that form the backbone of the economy. The SOEs are also not required to pay dividend to the government. It is because of such policies and due to other forms of subsidisation of labour costs of enterprises by local governments and municipalities that many countries are not willing to offer a market economy status to China. China, as the target of the largest number of anti-dumping cases, seeks market economy status in bilateral negotiations with different countries and is slowly moving towards financial sector reforms and prudential regulation of capital markets due to growing international pressure. The grant of market economy status to China by India could be considered once the transparent and prudential norms for capital markets have been established and financial sector reforms have been completed.

Finally, an interesting development is the increasing outward orientation of Chinese investment especially in resource-rich areas like Africa. The increasing outward orientation is the result of huge reserves accumulated over the years from its trade surpluses since the mid-1990s. This trend is set to rise further in the coming years as China’s mega investment plans in Africa materialise. Further, China is pursuing its ‘going global’ strategy effectively as can be seen from the formalising of regulations to help investors to invest abroad. In 2006, the State Administration of Foreign Exchange abolished quotas on the purchase of foreign exchange for overseas investment. However, most of these investments abroad are ‘resource-seeking’ in orientation. Some Chinese companies are now actively considering plans to set up an integrated steel plant in India. In 2007, China decided to set up an agency to manage more aggressively a considerable portion of its foreign exchange reserves for offshore investments following the Singapore model.

There are many other challenges in China’s growth story, for example - the massive and growing demand for energy, minerals and other natural resources and their increasing prices, environmental degradation and climate change resulting from rapid growth, widening inequalities between regions and emerging social tensions, governance and democracy, etc. which may have some implications for India’s development but are beyond the scope of the present study.

3. Developments in Chinese Trade Policy: Its relevance for India

3.1 Economic Environment

The macro-economic reforms undertaken by China, including its trade reforms, industrial policy changes, investment liberalisation, and other macroeconomic restructuring have contributed to a positive overall performance of its economy. Some of these initiatives are discussed in this section.

3.1.1 WTO Accession and Trade Policy Changes

After 15 years of negotiations for entry into the WTO, China’s accession to the same in 2001 was a major development in its trade policy¹⁶. Many analysts in China and abroad believe that the terms of agreement were quite tough on China in many areas¹⁷, such as the financial sector where China agreed to liberalise more than what it obtained from some developed countries. China’s post-WTO accession tariff rates are ‘bound’, meaning that China cannot raise them above the bound rates without ‘compensating’ WTO trading partners. All these reduced drastically China’s ‘policy space’ for active development policy. Despite these concessions, China was not given the status of a market economy until 2016, which means that until that date importing countries would bring in anti-dumping actions without having to prove that the export prices were lower than the domestic market prices in exporting countries. Instead costs in a third country can be used to measure the so-called ‘normal value’ for anti-dumping action. The process is thus open to somewhat arbitrary action and it is no wonder that China has become the target of the largest number of anti-dumping cases for several years in a row. Obtaining market economy status features prominently in China’s bilateral trade agreements. A perception of an unfair agreement under WTO accession prevails in many trade policy quarters in China.

China has also reluctantly accepted some discriminatory provisions in its accession protocol which can be used to limit access of its exports to overseas markets. The first is the transitional product-specific safeguard mechanism which targets Chinese products. It can be invoked if there is market disruption or the threat of market disruption caused by Chinese imports, instead of a more stringent injury test under the WTO Agreement on Safeguards. This safeguard mechanism will last for 12 years after China’s accession to the WTO. The second is the special safeguard mechanism that was applicable to China’s textile and clothing exports until the end of 2008. It provides for a 6.0-7.5 per cent annual increase in the growth of Chinese exports and it can be invoked immediately upon request by the importing country for consultation with China. An implication of the latter is that China has been restrained from taking full advantage of the MFA phase-out under the Agreement on Textiles and Clothing until the end of 2008.

It is also worth noting that trade liberalisation came after nearly two decades of rapid growth and productivity increase in the manufacturing sector. According to studies conducted by the World Bank and others by the mid-1990s, there was a lot of ‘water’ in the tariffs in China: for many of the products, the domestic price was lower than the international price. The principle of ‘infant industry’ protection was fully used by China and serious liberalisation started only after most of the protected industries had healthy growth. The Chinese policies on trade and investment remain in practice mindful of the needs of industrial capacity development in key sectors.

There are several WTO panels investigating China’s violations of WTO agreements. From 1 January 1995 to 31 December 2008, 677 anti-dumping cases have been initiated against China and in 479 cases, measures were taken against. In the year 2008 alone, 73 anti-dumping cases were initiated against China but measures were taken in 52 of these cases. India¹⁸ has initiated 120 anti-dumping against China and taken measures in 90 of these cases during the period 1995-2008. More than 23 per cent of the total cases in which India has taken anti-dumping measures are against China. It may be noted that India has so far taken up the maximum number of anti-dumping measures and anti-dumping initiatives against China as compared to other WTO members.

The tariff liberalisation initiated in China during the last few years is summarised in Table 3.1. The average bound rate was unchanged during 2007-11. In 2011, the average bound rate was 9.9 per cent, 14.6 per cent for agriculture and 9.1 per cent for industrial products. China has made significant reductions in tariffs on a range of sectors including motor vehicles and motor vehicle parts, office machinery, large appliances, furniture and chemicals. In one of its more significant tariff initiatives, in 1 January 2005, tariffs on Information Technology Agreement (ITA) products dropped to zero from a pre-WTO accession average of 13.3 per cent. However, China still maintains high duties on some products that compete with sensitive domestic industries.

As a part of its WTO accession commitments, China was to establish large and increasing Tariff Rate Quotas (TRQs) for imports of wheat, corn, rice, cotton, wool, sugar, vegetable oils, and fertiliser with most in-quota duties ranging from 1 to 9 per cent. By 2004, TRQ commitment was largely implemented, although transparency continues to be problematic for some of the commodities subject to TRQs. The number of product lines under TRQs was seen to be declining during the past decade. The number of lines as a proportion of total tariff lines at 8 digit HS declined from 0.9 per cent in 2001 to 0.6 per cent in 2009.

Significant progress has been achieved in standardising the procedures but there are some tendencies to use standards and regulations as a means of protecting domestic industry as tariff rates fall. Redundant testing requirements continue to trouble exporters, particularly in cosmetics, new chemicals, pharmaceuticals¹⁹, medical equipment, cellular phones and other telecommunication products, consumer electronic products and automobiles. Exporters also cite problems caused by lack of transparency in the certification process, lack of coordination among standard setting bodies, burdensome requirements and the long processing time taken for licenses. WTO (2010) reported that quantitative restrictions were eliminated on 1 January 2005.

China agreed to eliminate all subsidies prohibited under Article 3 of WTO Agreement on Subsidies and Countervailing measures, including all forms of export subsidies on industrials and agricultural goods upon its accession to the WTO in December 2001. However, the lack of transparency makes it difficult to identify and quantify the possible export subsidies provided by the Chinese government. China’s subsidy programmes are a result of internal administrative measures and are not often publicised. Sometimes these take the form of income tax reductions, or exemptions that are de facto contingent on export performance. China’s subsidy programmes can also take a variety of other forms, including mechanisms such as credit allocations, low interest loans, debt forgiveness and reduction of freight charges. Importing countries have expressed concerns about the involvement of local governments in the use of subsidy to promote exporters.

China has made substantial efforts to overhaul the domestic legal regime to ensure the protection of intellectual property rights in accordance with its commitment to the WTO Agreement of Trade- Related Aspects of Intellectual Property Rights (TRIPS Agreement). These efforts have fallen short in some respects, particularly with regard to the criminal liability of copyright piracy and trademark counterfeiting. In other areas, China has done a relatively good job of revising legal regimes. However, China has been less successful in enforcing its laws and regulations in ensuring effective IPR enforcement. According to the United States Trade Representative (USTR), counterfeiting and piracy in China remain at epidemic levels. In 2007, the US complained to WTO about piracy and blocked access to US films, among others.

A registration system was put in place for implementing China’s WTO commitments on liberalisation of trading rights, both for Chinese enterprises and for Chinese-foreign-joint ventures, wholly foreign-owned enterprises and foreign individuals, including sole proprietorships. Consistent with the terms of China’s WTO Accession Agreement, the importation of some goods, such as petroleum and sugar, is still reserved for state trading enterprises. In addition, for goods still subject to tariff-rate quotas such as grains, cotton, vegetable oils and fertilisers, China reserves a portion of the in-quota imports for state trading enterprises, while it is committed to make the remaining portion available for importation through non-state traders. Among the areas where trading right commitments have not been implemented are importation of books, newspapers and magazines and pharmaceuticals where China still requires foreign pharmaceutical companies to hire Chinese importers to bring their finished products into the country. This has been a major Non-Tariff Barrier (NTB) for Indian pharmaceutical exports.

In accordance with the terms of its WTO accession agreement, China agreed to conduct its government procurement in a transparent manner and to provide all foreign suppliers with an equal opportunity to participate in procurement opened to foreign suppliers. The country applied for the Government Procurement Agreement (GPA) and implemented its first Government Procurement Law in 2003. Under the WTO accession agreement, the government would not influence the commercial decisions of state-owned enterprises, although in practice this has not consistently been the case. However, the law also directs central and sub-central government entities to give priority to ‘local’ goods and services with limited exceptions. One area of special concern is that of government software procurement²⁰ where initial indications are that draft guidelines mandate central and local governments to purchase only software developed in China to the extent possible. At the intervention of the US, these draft guidelines have been suspended indefinitely.

3.1.2 Industrial Policy for Strengthening Industrial Base

Chinese industrial policy was effectively used to promote and protect certain favoured industrial sectors. China has not fully embraced the key WTO principles of market access, non-discrimination, and national treatment, nor has China fully institutionalised market mechanisms and made its trade regime predictable and transparent. Some of the industrial policies that are illustrative of this include, for example, the issuance of regulations on automotive parts tariffs that discourage the use of imported parts; the telecommunications regulator’s interference in commercial negotiations over royalty payments to intellectual property rights holders in the area of 3G standards; the pursuit of unique national standards in many areas of high technology²¹ that could lead to the extraction of technology or intellectual property from foreign rights holders; draft government procurement regulations mandating purchases of Chinese-produced software; a new steel industrial policy that calls for the state management of nearly every major aspect of China’s steel industry; and excessive government subsidisation benefiting a range of domestic industries in China. There is strict control over foreign ownership of steel companies implying that non- Chinese companies cannot acquire controlling stakes in the company.

China emulated Japan and South Korea in pursuing an industrial policy similar to what was earlier pursued by the two nations during 1970s and 1980s to create local multinational corporations (MNCs) or ‘national champions’ in select areas based on their core competence. Various supportive state policies were pursued including consolidation of fragmented capacities, subsidisation of financial resources²², encouragement of R&D activity and state patronage in their outward operations. The government plans to build 30-50 of its firms into local multinationals by the turn of the present decade. These companies would enjoy tax breaks, cheap land and virtually free funding via state-owned banks and government help in securing contracts or exploration rights abroad. Haier in home appliances is one such highly successful company having built up a commanding share in the domestic market of up to 70 per cent in most appliances, and now operates in over 100 countries. A few auto producers such as Geely are also quickly emerging as large exporters, especially to developing countries, of cheap cars. Some companies have acquired a global position through acquisitions such as Lenovo with a US$ 2 billion takeover of IBM’s PC division. Some of the most successful companies are engaged in the manufactures of telecommunication network equipment, for example: Huawei and ZTE. These companies have emerged as major players in their area of business, commanding nearly one fifth of global exports of telecom equipments. In this sector, India had a stronger manufacturing and R&D base in the form of public sector enterprises and R&D laboratories, namely C-Dot. However, they failed to make a transition with the mobile/cellular technology.

On the other hand, the Chinese strategy of building large manufacturing companies that can sustain large R&D budgets has enabled them to not only compete on the basis of just cheap labour or costs but also on the basis of technological innovation. These efforts enabled China to emerge as a production hub of the global economy. In the process, China has engaged in the process of mass production of manufacturing products, which has the advantage of lowering the price. Global experiences indicate that lead firms in certain countries, are engaged in various value-added services including R&D and design activities, which could bring them brand values in the global economy. Large firms in countries like Japan and Korea gained from the brand value of their products. But, similar experiences were not replicated for many including fast industrialising countries including emerging countries in recent years (Birnik, Birnik and Sheth, 2010).

Chinese companies have not developed a brand name for their products globally. Rather other countries have developed brand names using products originated from China. As such, China has a few valuable brands that are known globally. Among the top 100 brands in the Interbrand’s 2012 valuation of the world, a few Asian brands were listed from Japan and Korea but none from the Asian manufacturing giants like China and India (Interbrand, 2012).

The production base of China has not helped the country in developing its brand name. The Chinese policy of creating ‘Local Champions’ or local MNCs has not been successful in creating production giants with coveted brand names like the Japanese or Koreans. Though China followed the models of Korea and Japan in creating MNCs, the country achieved very little from this initiative as compared to Japan and Korea.

Interestingly, firms in other countries are using the production base of China for creating their own brand name in the domestic or international markets. For example, the Karbonn mobile has evolved a brand name in India in the low-end of the product, but sourcing the products from China. It is interesting to note that ‘margin of business from production’ may be high in a country having an efficient production base but the ‘margin of business from trade’ could be larger with the branding of a product. For example, a Barbie doll is sold at the price of $10 in the US market with the import price of $2. Out of which a Chinese manufacturer receives a remuneration of $0.35 and the rest ($1.65) goes to activities such as material cost, packaging, etc. (Barboza, 2006; Chen, 2005). In the US market, a Hugo Boss shirt is sold at the price of $120. While the Chinese manufacture shares 10 per cent of the cost, 60 per cent of it goes to the brand owner (Chen, 2005). For this reason, the top global manufacturers are not global top brand owners and the latter set of companies mostly outsource their manufacturing to Asia (Fan, 2006). When a country is able to combine its efficient production base with branding, it can optimise its ‘margin of business’.

However, China has doubled the R&D expenditure from 0.6 per cent of GDP in 1995 to over 1.2 per cent in 2004. It was projected to have emerged as the second largest investor in R&D after the U.S. in 2006 (OECD, 2007). Correspondingly, the number of researchers employed increased by 77 per cent between 1995 and 2004, possibly next to the US. Both state-owned²³ and domestic private firms compete in terms of their expenditures in R&D activities as shown in Table 3.2. While R&D intensity is much higher in state-owned firms than in domestic private firms in pharmaceutical and medical equipments, it is more in sectors like telecommunications²⁴ and office equipments for the domestic private enterprises. In China, R&D intensity is strong in certain sectors such as electric equipments, computer hardware and medical equipments. Interestingly, R&D intensity happens to be more strong for small firms than for others (see Box no. 3.1).

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Box 3.1. R&D and Innovation in China

In the Post-Cultural Revolution period, the scale of R&D activities offered very low support to the mammoth task of production activities in the domestic economy. During this period, production activities were mostly propelled by imported technology. The need for a renewed emphasis on a domestic ‘innovation-oriented’ approach was felt during the economic upheaval of China during the last few years. The S&T Strategic Plan 2006-2020 has set out the key objectives and priorities in science and technology and envisages the need to develop capabilities for indigenous or home-grown innovation. Institutional reform of the S&T system was launched in 1985 with reform measures focused on public R&D funding, transformation of R&D institutions in applied research into business entities and/or technical service organisations, and the incorporation of large R&D institutions into large enterprises, creation of markets for technology, and reform of the human resource management in public research institutions. R&D activities were mostly located in S&T industrial parks, university science parks and technology business incubators under the Torch programme and spin-offs from public research organisations started to fill the gap. By the turn of the century, a combination of experimental national policies in special zones, bottom-up initiatives supported by regional and local authorities, and top-down systemic reforms had given birth to the National Innovation System (NIS). China now pursues a growth path that is less dependent on low-skill, resource-intensive manufacturing. Human capital formation and the encouragement of capabilities in science, technology and innovation play a key role as potential engines of future growth. In June 2007, four industry-research strategic alliances, concerning steel, coal, chemistry and agricultural equipment, were set up with government support. They aim to address long-standing problems related to the low level and dispersal of innovation capabilities, the inadequate supply of generic technologies and the lack of core technological competencies in these sectors.

China has excelled in mobilizing resources for science and technology on an unprecedented scale and emerged as a major R&D player. R&D spending has increased at an annual rate of 19 per cent since 1995 and reached US$ 30 billion in 2005. Similarly, the R&D/GDP ratio improved from 0.6 per cent in 1995 to 1.34 per cent in 2005. As far as allocation of funds is concerned, more than 70 per cent of the gross domestic expenditure has been for experimental development, leaving only 6 per cent to basic research. The business sector is the dominant R&D actor performing over two-thirds of total R&D, up from less than 40 per cent at the beginning of 1990. The number of firms in technology business incubators (TBIs) has more than quadrupled since 2000 to almost 40,000 in 2005. In addition, China has ranked second in the world after the United States and ahead of Japan in number of researchers engaged in these activities since 2000.

Despite significant progress, the current state of innovation activities is far below the global standards. China’s NIS is not fully developed and imperfectly integrated with linkages between actors and sub-systems. Technology transfer to China through operations of the foreign-invested enterprises and related spill-overs to the domestic economy have not met expectations. Lack of effective IPR protection and deficiencies in framework manifest in conditions such as a passive learning-based education system, inadequate product market competition, top-down model of corporate governance and financing difficulties affects the R&D activity in the country. Current regional patterns of R&D and innovation activities are not optimal from the perspective of efficiency by creating a physical separation between knowledge producers and potential users. The demands for scientific inputs to innovation are very limited as the vast majority of domestic firms have not put innovation at the core of their business strategy. The concept of pre-competitive research, as opposed to near-market applied research or mere technological development, as well as that of public-private partnership, are not yet well understood by many actors in the innovation system. In order to build a modern, high-performance national innovation system, China will have to maintain a high-level of investment in R&D, innovation and education to overcome the remaining institutional and structural weaknesses of its current innovation system.

Source: OECD (2007)

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In an effort to build local MNCs, the Chinese government is supporting companies by consolidating fragmented domestic industries and then expanding these internationally. Baosteel (in steel), Chalco (in aluminium) and Yanzhou (in coal) are among companies that have been created through this process. A similar strategy is now being pursued to build cement champions by the National Development and Reform Commission (NDRC).

3.1.3. Exploiting the Potential of FDI for Export-oriented Production

One of the key features of China’s Foreign Direct Investment (FDI) regime has been the better than national treatment in its taxation polices for foreign invested enterprises (FIEs). The standard enterprise income tax is 33 per cent. However, an enterprise income tax rate of 15 per cent applies to FIEs located in special economic zones (SEZs), or to FIEs involved in manufacturing in the economic and technological development zones (ETDZs); and a rate of 24 per cent applies to FIEs involved in manufacturing and located in the coastal economic open zones, or the old urban districts of cities where SEZ or ETDZs are located. Hi-tech FIEs located in hi-tech industrial zones enjoy a two-year income tax exemption; those involved in manufacturing also enjoy the 50 per cent income tax reduction in the following three years. Export-oriented FIEs enjoy the same two-year exemption and the 50 per cent reduction as long as the volume of annual exports is at more than 70 per cent of the general sales of the enterprise. In addition, FIEs operating in designated manufacturing industries in the western and central regions of China enjoy a complete tax holiday during the first two years after making profits and a 50 per cent income tax reduction during the following six years.

Such preferential treatment of FDI supported by a well developed infrastructure and a large domestic market has helped China to become the largest recipient of FDI among developing countries²⁵. There has been a debate on the ability of China to mobilise such a massive inflow of FDI in contrast to India’s ability to attract only US$ 5-6 billion of annual inflows. However, it has been argued that more than the magnitude, the Chinese achievement has been in terms of making FDI work for its development. China has successfully leveraged access to its large market with foreign MNCs in return for building export capabilities. Foreign invested enterprises undertook 57 per cent of China’s merchandise exports and over 80 per cent of her high-technology exports in 2004 (OECD, 2007).

Having accumulated such a massive stock of FDI²⁶, China in early 2007 moved towards scrapping the preferential tax regime for FIEs. These are no longer exempt from paying land use tax. In March 2007, it moved to unify the income tax rates paid by foreign and domestic firms at 25 per cent and unveiled a series of tax breaks to promote high-technology, environmental protection oriented and energy saving ventures. China has revised its laws and regulations for foreign-invested enterprises in an attempt to eliminate WTO-inconsistent requirements relating to export performance, local content and foreign exchange balancing as well as technology transfer. China also revised the ‘buy China’ policies that regulated procurement of raw materials and fuels, and removed its requirements of joint ventures and wholly-owned enterprises to submit production/operation plans to Chinese authorities. However, some measures continue to ‘encourage’ technology transfer, without formally requiring it. Moreover, some Chinese government officials still consider factors such as export performance and local content when deciding whether to approve of an investment or to recommend approval of a loan from a Chinese bank. The auto industry policy of May 2004 continues to include provisions that discourage imports of auto parts and has drawn criticism from foreign companies. It has also included a requirement of a sizeable minimum investment (US$ 200 million).

Investors in China continue to confront a lack of transparency, inconsistently enforced laws and regulations, weak IPR protection, corruption and an unreliable legal system incapable of protecting the sanctity of contracts. Yet, foreign and domestic companies have continued to report high profitability in 2010, indicating that the challenges to doing business in China have been largely surmountable (World Bank, 2010).

3.1.4 Approach towards WTO’s Doha Round of Negotiations

China has been an active participant in the WTO’s Doha Round negotiations and works closely with India and other developing countries. On a number of important issues, its position is close to that of India. For instance, China is a member of G-20 and G-33 on agriculture along with India and shares the perception that distortions in developed countries in agriculture need to be reduced while developing countries should retain flexibilities for food security and livelihood concerns through SP and SSM. Even though China is not a member of NAMA-11, it has supported India position and of NAMA-11 countries that tariff peaks and tariff escalation in developed countries on products of export interest to developing countries should come down. China’s position on IPRs especially on the relationship between TRIPs and the Convention on Biodiversity (CBD), in particular on the need for evolving a system of prior informed consent and access and benefit sharing for the exploitation of indigenous knowledge and biodiversity of developing countries, is similar to that of India’s. In the early years of Doha negotiations, China supported India’s position on Singapore Issues. The China-India Joint Ministerial Statement on WTO issued during the visit of India’s Commerce and Industry Minister to Beijing in 2007 was an important milestone in the direction of growing coordination between the two countries in multilateral trade negotiations.

3.2 Trade and Trade Policies in Key Sectors of Interest to India

The sectoral composition of China’s exports has some interesting characteristics. While China is usually seen as specialising in exports of labour-intensive products, its export basket is rapidly moving towards high technology products. The cutting edge of China’s exports is now provided by relatively high technology products involving machinery and transportation equipment, particularly office machines and telecommunication equipment and parts. Exports of these products have increased more than five-fold in the last 7 years and they now account for nearly half of the manufactured products. One important gap in China’s export drive is evident in the service sector. In the old socialist paradigm, services were not included in GDP in China as in other socialist economies. The national income statistics include services since the initiation of market oriented reforms, but the sector is still relatively underdeveloped. With respect to external trade too, China was lagging in exports in this sector. In 2012, China is expected to have a significant trade deficit in the service sector.²⁷ India on the other hand has a large service sector and its exports of services are increasing rapidly. As discussed below, this may well be a niche area for India’s exports to China.

For assessing sectors in which India may have opportunities for expanding its exports to China, it is useful to review China’s trade policy in some key sectors.

3.2.1 Agriculture

The tariff liberalisation policy in agriculture has been striking in China since its accession to WTO. Applied tariffs on agricultural products declined from 23.2 per cent in 2001 to 14.5 per cent in 2011. There has been a considerable reduction in the average rate of applied tariff in sectors like dairy products, grain and oilseeds. Tariffs on sugar and tobacco remained high for some time. Lower tariffs apply to sub-sectors where China apparently has a comparative advantage such as labour intensive horticultural and animal products. The agricultural average bound tariff rate was 17.9 per cent in 2002 and declined to 14.6 per cent in 2011.²⁸ Despite a sharp reduction in the average bound rate, the divide between agriculture and industrial sector remained significantly high during the last decade.

The proportion of product lines under tariff quota in the total number of tariff lines declined from 0.9 per cent in 2001 to 0.6 per cent in 2009. As in other countries, the system serves to restrict the quantity of imports and is necessary to avoid large quantities of imports affecting farmers’ incomes and social stability. Despite liberalisation, the government retains some influence on imports and exports through State-Trading Enterprises which include grain (including maize, rice, and wheat), vegetable oil, sugar, tobacco, and cotton as well as chemical fertilisers. Exports of agricultural products are subsidised by local and the central governments. The Trade Policy Review (TPR) of the WTO finds that concerns are mostly due to subsidy-related programmes for exports by local governments. Besides officially supported export credits are also source of concern for the WTO members. WTO (2010),²⁹ has outlined the need for submitting fresh notifications regarding its subsidies.

Government intervention in agriculture, though declining is still significant. For achieving the broad objective of food security to promote industrialisation, along with raising rural incomes through price support, a heavy financial burden falls on the government on account of providing subsidies, managing consumer prices, and other measures. According to USTR, agricultural trade with China remains among the least transparent and predictable of the world’s major markets. Capricious practices by Chinese customs and quarantine officials can delay or halt shipments of agricultural products in China, while sanitary and phytosanitary (SPS) standards with questionable scientific bases and a generally opaque regulatory regime frequently bedevil traders in agricultural commodities. The restriction on Indian fruits and vegetable until recently is a case in point. India has been struggling to gain market access in China in number of fruit and vegetable products where it has global competitiveness for exports including in China.

3.2.2 Manufacturing

Tariff liberalisation has been very dramatic in the Chinese manufacturing sector during the past decade. Average applied tariffs on industrial goods have come down from 14.3 per cent in 2001 to 8.6 per cent in 2011. However, an array of non-tariff measures are still used in some instances to restrict imports and exports.

China is the largest textiles and clothing producer in the world. Of the sector’s total output, more than two-thirds is consumed domestically and the rest is exported. Since 1995, China has emerged as the world’s largest textiles and clothing exporter. Its trade policy regarding the textiles and clothing industry consists mainly of reducing tariffs and non-tariff restrictions on imports and relaxing controls on some exports. In addition, in agreement with certain trading partners, China imposed restrictions on some exports. China has signed an MOU with the EU, the USA and Brazil to limit the growth rates of its exports to these countries until 2008 at annual rates within the range of 10-18 per cent. China also encourages investment abroad by textiles and clothing companies, in particular in developing and least developed countries, by providing preferential loans, simplifying administrative procedures, and enhancing information support.

It is highly likely that as China moves into more advanced technology-oriented products, the production base for textiles and clothing will slowly shift to other countries. India should be ready for benefits from such a restructuring and get into partnerships with foreign firms now establishing production facilities in China as also with the Chinese firms to prepare for the phase when that shift occurs. In particular, India needs to gear itself up for mass produced garments — an activity in which China has a clear advantage with massive production bases that can handle very large orders-to be able to take advantage of the opportunities arising from the Chinese industry phasing itself out of the garment trade. However, western importers may be willing to buy more from India in preference to China, provided we can supply volumes, as a part of their strategies.

China has been the world’s fourth largest automobile manufacturer since 2003, after the United States, Japan and Germany. In 2004, China became the third largest market in the world, after the United States and Japan. According to forecast made by Goldman Sachs reported in The Economist, 16 September 2006, the car ownership in China may exceed that of the US by 2025 and may become twice as high (over 400 million vehicles) as the level of US ownership by 2040. China has become the world’s second largest car market in terms of sales as millions of Chinese are buying cars for the first time. India cannot afford to ignore this market. India should start preparing for penetrating this market. Just as Japan and Korea succeeded in competing with the giant car manufacturers of the US, India can succeed in competing with the manufacturers in China, which are generally joint ventures between state-owned enterprises and foreign car majors. A few home grown companies like Geely and Cherry have come up rapidly as producers of cheap cars. However, quality and reliability concerns have affected their plans to move into the developed country markets until 2008. Foreign investment plays an important role in China’s automotives sector and FIEs accounted for around three-fourth of China’s passenger car production.

China’s electronic and communications equipment industry is the third largest in the world in terms of output, after the United States and Japan. Electronic and communications equipment also account for the largest share of China’s exports. The export revenue of the sector constitutes nearly one-third of China’s total export value. In the total export proceeds, the share of domestic firms has been insignificant. The central government has adopted several measures to assist the development of the electronic and communications equipment industry, in particular to improve the technological capabilities of domestic enterprises. Under this policy, the government allocates funds to software and IC industries for the establishment of software design centres in, inter alia, universities and research institutes. Preferential policies include VAT rebates, tariff exemptions for imported equipment for own use, export loans provided by EXIM Bank and export credit insurance provided by SINOCUE at favourable terms, government procurement preferences, and a special fund to promote domestic enterprises’ R&D ability in the semi-conductor industry. The government is also encouraging domestic industries to invest abroad in an attempt to upgrade technology and to establish a commercial presence in the international market. China joined the WTO Information Technology Agreement (ITA) in 2003 and 258 tariff lines at the HS eight-digit level were subjected to zero tariffs according to the new agreement. Import licenses and quotas on certain electronic and communications equipment products have been removed.

In the pharmaceutical sector, China is very poorly placed in comparison with India due to a differentiated policy regime and management skills. There is no Chinese product line or new chemical product that has been certified by FDA (Food and Drug Administration of the U.S.). China is mostly a raw materials supplier and is lacking in production of generic branded products. The Chinese market could be potentially a high export market for Indian pharmaceutical products. However, there are reports that in several bulk drugs, producers are complaining about imports of cheap drugs from China. The competition is very severe for firms producing bulk drugs like azithromycin, clarithromycin, ciprofloxacin, norfloxacin, roxycomycin, cephalosporins and anti-quinolines.

3.2.3 Services

The services sector in China has been underdeveloped during the planning era and now presents a significant potential in view of the rapid growth of the economy. In order to tap that potential, the Chinese government has identified the development of services sector as a priority sector in the 11th and 12th Five-year Plans for National Economic and Social Development. With the spectacular performance of exports and imports over the past few years, the contribution of services to GDP in terms of value added has surged from 39.7 per cent in 2005 to 40.1 per cent in 2008. Some of the most important export sectors in services have been transport and other business services during the last decade. Potentially other important export sectors are communication, construction, computer and information, insurance, finance & royalties and license fees, which are expanding fast in recent years.

Both as a matter of policy and as a result of its WTO commitments, China decided to significantly liberalise foreign investment in its service sectors. In its Accession Agreement, China committed itself to the substantial opening of a broad range of services particularly, in sectors of possible importance to India such as banking, insurance, distribution, telecommunications and professionals services. These commitments are in principle far reaching particularly, when compared to services commitments of many other WTO members. These areas also happen to be of interest to the US and there is much potential for India to work jointly with the US companies in expanding India’s presence in China in these areas.

While China continued to keep pace nominally with the openings required by its WTO accession agreement, it frequently maintained or erected terms of entry that were so high or cumbersome as to prevent or discourage many foreign suppliers from gaining access. For example, despite some progress, excessive capital requirements continue to restrict market entry for foreign suppliers in many sectors, such as insurance, banking, securities, non-bank motor vehicle financing, asset management, direct selling, franchising, freight forwarding and telecommunications, among others. In addition, in sectors such as insurance and legal services, restrictions continue on the expansion of branches, which are contrary to China’s commitments to WTO in its services schedules.

In what follows, we discuss the position with respect to some selected services.

Construction, engineering, architectural and contracting services: In September 2002, the Ministry of Construction and MOFTEC jointly issued Decrees 11 and 114, which opened up construction and related construction design services to joint ventures with majority foreign ownership, 2 years ahead of schedule, to wholly foreign-owned enterprises. At the same time, however, these decrees created concerns for the foreign firms by imposing new and more restrictive conditions than those that existed prior to China’s WTO accession. In particular, these decrees for the first time required foreign firms to obtain qualification certificates, effective 1 October 2003. In addition, these decrees for the first time required foreign-invested firms supplying construction services to incorporate in China. High minimum registered capital requirements and foreign personnel residency requirements that are difficult for many foreign firms to satisfy were also imposed. There are other restrictions as well. Foreign firms cannot hire Chinese personnel to practice engineering and architectural services as licensed professionals. Currently, China’s reengineering and architectural firms must approve and stamp all drawings prior to construction.

Accounting and management consultancy services: Upon its accession to the WTO, China agreed to allow foreign accounting firms to partner with any Chinese entity of their choice. China also agreed to abandon the prohibition on foreign accounting firms’ representative offices engaging in profit-making activities. In addition, China agreed that foreign accounting firms could engage in taxation and management consulting services, without having to satisfy the more restrictive requirements on the form of establishment applicable to new entities seeking to provide those services separately. Accounting systems in China are badly in need of modernisation. The MOF has been active on standardising accounting procedures across a wide range of topics including investments, inventories, cash flow statements, and fixed assets. The Chinese Securities Regulatory Commission meanwhile requires a listed company to appoint a certified international CPA firm to conduct audits on prospectuses and annual reports in accordance with international standards. China complied with international accounting standards since 2007. As such the demand for accountants is on the rise and with India’s expertise in accountings services this may a niche market for India.

Finance: Financial sector reforms began in China in 1979, when the monopoly of the People’s Bank of China (PBC) was removed and its commercial functions were separated into four state-owned banks. Joint-stock banks were introduced later to diversify the ownership structure in the banking sector. A notable feature of the financial sector is the high degree of government ownership (WTO, 2007).

The banking sector remains the most important source of credit in the financial sector (Zhou, 2009). The assets of the banking sector are highly concentrated; the largest four banks currently account for 54 per cent of banking assets. The reforms that began over 25 years ago are, however, slowly starting to improve competition in the banking and insurance sectors. Since the 1990s, the government has also been trying to deal with the problem of non-performing loans (NPLs), which remain relatively high in the state-owned banks (Tong, 2002; Lu, Thangavelu and Hu, 2005; WTO, 2007). With official statements claiming to have controlled the NPL ratio, several research reports document that new bad loans are accumulating in the financial system. Further, in the fast moving Chinese economy with accelerating rates of investment, the government has hinted at a tightening of the economic policy to control money supply growth.

WTO’s Trade Policy Review finds that the restrictions on the operations of foreign banks have gradually declined. Since reforms these have been permitted to establish branches, although with geographic, product, and client restrictions. However, as a result of its accession to the WTO, China permitted foreign investment in the banking sector without geographic or client restrictions by the end of 2006. Beijing agreed to free its banking sector to full foreign competition by December 11, 2006 though with proposed regulations that according to some analysts could hamper overseas banks in attracting retail customers.

Movement of professionals: There are no special entry restrictions placed on professionals working in China such as doctors and engineers. Government seems to be considering measures to liberalise access by issuing permanent resident visas to long-term foreign residents of China. Given the shortage of doctors of western medicines in China and India’s expertise in this area there may be large opportunities for Indian doctors perhaps working initially in large cities with a significant expatriate population with international clinics.

4. India-China Bilateral Trade and Economic Relations

4.1 Trends in Chinese Trade with the World

In the resurgence of the Chinese economy in the recent decade, the external sector played an important role, though it passed through a phase of volatility due to the periodic swing of global business cycle. Between 1998 and 2012, Chinese trade with the world economy registered an eleven-fold increase, surpassing the performances of other fast growing countries of the world. The country’s total export was US$ 184 billion 1998 and increased to US$ 2.05 trillion in 2012 (see Table 4.1). Similarly, imports increased from US$140 billion to US$1.8 trillion dollar between 1998 and 2012, showing a more than thirteen-fold increase during the decade. It is important to note that imports increased more rapidly than exports.

The global business cycle has had a profound impact on the performance of the Chinese external sector. During the slump period of 2001-2003, the average growth rate of the trade sector was 22.1 per cent per annum on an average, and revived during 2004-07 with an average annual growth rate of 26.5 per cent with global recovery. In the recent episode of ‘global financial recession’ (2007-2009), the average annual growth rate remained positive, but remained lowest in recent years owing to the negative external sector growth recorded in 2009. Despite the Euro Zone Crisis’, Chinese external sector resumed with high growth in 2012. During 2010-12, Chinese overall trade expanded at the CAGR of 14.1 per cent, where imports grew faster than its exports. The experience shows that the revival of the Chinese trade sector in the subdued global economy has been very swift in recent years.

One of the important features of the Chinese export sector has been its persistent creation of trade surplus over a period of time despite global recession. The size of trade surplus from merchandise trade was growing at the CAGR of 101.4 per cent during 2004-07. The growth trajectory of trade surplus was so stiff that a negative growth rate was recorded in 2009 after 5 years of persistently positive growth performance. Although the recession continued the world economy until 2009 in the first phase of global recession, China generated a trade surplus of US$ 200 billion, covering 16.6 per cent of its exports. This process continued even during the ‘double-dip’ recession where it registered a trade surplus of US$235 billion in 2012 and grew at the CAGR of 12.1 per cent during the period 2010-12.

China has impressively integrated itself with the world economy, particularly after its accession to the WTO in 2001. During 1998-2009, the world trade grew by 2.3 times, but trade by China grew three times more than that of the global trade. Sparks of such growth performances were felt in both exports and imports of the country. China has gradually improved its global share in exports and imports since the post Asian Financial crisis. In 1998, the country’s share in the global exports and imports were 3.4 per cent and 2.5 per cent respectively, but these shares increased to 9.7 per cent and 7.8 per cent respectively, in 2009. Interestingly, Chinese share in the global trade improved significantly during the period of recession. The global trade increased by 40 per cent during the period 2010-12, but Chinese trade with the world grew faster than the world trade. Chinese exports and imports share with the world were 9.0 and 8.2 per cent respectively during the same period. Chinese exports have been dependent on its imports and opportunities in the import sector have to be explored strategically to have a wider market access in China.

4.2 Changing Trends of Bilateral Trade Engagement

Bilateral trade between India-China has grown rapidly in the past few years and picked up significantly after Chinese accession to WTO. Bilateral trade turnover jumped by nearly twenty five times, from US$ 2.7 billion in 2001 to nearly US$ 68.8 billion in 2012 (Table 4.2). With a conservative estimate, the India-China trade turnover was expected to cross US$ 60 billion in 2010 and further to 125 billion in 2012. The expected target was almost achieved where trade reached US$ 58.9 billion in 2010. However, expected target was significantly under achieved to touch the level of 68.8 billion in 2012 due to ‘double-dip’ recession. China has now emerged as the largest trade partner of India³⁰ since 2008-09.

During the last nine years, exports of India to China have grown at an annual rate of 29.8 per cent and by 2009, formed 7.7 per cent of the total exports. In 2001, China was lagging behind several countries including Belgium and Singapore so far as its share in the total trade of India is concerned. In the same year, China shared 3.5 per cent of India’s total trade whereas the US shared 14.4 per cent, the UK 5.1 per cent and Belgium 4.1 per cent of total India’s trade. The trade scenario changed significantly in 2009 with a sizable increase in India’s bilateral imports. China not only jumped up in its ranking among India’s lead bilateral trade partners but also splashed the Indian market with its exports, causing serious bilateral trade imbalances. It is now sharing nearly 9 per cent of India’s total trade in 2009. Its current bilateral trade is larger than the combined bilateral trade of Germany, the UK and Japan with India.

During the last decade, the growing bilateral trade imbalance against India was not corrected, while taking an unmanageable shape even during the current episode of recession. With an increase in the two-way trade, the trade deficit increased exponentially, and it may not be sustainable for a long period of time. While the uncovered trade gap was reported at US$ 602 million in 1998, it increased alarmingly to US$ 39.2 billion in 2012. During the earlier part of the decade (i.e. 2001-02), the size of the trade deficit declined for a few years, but started growing since 2002. During the last decade, the growth of the trade deficit was robust for the period 2004-07 when the global economy was booming. The trade deficit made a quantum jump in 2006 to reach a level of US$ 7.9 billion from US$ 3.5 billion in the previous year, posting an annual growth rate of 129 per cent. A peak bilateral deficit to the extent of 39.2 billion was reported in 2012. However, the growth rate of bilateral trade deficit has started declining since 2006, though the volume of the same is growing significantly over the years except for 2009.

4.3 Changing Composition of Trade

A look at composition of India’s exports to China, however, raises doubts as to whether the recent trends in exports can be maintained. India’s export basket has been dominated by primary and resource-based products. The past growth rates in these exports are unlikely to be maintained, partly because as a part of India’s new mineral policy, it may seek higher value addition for minerals and thus discourage such exports and partly because China’s demand for such imports connected with the current investment boom may not be sustainable. There are some signs of diversification in Indian exports in recent years. Exports of auto components, pharmaceuticals and machinery items have been increasing over the last few years. Acceleration in the growth rates of these manufactured products may be essential for achieving the target³¹ of India’s exports to China. India’s import from China began to take momentum during the last decade (i.e. since 2001), and this is mostly led by technology-intensive sectors. With India conferring MFN status to China, and the Chinese imports enjoying high demand-elasticity in the domestic market, India’s bilateral imports may not be capped in the medium term. The sensitive issue of bilateral trade imbalance can be addressed effectively by making inroads into the Chinese market with India’s technology-intensive exports.

4.3.1 Structure of India’s Import from China

In recent years, India’s imports from China have been diversified, and certain sectors continue to dominate in the bilateral trade. Other imports are spread thinly in almost all the manufacturing sectors as shown in Table 4.3. India’s imports from China comprise both agricultural and manufacturing products. India imports small quantities of agricultural products and they cover, nearly 1 per cent of its total bilateral imports. These products are mainly from the fruits and vegetables category.

India’s bilateral imports are mostly concentrated in the manufacturing sector. Four dominant sectors comprising of chemicals, machinery, base metals, and textile & clothing contributed around 85 per cent to bilateral imports in 2008. Among these sectors, the largest and the most dynamic sector has been that of machinery import. Its share in the total bilateral imports increased marginally from 46.08 per cent in 2007 to 46.99 per cent in 2012, registering a CAGR of 32 per cent per annum between 2004 and 2012. The chemical sector registered a CAGR of 31.4 per cent during 2004-12, but its share did not increase much during this period due to significant growth in overall bilateral imports. Some of the sectors such as minerals, plastic products, automobile sector and cinematography products also witnessed substantial penetration in the domestic market. According to the UN statistics³², India’s bilateral imports were US$ 24.2 billion in 2007 and increased to US$ 28.9 billion in 2009, despite being affected adversely by the global meltdown during that time. Robust growth has been noticed in some of these sectors which are generally technology-intensive in nature, thus enjoying high demand elasticity in the domestic market. Imports are seen as declining in some sectors due to the Chinese policy restriction of exports in order to conserve domestic resources (WTO, 2010). In terms of composition of India’s bilateral imports from China, sectoral shares are declining for minerals, pulp products, textiles & clothing, and base metals. India’s bilateral pattern of imports clearly indicates that demand for technology-intensive products is becoming strong in the domestic market whereas demand for labour intensive and resource-based products is gradually weakening in recent years.

China’s global pattern of export is similar to its bilateral exports to India. Agricultural products constitute a small proportion of China’s total export, but are expanding over the years. Contrary to its earlier practices, mineral exports are declining in the country’s trade basket and form 2 per cent of the total exports in 2008. Manufacturing exports dominate Chinese global export. Some of the major sectoral drivers of exports are textiles and clothing, machinery, auto sector, and chemicals. Other important export sectors are plastics, footwear, cinematography products, etc. and many of these have grown fast in the pre-crisis period.

Constant up-gradation of technology, product development, constant rise in R&D expenditure and indigenisation of foreign technology accompanying FDI, are the important factors for the structural transformation taking place in Chinese export.

4.3.2 Structure of India’s Exports to China

India’s exports to China are highly concentrated where in four sectors take the lion’s share of 79 per cent of the total bilateral exports in 2012 (Table 4.4). These dominant sectors are mostly resource-based and labour intensive in nature, though some of them are partially technology intensive sectors. Agricultural exports constituted 7.3 per cent of the total bilateral exports of India. The shares of sectors like fruits & vegetables as well as fats & Oil are picking up recently.

For the last several years, mineral sector dominated India’s bilateral export basket with China, but its prominence declined significantly in recent years. Especially during the period of recent episode of recession, the share of mineral sector declined noticeably to emerge as the second largest export sector of India to China in 2012. Share of the mining sector declined from 55.4 percent in 2007 to 24.0 percent in 2012. However, both mineral and base metal sectors have complemented each other in focusing exports to the market of China. From the base metal sector, substantial exports are made in the form of iron ores, slag and ashes. In the process, base metal sector became the third largest export sector of India to China in 2012. During recession, textiles & textile products emerged as the largest exporting sector which is expanding at a CAGR of 49.7 per cent during 2004-12 and its share increased significantly from 10.4 per cent to 26.1 per cent between 2007 and 2012 respectively.

Besides textiles, mineral and metal products, India has a major export interest in the chemical sector including pharmaceutical products. Bilateral exports are also significant in certain sectors like animal products, fruits and vegetables, processed food, footwear, cement and machinery & mechanical appliances. Some of these sectors have not only enjoyed a high export share but have also continued to maintain high growth in recent years, which has also been true of some dynamic sectors such as fruits and vegetables, prepared food, minerals, cement, etc. The nature of India’s bilateral export basket indicates that these sectors fall mostly in the categories of resource-based and labour intensive products. India’s attempts to export technology-intensive products have been much below its potential as shown from its current engagement with China. India needs to improve its export efforts to meet the specific import requirements of China if it is to have wider market access without a bilateral FTA.

In this context, it is important to examine the import structure of China from the rest of the world. China mostly imports minerals and manufacturing products from the rest of the world, and agricultural import forms a small proportion of its total imports. Agricultural³³ imports were 5.2 per cent of its total imports in 2012, and more than half of such import was concentrated in fruits and vegetables (Table 4.5).

In the non-agricultural segment of imports, mineral is an important sector for China, but its imports of machinery products from the rest of the world was more than double the size of its mineral imports in 2007. During the recessionary period, the importance of the machinery sector imports continued and the share of the mineral sector consolidated further. The combined import share of minerals and machinery in total imports was reported to be 58.0 per cent in 2012. China follows a clear policy on imports, where the current import practice is to make either significant import or no import. This signifies that China continues to import those products that are critically required by the domestic economy. In case of ten out of twenty one HS sections, the share of each of these sectors is turning out to be less than 1 per cent of the total import in 2012. The structure of the import basket shows a definite trend, where it is focused on natural resource-based products and technology-intensive products. Technology intensive³⁴ imports constitute nearly two-thirds of its total imports where the shares of primary as well as labour-intensive imports in the total are relatively smaller than that of knowledge-intensive sectors.

As China’s import focus is shifting towards knowledge-intensive products, India has to change its bilateral export basket to accommodate more technology-intensive³⁵ products for wider market access in China. India’s closer engagement with China in the global production network could be a possible way to improve its technology-intensive exports. India has to evolve a strategic approach to deal with the frequent use of NTBs by the Chinese authorities and to address product standard issues for achieving uninterrupted access to the Chinese market, which is expanding fast as seen by trends in the last decade.

4.4. India’s Bilateral Trade Imbalance with China: Sustainability Issue

There is a growing concern in India relating to sustainability of mounting bilateral trade along with surging trade imbalance between them in the medium term. Some argue that India is an emerging country with a large demand for imports to enhance its exports and also to meet growing domestic demand for consumption including modernisation of its industrial sector. While others argue that excess of consumption over production may lead to an unsustainable current account deficit. Both arguments assume that import from China is competitive compared to many other suppliers in the domestic market. However, cost efficiency of Indian imports from China is an empirical question that needs to be examined.

In the trade literature, laissez-faire is preferred because it is welfare enhancing in nature. Cost efficiency principle has been the driving force behind laissez-faire and this has been argued in several trade theories³⁶. In the 1950s, several studies took this argument further to emphasise that trade based on least cost principle became the basis for formation of Regional Trading Agreements (RTAs). Viner (1950) argued that the basis of an RTA could be ‘trade creation’ and ‘trade diversion’, but domestic welfare could be maximised for the importers and also the world welfare, when trade augmentation is driven by ‘trade creation’. According to Viner, ‘trade creation’ takes place when purchases happen on a low cost basis among available suppliers in the importing market. Johnson (1960), Greenway et al. (1989), and Low (2003) have made extensive literature survey to highlight the relevance of trade creation in fostering trade among member countries. The broad conclusions indicate that trade creation based on the most competitive cost structure of imports would enhance the welfare of an importing country and contributes to deep rather than shallow integration (Viner, 1950 and Meade, 1955). Several studies have examined the empirical relevance of such an assertion in a number of RTAs across the world (see for example, Greenaway, Mahabir and Milner, 2008; Bohara, Gawande and Sanguinetti, 2004; and Magee, 2008).

There are reasons to believe that China could be a cheap source of bilateral imports. In recent years, world trade is dominated by ‘global products’ which are produced in several countries at different stages of production, based on an international division of labour. Regional trade is growing fast because of rise in activities relating to ‘production fragmentation’. The basis of production fragmentation has been to bring down the cost of production to maintain global competitiveness. Present global trade flows indicate that China is a major global player in global value chain (GVC) in diversified sectors through production fragmentation, and several such products are found to be competitive in the global market. This phenomenon of Chinese competitiveness could explain India’s bilateral surge of imports in these product segments. Continuation of trade in this sector could promote trade in intermediate products at the bilateral level.

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Box 4.1: Classification of technology intensity of tradable products

Primary Products have very little technology basis for retaining comparative advantage.

Resource Based Products, having competitive advantages, arise generally from local availability of natural resources, using simple and labour intensive technology.

Low Technology Products are having well diffused technologies, based on simple technologies. Technologies are mainly embodied in capital equipment and labour constitutes major element of cost in order to make the product competitive. Such products operate under low scale economies with low entry barriers.

Medium Technology products comprise of skill and scale intensive technologies in capital goods and intermediate products. Product development takes place with complex technologies, involving high level of R&D expenditure. It requires lengthy learning periods and subject to high entry barriers.

High Technology products are subject to advanced and fast changing technologies where emphasis is on product design. As product development requires high R&D investments, production of such products involve sophisticated infrastructures, high levels of specialized technical skills and close interactions between firms and universities/research institutions.

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India is a major importer of primary and technology intensive products for sustaining its ambitious programme of industrialisation and the country’s growing needs for energy consumption (see box 4.1). As India is gearing up with its new ‘manufacturing policy’³⁷ to intensify its domestic industrialisation in the medium term, its dependence on imports for competitive technology-intensive machineries is becoming important. Since machineries in technology-intensive product segments are expensive in industrialised countries, China could be an alternative source because it is gaining global reputation as a competitive supplier of machineries. However, the competitiveness of Chinese products in the Indian market is an empirical question that needs empirical examination.

Chinese Labour Reforms and Export Competitiveness

Labour cost is an important element of the overall production cost, which can offset the adverse effect of any other macroeconomic misalignments including foreign exchange rate, corruption, other trade policies, etc. Several studies indicate that Indian labour laws are stringent enough to increase the cost of labour dispute ad such problems are more intense in capital-intensive manufacturing industries (Ahsan and Page, 2009). Flexible labour regulation in the country can generate more employment opportunities in the manufacturing sector. Empirical analysis of Amin (2009) indicates that flexibility in labour laws in retail stores can generate additional employment of one fifth of the current level of employment in the sector.

In 2011, the Suzuki Company faced labour problems in Gurgaon and this created uncertainties such as availability of labour and high wage rate in the market. Despite a stable exchange rate in India, the manufacturing cost is high due to lack of labour reforms in the country. In China, several orderly policy reforms took place over a period, leading to a reduction of cost in manufacturing (Meng, 2012). Yuan undervaluation may be there, but it may be over compensated by advantages derived from labour sector advantages. This may enable foreign companies to gain competitiveness in the production sector.

Trends in Uncompetitive Imports from China

It is commonly believed that Chinese products are more competitive than other suppliers in India; and therefore Chinese presence has been strong in the Indian market. However, empirical findings suggest that India’s imports from China have been uncompetitive³⁸ in large number of products, which are spreading into several sectors. In certain critical sectors, the proportion of uncompetitive imports in the total has been significant. It is a matter of concern as the share of uncompetitive products in total imports is increasing over a period of time, which includes trade in normal years. They are both in terms of number of products imported and also in value terms. The magnitude of uncompetitive bilateral imports from China increased from US$ 6.3 billion in 2007 to US$ 8.4 billion in 2008, and further to US$ 9.7 billion in 2012. Despite global recession, such imports grew moderately during the period 2007-12. The relative size of uncompetitive imports to total imports was very high, ranging from 26.0 per cent in 2007 to 29.7 per cent in 2008 but declined to 19.5 per cent in 2012. In terms of number of products imported, India imported 3875 items in 2007; this number increased to 3915 items in 2010 and further to 4060 items in 2012. These products from China are disaggregated at 6-digit HS; nearly one-third of these turned out to be uncompetitive³⁹ in 2007, and the figure declined marginally to 32.6 per cent in 2012.

Import of uncompetitive products from China varies significantly in its structure across sectors and over time. The composition of India’s bilateral uncompetitive imports in broad HS sectors is presented in Table 4.6. The distribution of such imports is disproportionately spread across sectors, and uncompetitive imports are concentrated in certain sectors. It is heavily concentrated in five sectors such as chemicals, textiles, minerals, base metals and machinery where these sectors share around 76.1 per cent to more than 85 per cent of the total uncompetitive bilateral imports during 2007-12. Interestingly, these are the sectors where maximum number of uncompetitive products are imported. There are another three sectors such as plastics, gems & jewelleries, and automotive sectors, where importation of uncompetitive products is important. The combined share of these eight sectors exceeded 87 per cent of total uncompetitive imports in 2012. In the machinery sector, uncompetitive exports increased from US$ 1.4 billion in 2008 to US$ 1.6 billion in 2012. Moreover, instability in the sectoral share of uncompetitive exports has been significant during the period of recession. While such imports increased in chemical sector, relative shares of machinery and base metals declined significantly between 2008 and 2012. Among the lead sectors, import growth of uncompetitive products remained negative in gems & jewelleries and mineral sectors.

Empirical evidences indicate that bilateral imports from China have been uncompetitive in several sectors including textiles and clothing, automotive, chemicals, etc. The textiles and clothing sector is very large in India, and China is gradually withdrawing from the lower end of the sector because of rising wages touching double digit rates in both coastal and inland provinces. This is expected looking at the current trends in China where outsourcing of some products in the production chain of textiles is taking place. In case, the present trend of rising wage rate continues in China, the production base of textiles and clothing will slowly shift to other countries, as has been the case with the textile industries of a number of East Asian countries in the past. India should start preparing itself for such a restructuring in China by getting in to partnership with foreign firms to establish production centres in India for mass production of garments. The Chinese phase out from the garment industry may be an opportunity for India to replace it in the global market in a phased manner.

The automobile industry in India has expanded rapidly during the last two decades and so also is the case in China. In certain product segments, like auto components, small-cars and two-wheelers, India continues to be competitive in the global market. India’s imports from China in many product segments are turning out to be uncompetitive, and imports of these products can be managed efficiently from other competitive suppliers. India is also emerging as competitive player in the niche area of auto designing which is related to the IT sector. These trends indicate that Indian firms can venture into the Chinese market in certain segments though they are likely to face strong competition from various domestic firms and also from other foreign competitors.

Uncompetitive Imports in Technology-Intensity sectors

Medium- and high-technology products dominated India’s bilateral import from China during 2007-12. The share of these two segments decreased from more than 61 per cent in 2009 to over 52 per cent in 2012. On the other hand, the combined share of primary, resource-intensive and low-tech imports constituted around one-third of total bilateral imports during the first phase of global recession but the share increased during the second phase. In the five broad product segments, based on technology intensity, the size of import was diverse in different phase of global business cycle during the last decade. Import in the medium and high technology segment dominated among others in 2009 but combined importance of the sectors declined after 2010. Bilateral import growth was most impressive in the medium-technology intensive sector during the period 2008-12. Global recession had adverse impact on the import profile of India in the resource intensive and high-tech product categories.

While the bilateral imports of uncompetitive products from China is large, the distribution of such imports was skewed across various technology intensive sectors, (Figure 4.1). More than one-third of the uncompetitive imports were registered in 2007, and the proportion declined to 32.6 per cent level in 2012. The largest concentration of such imports was noticed in the segment of medium-technology products. The share of uncompetitive imports in the medium and high technology segments increased during 2009-10 but declined in 2011 and 2012. While uncompetitive import growth was 17.0 per cent per annum for medium-tech sector, similar estimates for the high-tech sector was 3.7 per cent during 2008-12. India’s imports in these two sectors are likely to grow in future in view of present emphasis on industrialisation as discussed in the New Manufacturing Policy of India.

Figure 4.1: India's Uncompetitive Imports from China in 2012

Uncompetitive Imports in Intermediate sectors

In a globally dependent economy, intermediate products are very important for meeting critical export obligations of an emerging country like India and also in supporting domestic production to meet a growing demand in the economy. Imports of intermediate products are likely to increase because of an increased emphasis on exports of manufactures and the growing demand for ‘global products’ in the domestic and external markets. The issue has been to identify these products, and also to locate these products at the most disaggregated level.

The UN Broad Economic Category (BEC) product classification provides a framework to identify the intermediate products at a disaggregated level. These products are again concorded with the Harmonised System (HS) of trade classification in order to identify the intermediate products used in the trade sector. These intermediate products comprise of two sets of products such as semi-finished goods and parts & components. Import of these products is expected to be competitive in order to make the domestic production competitive for meeting its export obligation as well as dealing with foreign competition in the domestic market. Although Chinese intermediate products have considered competitive, the extent to which import of Chinese intermediate products have competitiveness in the Indian market is examined vis-à-vis other competitors in the domestic market, taking India’s bilateral import data at a disaggregated level.

East Asia’s intra-regional trade miracle has been propelled mostly by production fragmentation, based on regional division of labour. To some extent, India’s success on the export front has been partially the outcome of its linkages with the global value chain. China being the hub of the regional value chain⁴⁰ in East Asia, India’s bilateral import from China is important for its bilateral export to the country and to other markets. In this context, low-cost intermediate imports from China is important for improving India’s overall competitiveness in the exports of final products.

The competitiveness of India’s imports in the intermediate product sector is examined, taking disaggregated products at 6-digit HS from the UN Comtrade database. As an emerging country, India’s import of intermediate products has been important for fostering industrialisation, meeting domestic demand and addressing its export needs. In the total bilateral imports from China, intermediate products constitute nearly two-third of the total. The share of such products was 59.8 per cent in 2007, which increased to 63 per cent in 2008 and declined to 60.9 per cent in 2012 - owing to global recession. Bilateral import in this sector is mostly in the industrial sector though some imports are taking place in agricultural and mineral sectors. Though imports of industrial intermediates spread over several sectors, a high concentration of imports is observed in sectors like chemicals, base metals, automotive and machinery & mechanical appliances. Other important sectors engaged in imports of intermediate products include plastics and textiles & clothing. Some of the dominant sectors clocking a sharp rise in imports, are gems & jewellery, automotive sector and machine & mechanical appliances.

In the intermediates product segment import of uncompetitive products is largely felt in several sectors. The proportion of imports, turning out to be uncompetitive in different sectors, are presented in Table 4.7. It ranges from one-fifth to more than one-third of total sectoral bilateral imports from China depending upon the global situation. Nearly 36.0 per cent of bilateral imports of intermediate products from China happened to be uncompetitive in 2007, which increased to 38.4 per cent in 2008 and declined to 21.5 per cent in 2012. The proportion of uncompetitive imports in some of the important sectoral intermediate imports from China increased during 2007-08. A growing share of uncompetitive intermediate imports is observed in important sectors like textile & clothing and base metal sectors. Some of the other important sectors, experiencing a similar trend of rising share of uncompetitive imports, are cement & plaster and automotive sectors. There is no stylised trend observed in the import of uncompetitive industrial intermediates. While the growth rate of such imports increased rapidly in automobiles and base metal, it became negative in a few other sectors during 2007-09. In 2012, improved sectoral share of uncompetitive imports of intermediate products was noticed in sectors like fats and oils and optical &cinematography products. This is an alarming trend for India’s external sector performance. Rising import costs would not only hamper India’s export performances and maintenance of domestic price stability but would also affect the current account balance and other macro-economic parameters.

These empirical evidences suggest that India has been importing a large amount of uncompetitive products that can be easily be supplied by other competitors of China at a competitive cheaper price in India. It may be premature to resolve the problem by general observation of the current trend of bilateral imports unless these issues are considered at the product level. In this analysis, each product at the 6-digit HS is examined separately, and therefore anomalies in imports at the product/suppler level have to be examined carefully. As determination of tariff at a product level is considered by looking at the sensitivity of a product, a similar approach may be considered to understand why an uncompetitive product is being imported from China in the presence of several competitive suppliers available in the domestic economy. In this empirical study, the competitiveness of products is examined at a disaggregated level (i.e., 6-digit HS), and therefore reasons should be explored at the product level which is beyond the scope of this study.

Even though, the figures reported in the study are just indicative estimates, they emphasise the issue of import dependence on a costlier source of imports. This has been contributing to India’s mounting bilateral trade deficit with China, and is also responsible for the country’s overall trade deficit. It is important to note that uncompetitive bilateral import from China is not limited to a few products/sectors, but spreads across most of the trade sectors. In certain cases, levels of uncompetitive imports in different sectors are significant. In terms of volume of uncompetitive imports, certain sectors such as chemicals, textiles, base metals, machinery & mechanical appliances, automotive sector, gems & jewellery, etc, are more adversely affected than others. It is important to know the reasons for such trade distortions.

This brings in the issue of sustainability of India’s bilateral trade deficit with China. It is widely discussed in the literature that China has been using different modes of hidden subsidy to aggressively market its products in various countries including India. In response, India has invoked a large number of anti-dumping cases against China during the last few years. Besides aggressive marketing, China has been using several other instruments such as cheap interest policy, concessional credit facilities, technical collaboration arrangements, etc. for accessing global market for its exports. The implication of these policies on exports of products to other countries, including India, requires further exploration at the product level. However, India’s bilateral trade balance can improve considerably if India could restrict importation of uncompetitive products from China and switch over to more competitive suppliers for its imports.

4.5 Regional Disparity in Trade in China

Although China’s external sector has been expanding rapidly after its accession to the WTO in 2001, the contribution of various regions of the country to the trade sector has been highly skewed. Several parts of the country have not closely integrated with the global economy, particularly the hinterlands. The trade-affluent regions in China are located in a ‘D’ shaped formation, covering the North, East and the Southern regions of the country. This part of the country has been the hub of all trade-related activities since the beginning of its reforms. This part of the region shared nearly 83-91 per cent of the country’s total trade activities and there was no change in the structure of trade activates within the provinces during the period 2003-12 (see Table 4.8).

On the other hand, a large area of China has very little exposure to foreign trade. The coverage of the ‘trade poor’ regions has been Central, North-eastern, North-western, and South-western regions of the country. These regions constitute around 7-10 per cent of country’s overall trade activities during the period 2003-12. The disparity among regions is such that trade activities in some provinces of trade affluent-regions are better than the entire ‘trade poor’ region of the country. Some of these provinces which are performing well over a couple of decades are Jiangsu, Shanghai, Beijing and Guangdong among others.

Most of the trade affluent-regions are not in the close vicinity of India. The regions that are close to India are North Western and South-Western which fall under the ‘trade poor’ region of China. In these regions, the trade activities are also skewed (Table 4.9).

In the North-West region, provinces like Shanxi and Xinjiang are better placed in terms of their trade activities in the region. Similarly, some of the provinces of the South-western region engaged in better trade activities are Chongqing, Sichuan and Yunan. These provinces are located in the hinterland and they have considerable potential for trade activities. Indian businessmen should focus on these provinces that are almost located in the close vicinity of India. The Chinese government has offered preferential treatment to investors in specific regions such as the Western and Southern regions of the country. Since these regions are not considered as global centres for business, Indian investors should explore the possibilities of business opportunities in these regions.

4.6 Constraints to India’s Exports to China

In general, tariffs in China are lower than those in India particularly, for India’s major export items such as ores, pharmaceutical products, plastics, manmade staple fibers, and iron and steel. The non-tariff barriers and informal restrictions are of greater concern. Such restrictions in China on imports of goods and services apply to imports from India as well. Indian industry and business organisations have identified similar constraints in promoting their exports to China, for example: customs procedures, standards, certification and regulatory practices, and quantitative restrictions.

It was noted while examining the customs procedures that even after the issuance of valuation regulations in accordance with WTO Customs Valuation Agreement, many customs officials continue to use the minimum or reference price rather than the actual transaction price for valuation of goods. The same product may be subject to a case-by-case determination of customs value depending on the port of entry and often the decision regarding duty on the products becomes subject to negotiations between traders and customs officials. Re-exporters are allowed to import raw material only through a specified port. If they operate through other ports, they have to follow extremely difficult procedures to avail duty-free clearance of cargo. This problem is especially serious for Indian traders because of the limited transport links between India and China, which do not allow free choice of ports for landing.

Rules and regulations pertaining to standards and certification as applied to imports are different from those applied to domestic goods and these are frequently changed, the details of which are not easily available in a published form in the English language. The implementation of these regulations is different at different levels of government, with very little coordination between national and sub-national levels. Exemption procedures for import of replacement parts or imports of parts for assembly and re-export are burdensome and costly as the application is to be submitted in person and requires knowledge of the local language. Certification remains difficult, time consuming and a costly process for many commodities of interest to Indian exporters. In many cases, foreign companies’ products can only be tested at certain laboratories, and results from other competent authorities are unacceptable. For drugs and pharmaceuticals, the registration fee is very high and it takes a very long time to complete the registration process. Regarding sanitary and phytosanitary measures (SPS), it was noted that the certification requirements for some products, such as seeds, seafood products and fruits and vegetables, exceed what is necessary (as defined by international standards) to protect consumer health and often difficult to meet. In cases of trade disputes, the international system of arbitration for trade disputes is not recognised. It was also mentioned that quantitative restrictions like quota and licensing continue to be practiced by China particularly in certain categories of foodstuffs. Although such trade barriers are tough in China, India can yet explore the opportunity of a large trade potential in China in diversified sectors. Considering the trade opportunities in China and India’s competitiveness in several lines of exports, the present trend of trade imbalances may be settled without limiting the size of bilateral trade.

5. Changing Pattern of Tariff Liberalisation

The tariff policy of a country is closely linked to its production structure, as revealed by the experiences of countries. In relation to sectoral protection, India and China have a strong and divergent opinion on liberalisation in the agricultural sector. India considers agriculture as its important sector from the point of view of ‘livelihood security’, but not for its contribution to GDP. For protecting the interest of the rural poor, the Indian agricultural sector is protected as can be seen from the large gap existing between the domestic and border prices. China takes a lenient view of the protection of agriculture and, therefore, the tariff regime in agriculture was liberalised considerably as compared to India. China has adopted a strategic policy of protecting the domestic mineral resources and import of these to meet the pressing demand of its domestic industrialisation. Therefore, it has pursued a policy of importing minerals freely with a liberal tariff regime. Although India is a ‘mineral scarce’ economy, taking into account its future demand for industrialisation, it has not liberalised its mining sector too much, and, therefore, cannot be compared with China. As India unilaterally decides to bring down its average tariff close to the ASEAN as well as upto China’s level, independent tariff liberalisation in the manufacturing sector may be seen as the hallmark of trade liberalisation in both the countries.

5.1 Overall Liberalisation in the Tariff Regime

India started its comprehensive trade policy reforms one and a half decades later than China, and therefore, the tariff regime in China was much more liberal than in India. In 1992, China’s simple average tariff was 43.2 per cent as against 56.3 per cent in India (Table 5.1). With continued liberalisation, the simple average tariff declined to 9.7 per cent for China whereas it came down to 12.4 per cent for India in 2009. China made significant progress in liberalising the agricultural sector whereas this sector remained protected in India. In the present decade, both the countries have taken conscious decisions to liberalise their trade regimes unilaterally to facilitate their integration with the world economy. It is important to mention that the simple average overall tariff rate in India is lower than in China in the manufacturing sector in 2008. While the overall manufacturing tariff was 9.0 per cent for China the corresponding statistic was 8.7 per cent for India in 2008. The mining sector is relatively more liberalised in China than in India, but NTBs hinder Chinese exports of mining products. The overall import weighted tariff indicates that both the countries have made major strides in bringing down the level of tariffs since 2001. Tariff liberalisation was almost stagnant since 2005 for China, but India brought down its import weighted tariff significantly, mostly in the manufacturing sector in 2008.

As India and China are almost at similar levels of tariff regimes, further tariff liberalisation may not be a critical negotiating point for India in order to secure better market access in China. If preferential reduction of tariff takes place between the two countries, it may be more advantageous to China in the agricultural sector than to India. Considering the small export basket of India to China, peak tariff and preferential tariffs could be detrimental to the export interest of India. China is gradually following regionalism, and extension of tariff preferences to more regional partners could prevent Indian access to the Chinese market and realisation of its export potential. If China continues to maintain peak tariff on certain products which are of export interest to India, and continues to provide tariff preferences to many competing suppliers from emerging countries, India may have to look for an alternative strategy to join more Southern-based Regional Trading Arrangements to compensate the loss of trade in China.

5.1.1 Sectoral Tariff Liberalisation

There is a considerable level of similarity between India and China in the current level of reforms and their commitments for future liberalisation. Despite strongly adhering to the process of regionalism, their commitments to the multilateral process are very strong. These countries have displayed a strong inclination for self-propelled liberalisation to provide opportunities to their domestic firms to compete in a competitive business environment. These policy perceptions can take them forward with the passage of time. A comparative analysis of the existing tariff policies prevailing in India and China can provide some insight into the possibility for comprehensive economic engagement between them.