The South Asia Channel

Could Modi Be India’s “Nixon to China?”

In February, Narendra Modi, the front-runner to be India’s next prime minister, urged China to leave behind its "mindset of expansion." Speaking to a gathering in Arunachal Pradesh, an Indian border state that is partly claimed by China, Modi added in the same breath that Beijing should work for "development and prosperity." While a one-off ...

Kevin Frayer/Getty Image
Kevin Frayer/Getty Image

In February, Narendra Modi, the front-runner to be India’s next prime minister, urged China to leave behind its "mindset of expansion." Speaking to a gathering in Arunachal Pradesh, an Indian border state that is partly claimed by China, Modi added in the same breath that Beijing should work for "development and prosperity."

While a one-off election speech is hardly a comprehensive guide, Modi’s statement provides some clues into India’s prospective foreign policy. Namely, it reveals his preference for a "compartmentalized" approach to China.

Even as New Delhi and Beijing have strived towards deepening economic cooperation, the relationship between the two sides has continued to be defined by high politics and geopolitical rivalry, and exacerbated by regular border standoffs. But with Modi, domestic priorities are likely to play an even greater role in his government’s China stance than foreign policy concerns. The broad contours of the India-China bilateral relationship could be marked less by high politics and grand strategy and more by unprecedented investment cooperation in coming years.

New roadmaps

What is the reasoning behind such a conclusion? Both India and China are in throes of a tectonic shift in their economic models. Two documents point in that direction.

In November last year, during the high-level government meeting called the Third Plenum, China released its new economic reform plan. China’s President and Communist Party Secretary Xi Jinping announced his vision for a "great rejuvenation of the Chinese nation," outlining a broader role for private enterprise and consumption in the economy. And the leadership has already started moving in this direction, announcing significant financial reforms in recent weeks.

In India, Modi’s Bharatiya Janata Party recently released its manifesto. It promises to strategically push forward the development of job-creating, labor-intensive manufacturing. The document, which was personally vetted by Modi, focuses heavily on infrastructure, laying down an ambitious agenda to construct high-speed rail networks (called the "Diamond Quadrilateral Project"), a national gas grid, and 100 new cities and satellite towns. It also details an expansive "Sagar Mala" project to modernize existing ports and develop new ones.

It is clear that a structural re-balancing both within and between India and China is taking place, and a section of the political leadership in both countries is seeking to ride the wave of change to their advantage. China is trying to transition from an economic model based on assembly and offshoring to an innovation-driven, high-value industrial and services supplier (think present-day Japan or South Korea). Meanwhile, India is looking to "transition out" of its peripheral role as a raw materials exporter to a medium-level industrial base (present China), while retaining a competitive edge in certain "knowledge sectors," such as information technology, biotechnology, and pharmaceuticals. As China recedes from a state-led investment model, this opens up space for an Indian manufacturing renaissance.

Consider this: As China’s workforce shrinks and domestic wages rise, up to 85 million Chinese manufacturing jobs are waiting to migrate elsewhere. With India likely to provide the largest increase to the global labor force over the next decade, it is uniquely positioned to capture a significant share of the manufacturing jobs that are leaving China. 

For China, herein lies an opportunity. Sitting atop nearly $4 trillion of foreign exchange reserves, $1.27 trillion of which is in the form of low-yield US treasuries, Beijing is eager to re-allocate its savings to higher-yield assets. And India’s manufacturing potential and its likely push towards large infrastructure projects presents high-value investment opportunities.

China’s leading sovereign wealth fund, the China Investment Corporation (CIC), which manages $575 billion in assets worldwide, is also shifting its long-term focus to infrastructure projects in emerging markets. In 2011, CIC, in partnership with the Russian Direct Investment Fund, launched the joint China-Russia Investment Fund to invest $1 billion in Russian assets. Beijing plans to create a similar investment fund with Mexico. It has also begun preparations to set up a multilateral bank with an initial capital of $50 billion to fund infrastructure projects in Asia.

India, with a massive appetite for infrastructure investments, is the next logical destination for Chinese savings. The Chinese are already testing waters with an offer to finance 30% of India’s infrastructure development.

A financing model led by the Chinese state could be a short-term strategy for India. As China moves towards greater market reforms, it is likely to face downward pressures on its current account surplus, chipping away at its forex stock. China’s current-account surplus has already fallen to 2% of GDP, down from 10% in 2007.

But it is private Chinese wealth and India’s ability to attract it that will be the story of the future. Chinese policymakers have already indicated that the country’s tightly controlled interest rates will be liberalized within two years, with a gradual opening of the capital account thereafter. The challenge for India will be to make itself attractive to wealthy Chinese wh
o will look to diversify in the coming years.

A major portion of that challenge — making India a less risky investment destination for both public and private Chinese savings — will lie in addressing the structural rigidities that have weighed on India’s growth potential. Streamlined environment and land acquisition approvals, investment in transport linkages, and broader policy coherence at the national level are among the many suggestions already put forth by experts.

As chief minister of the Indian state of Gujarat, Narendra Modi put in place a successful policy framework to attract business and spur industrial growth. Will he be able to replicate that success at the national level?

Modi’s possible ascendance to the position of India’s prime minister could be only the first step towards a far more ambitious bid to lead the country for two successive five-year terms and beyond. To maintain his hold on power, Modi will likely look to reverse the jobless growth that has defined India’s economy in the last decade. Politically, this is where Modi stands to benefit the most; if he manages to usher in a manufacturing and infrastructure boom in the next five years, he will have won over a sizable political constituency — the youth. Every 1 percentage point growth in manufacturing will likely create 20-30 million additional jobs in the country. A political project of this nature will require not only strong executive action, but also an ambitious legislative agenda to clear legal and regulatory hurdles.

Modi’s internal political play to secure a bold reform agenda – a political strategy on which his own political future depends — could therefore serve as an important confidence building measure for Chinese investors looking for a departure from the past. For them, bureaucratic red-tape, regulatory hurdles, and policy uncertainties have enhanced the riskiness of their Indian investments, in comparison to otherwise low-yield, but safer assets in the developed world.

For India’s next government, setting up a joint India-China investment fund with the help of the China Investment Corporation (CIC) would be an effective way to direct Chinese public savings to Indian infrastructure assets. Additionally, while India maintains a liberal FDI policy in infrastructure, concerns still remain about Chinese investments in "strategic" sectors such as railways. With a few security exceptions for sensitive border regions like Jammu and Kashmir and the northeast, India could benefit by removing restrictions and allowing Chinese investments and cheaper import technology to enter the country – especially in India’s ambitious high-speed rail projects.

Undoubtedly, these significant shifts in India’s China policy will require Indian leadership to make a convincing political argument to domestic audiences and international allies alike. Reconciling his Japanese tilt with overtures to Beijing will be a delicate balancing act for Modi to perform.

Domestically, however, what works in his favor is that he already represents a broad spectrum of the nationalist view, which tends to take a hawkish line on China. In other words, he could play India’s Nixon to China, leveraging his nationalist credentials to exercise enough political legroom to re-orient the India-China relationship towards trade and investment, without being outflanked by security hardliners and foreign policy hawks at home.

Inviting more Chinese investments into India also raises strategic costs for conflict in the near term, meaning that economic convergence rather than geostrategic rivalry may guide the bilateral relationship.

With China and India declaring 2014 as their "Year of Friendship" and President Xi scheduled to visit India later this year, Modi’s rise presents an opportunity for a reset with China. Hopefully, a new investment-led economic cooperation will form the mainstay for the future bilateral relationship.

Shrey Verma is an MA Candidate at the Johns Hopkins School of Advanced International Studies in Washington, D.C. Follow him on Twitter at @shrey7

Shrey Verma is an analyst covering international geopolitical and sovereign risk issues at Height Securities, a Washington-based investment firm.

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