A weak yuan has contributed to a surge of Chinese imports into vulnerable sectors such as raw silk. At another level, China is increasing its presence in strategic sectors, including power. India has failed to come to grips with this situation.
The government's reported efforts to rein in Chinese incursions into the Indian economy reflect the dangerous turn that economic relations between the two countries have now taken. The concerns over the balance of trade shifting sharply in favour of China have acquired a strategic edge, with state-influenced Chinese companies gaining a significant share of critical sectors of the Indian economy. The knee-jerk reaction to this turn of events would be to raise tariff and non-tariff barriers at random.
But, apart from generating retaliatory measures on the Chinese side, this would also hurt the beneficial dimensions of trade between two of the world's fastest-growing major economies. It would be more meaningful to explore the nature of the unfair advantage the Chinese have and work to create a more even trading field.
At the heart of the Chinese success is their ability, and willingness, to take the instruments of state control into the battleground of the free market. Their trade with the United States has been spurred by keeping the yuan consistently weak against the dollar. This makes Chinese products cheaper and has allowed China to gain a major share of the American market.
China's rising exports to the US should normally have led to an increase in the demand for the yuan and, hence, a strengthening of that currency. But China has avoided that outcome by buying dollar bonds and simultaneously not allowing the yuan to respond to market trends.
To the extent that India tries to maintain some kind of stability in the rupee-dollar exchange rate, the Chinese advantage against the dollar is transferred to the rupee as well. And if this advantage is countered by the rupee weakening against the dollar, as it has in recent weeks, it simultaneously raises the cost of our essential imports.
This has an inflationary impact at home as it pushes up the price of oil and food imports. There is thus an Indian interest in keeping the rupee stable against the dollar, even if it offers an advantage to Chinese imports into India.
The Chinese have built on this exchange-rate induced advantage for their products in Indian markets through strategic investments in key sectors of the Indian economy. By keeping their currency weak they are no doubt increasing the cost of their investment in Indian companies.
But the Chinese evidently believe this investment is still worth their while because of the strategic importance of the sectors their state-influenced, if not controlled, companies are investing in. They are now believed to have a significant stake in India's power sector and are making rapid inroads into the telecom sector as well.
Even as the Chinese are breaking out of old ideological moulds to use their state power in a relatively free global market, India is helping their cause by making it easier for them to target vulnerable sectors of the Indian economy. A striking example of this trend is the Union government's approach to Indian sericulture.
Karnataka emerged as India's largest raw silk producing State, largely on the basis of a concerted effort in the 1970s to develop sericulture as a secondary occupation for agriculturists. The success of this initiative provided a safety net for agriculturists in the decades when the Green Revolution began to falter.
For several years now this sericulture segment has faced the challenge of the Chinese dumping raw silk into the Indian market. Aided by a favourable exchange rate as well as possible state support, China has been grabbing a larger share of the Indian raw silk market. And the Indian government has, in its commitment to liberalisation, aided this process by reducing the duties on raw silk.
Thus, the Chinese have developed an ability to hurt vulnerable sections of the Indian economy. It may be paranoid to see this as being part of a Maoist conspiracy, but its destabilising potential cannot be ignored.
The seriousness of the current situation may demand the immediate erection of tariff and other barriers, but there is little to be gained in the longer term by building barriers between the two major economies that are outside the direct impact of the economic crisis that has engulfed the Western world. Rather than blocking all trade, the way forward would be to target the instruments that China has used to gain this hold on the Indian economy.
Prominent among the longer-term steps India could take is to join the international pressure that is being built up on China to make its currency reflect market realities, at least to a greater extent than is the case today.
India would also have to consider increasing state investment, not to subsidise specific industries, but to at least offset some of the advantages that Chinese products are provided by their state. Special care must also be taken to ensure that state- supported Chinese goods are not dumped in a way that destroys the most vulnerable sections of the Indian economy.
As India gears up to meeting the economic and strategic threat that China now poses, it is important to remember that the most rewarding way forward lies in fair trade rather than no trade.
(The author is Professor, School of Social Science, National Institute of Advanced Studies, Bangalore. blfeedback@ thehindu.co.in)