Diwali, China, India and the Asian Trading Bloc Dilemma

The lights on Delhi’s streets this Diwali were mostly shipped out of China’s Shanghai port and many of the plastic images of Goddess Lakshmi, the Hindu godess of wealth, being sold in its bazaars, were  made out of dingy factories in Guangde in South China.
The cheap lights and shiny images may bring cheer to many Indian homes, but for its policy makers led by prime minister Manmohan Singh, they are a pointer to the dilemma Singh will face in Phnom Phnem next week. Those trinkets imported from India’s largest trading partner, have already driven thousands working in small scale lighting and decorations factories in western Uttar Pradesh into the ranks of jobless over the last decade-and-a-half. 
Rising Chinese imports and falling Indian exports have meant that in the first ten months of this calendar year, India has already run up a trade deficit of $ 23 billion. India imports finished goods ranging from cheap lights and mobile phones to stainless steel and consumer durables to electricity plant gear from China, but mostly sells raw materials like iron ore, chrome, lead,  copper and cotton to its northern neighbour.
At the Cambodian capital, Singh will join leaders from China, Asean and East Asian countries in talks to create the RCEP – or Regional Comprehensive Economic Partnership – an Asia-wide trading bloc which China wants to forge as a counter to US President Barack Obama’s Trans-pacific trade bloc which shuts out China and draws Asia closer to the Americas in a trade partnership.
Till now, for nearly a decade, China had sought to keep a trading bloc it sought to create, restricted to East and South East Asia, by involving Asean, Japan and Korea, while shutting out India, Australia and New Zealand.  India and Japan on the other hand had long been resisting China’s attempt to forge a trade pact, which it would dominate, by demanding a Pan-Asian trading block of Asean + 6 (Asean, China, Japan, Korea, India, Australia & New Zealand).
Possibly to trump Obama’s proposed trade block, China has suddenly changed tack and adopted the Indo-Japanese proposal as its own. With this comes India’s and many other potential RCEP members’ dilemma.
If they do not join in, they could lose a first mover advantage to be part of the world’s most powerful trading block which would control nearly 30 per cent of the global GDP. However, joining it could mean reducing tariff walls and letting cheap Chinese imports flood local markets killing off domestic industry.
Analysts say Chinese industry benefits from dirt cheap finance, almost no labour laws, hidden subsidies by way of capital costs often underwritten by provincial or central government besides unfair price under-cutting. 
The Indian government’s  Standard Board of Safeguards will hold a meeting on November 15 to decide whether China is dumping stainless steel products in India, causing huge losses for Indian manufacturers, acting on a complaint by Jindal Stainless Steel. The Directorate General of Safeguards has already supported Jindal’s case. India had earlier too been forced to raise import duty on steel to protect domestic manufactures from dumping by Chinese steel firms.
Last year in a speech, Eximbank President Fred Hochberg had pointed out  “In India, (Chinese telecom equipment maker) Huawei grew to $2.5 billion in sales from $50 million in one year. Folks, that kind of growth takes more than just good sales and marketing strategies",  and went on to blame Chinese "state-directed capital" for that growth. It's well known that telecom operators and private power plant owners in India ordered Chinese gear after availing of extremely low cost loans from Chinese banks.
The result has been disastrous for our industry. Latest industry data shows India’s capital goods sector contracted 12.2 per cent in September, a fact which has caused considerable alarm in North Block  and Udyog Bhawan home to India’s  finance and Industry ministries which for long have been beset by representations from India’s top chambers cautioning against dumping of capital goods by China.
On the other hand, these chambers also complain of non-tariff barriers are shutting out their exports of manufactures from China’s markets. The challenge this `unfair’ trade poses was best summed up by commerce minister Anand Sharma in an interaction at last week’s World Economic Forum “We will continue trying to create a balance because there is an adverse balance of trade and we are seeking market access for Indian IT companies and pharmaceuticals and I hope it will come …  we have talked to the previous (Chinese) Prime Minister. We would continue our dialogue and engagement. China is an important partner for India."

Yen, Rupee and Risk Swaps

Worried by the rate at which the rupee has been falling against the dollar with currency speculators beating down the Indian currency, the government has reacted with alacrity to a Japanese offer to renew a currency swap agreement which had lapsed June, this year.
Japan of course wants to do more than just swap financial risks. Lurking behind the two nation's economic enagagement, are serious strategic considerations which could shape Asia in the future.

The last forex swap deal between the two nations, was for $ 3 billion and provided for either side pitching in with $ 1.5 billion to help shore up the other’s currency. This time round the war chest will be larger at $ 15 billion, with both sides committing $ 7.5 billion which the other side can use.

Japanese Prime Minister Yoshihiko Noda who arrived on Tuesday, December 27, is expected to finalise the deal. Japan’s forex reserves are at a high of $ 1.3 trillion, the second highest forex reserves globally but it has still signed up for currency swap deals with a number of key countries.

The arrangement will allow the Reserve Bank of India to borrow dollars from the Bank of Japan to sell in the forex market to stabilise the rupee. BoJ will have similar rights in case the Yen is under attack.

India’s currency has been under attack in recent weeks. Partly, because foreign institutional investors who play in the bourses of this country  have been selling stocks, converting their earnings into dollars and taking it out to invest in other markets. The rupee's value has fallen by some 20 per cent since June, 2010.

In part, the rupee is falling as it is also under attack from currency speculators who are betting against the currency. India, despite having one of the largest forex reserves, globally, holds much of this reserve in the form of debt inflows. Of India’s $ 302 billion reserves, net foreign liabilities which include Non Resident Indian (NRI) deposits, FII investments, foreign borrowing by Indian corporates, stand at $230 billion or so. This high proportion of debt in India's forex assets makes the rupee vulnerable to speculative runs on it, especially near dates when large portions of this debt come up for redemption.
Large bits of the NRI deposits and some of the corporate debt mature in the coming year, which perhaps explains why currency speculators have started pulling down the rupee and also why India is in a hurry to sign up on swap deals.
Japan, has a stake in the rupee's well being. India, an important trade partner for the island nation, whose auto parts and capital goods sales to the South Asian nation, has been impacted by the rising price of the Dollar/Yen. Japan probably feels if it can help check the erosion of the value of the rupee, it can protect its market share here. A stronger rupee could enthuse Indians to import more Japanese goods as the Japanese prices would then look more affordable .
Japan’s competitors in the Indian market are China and Korea and China has already started floating Renminbi loans so that India can purchase  power and telecom equipment from it at attractive rates bypassing the strengthening Dollar.

But underlining all this economic bonmhomie are strategic considerations. Japan is also wary of a militarily rising China, which has been making territorial demands on it, and has been consequently looking to balance China by engaging with India both strategically as well as economically.

The Japanese government is alarmed by aggressive Chinese naval moves in the East China Sea, where it disputes Japanese control over the Senkaku islands as well as by anti-Japanese demonstrations in China, and has been quietly advising its firms to look westwards towards Vietnam in the Asean region and towards India.
The Japanese currency swap deal should be seen in this broader strategic and economic context.
Luckily, Japanese businessmen too feel India is a better business bet in the long run. A survey conducted some time back, by the Japan Bank for International Cooperation for the island nation’s Ministry for Economy, Trade and Industry, shows some 75 per cent of Japanese businessmen considered India as “the most promising country” ahead of China, Brazil, Vietnam and the US.
More than 1,200 Japanese firms have already invested in India including Suzuki, Honda, Nissan, Toyo, Mitsubishi, Panasonic, Daikin, Toyota, Komatsu, Sanyo, Nissin and Shimadzu. While a second wave of investment by small and medium Japanese enterprises as well as major players expanding their business has started earlier this year.
The two main political parties in the island nation - the Liberal Democratic party which ruled Japan  for more than 40 years since 1955 and Democratic Party which currently rules it - are both agreed on the need for closer strategic and economic ties with India.
Takeshi Iwaya, LDP’s shadow defence minister and member of the Japanese Diet had told this writer when he visited Japan, in Autmn this year, : “threats surrounding Japan are increasing, China is expanding its military technology and  capacity at a ferocious speed …  Japanese alliance with US will remain our cornerstone  …(but) we have to work out common strategic objectives and economic agenda with India.”
A case of double risk swaps both ways?

Postscript:
Hours before Prime Minister Noda left for India on Tuesday, Japan's security council relaxed a four decades-old arms exports ban. Though India was the world's top weapons importer last year, the lifting of the ban is seen as a move which could be used by firms like Mitsubishi to cooperate with Indian shipyards and factories in building defence vessels and  missile defence systems, rather than India buying off the shelf hardware from the East Asian powerhouse.

Mitsubishi has a deal with India’s L and T Shipyards and defence analysts say that the two could use the opportunity to co-produce a wide range of Naval vesels. As it is the two countries are working in the words of  former Prime Minister Shinzo Abe, so that "sooner rather than later, Japan's navy and the Indian navy are seamlessly interconnected."

India has cooperated with Israel in missile design, while Japan has deals with the US on missile development. Well known Indian defence analyst Brahma Chellaney in an article in Japan Times on December 28, mooted a deal between the two Asian powers – India and Japan - in this sphere.    


Related Reading:
To read a very US-centric take on the US-Japan-India trilateral in mid December, readers maybe interested in Josh Rogin's blog at the Cable : http://thecable.foreignpolicy.com/blog/11505 .