India-China relations thaw: Will trade and investments bloom?

That “may you live in interesting times” is an English translation of a Chinese curse is apocryphal. However, what is true is that we are living in interesting times. Two wars are in the headlines daily, and scores of armed conflicts across the globe. In the US, Donald Trump will take office as the 47th President on January 20, 2025, and could spark trade turmoil with China and India.

Economy watchers, meanwhile, are keen to see trade and investment ties between India and China go back to the pre-2020 days. During the Covid-19 pandemic’s lockdown in March 2020, India banned all direct passenger flights between the two countries. Then came the diplomatic freeze after the June clashes in Galwan in Ladakh in which 20 Indian soldiers were killed.

Indian businesses are sensing a thaw in diplomatic relations between India and China and expect Delhi to lift curbs on investment by Chinese companies-even though the government has ruled out such plans for now, citing Press Note 3 of 2020. This Press Note revised a clause of the Consolidated FDI Policy 2017 to rule out investment by any Chinese company except through the government route. It does not name China but excludes any entities of a country “that shares a land border with India” or where the beneficial owner of an investment into India is situated or is a citizen of any such country.

The government said it wanted to check opportunistic takeovers of Indian companies during the pandemic.

“As of now, there is no rethink on this issue; the amendment to the FDI rules was brought in after much thought was put into safeguarding strategic sectors and interests,” said official sources.

The first signs of a thaw

Policy watchers and experts saw the thaw begin on October 23, when Prime Minister Narendra Modi met with Chinese President Xi Jinping on the sidelines of the 16th BRICS Summit at Kazan in the Russian republic of Tatarstan. This was the first formal interaction between the two leaders in five years since the Galwan clash. Their historic handshake paved the way for a dialogue to begin.

More recently, on December 3, External Affairs Minister S. Jaishankar informed the Lok Sabha that India-China relations have seen signs of improvement in resolving some border issues, including the October agreement on patrolling protocols along the Line of Actual Control (LAC). “In the coming days, we will be discussing de-escalation and effective management of our activities in the border areas,” he said.

Then on December 18, India and China held the first boundary talks in Beijing between the Special Representatives of the two countries-National Security Advisor Ajit Doval and Chinese Foreign Minister Wang Yi-after a gap of five years, where they affirmed the disengagement agreement at the LAC.

Earlier, the government’s Economic Survey of 2023-24 had made waves for its suggestion that India revisit the FDI curbs. The Survey argued that FDI inflows from China can help India boost exports and increase participation in global value chains.

“…focusing on FDI from China seems more promising for boosting India’s exports to the US, similar to how East Asian economies did in the past. Moreover, choosing FDI as a strategy to benefit from the China plus one approach appears more advantageous than relying on trade,” the Survey, presented in Parliament on July 22, had said.

Trade Tied  

• Political relations between India and China deteriorated after border clashes in June 2020 in the Galwan region
• Trade remained unaffected but India tightened norms for Chinese investments and withdrew automatic clearance for countries that share land borders through Press Note 3
• India also banned several Chinese mobile apps and stopped direct flights to China
• Recent disengagement between the two neighbours has led to some improvement in diplomatic relations
• There are expectations that this could also ease investment

What is Press Note 3?  

• Press Note 3 of 2020 amended the FDI policy mandating that countries that share a land border with India can only invest under the government route
• The rule also applies to cases where the beneficial owner of any investment into India is situated in one of these countries
• The aim was to curb an opportunistic takeover of an Indian company during the Covid-19 pandemic
• Economic Survey 2023-24 had suggested FDI inflows from China can help India boost exports and increase participation in global value chains

Expectations are growing that the two trading partners will try to normalise investment ties and ease the movement of skilled manpower and experts. More investments could also help boost domestic manufacturing and create jobs.

Biswajit Dhar, a Distinguished Professor at the Council for Social Development, feels India and China seem to be moving towards an end of hostilities. “There also seems to be some realisation that FDI from China is useful for India. This will likely lead to an eventual lifting of curbs. This situation is likely to change, but it is difficult to predict when it will happen as there are a lot of geopolitical issues at play,” he says.

India has also prioritised its interests, such as buying crude oil from Russia despite Western sanctions on Moscow over the Ukraine war. Dhar feels India will likely continue to decide on issues for its benefit despite deteriorating relations between the US and China.

Agneshwar Sen, Partner-Tax and Economic Policy (International Trade), EY India, is also confident that 2025 will be the year we can expect the normalisation of the India-China economic relationship.

“India used its economic clout to retaliate [for Galwan]. We did not resume direct flights to China following the Covid closures, curbed investment inflows, and shut down online businesses, which probably surprised the Chinese. Now there’s a better understanding,” he says.

The next logical step would be resuming direct passenger flights between India and China. Sen said the Indian industry has been asking for Chinese technicians to help install machinery and equipment.

Trade and investment

Experts stress that even after the Galwan clashes trade between India and China continued, and in FY24, China remained India’s largest trading partner. But it has been a double-edged sword, given India’s growing reliance on Chinese imports for their cost competitiveness and technological know-how in energy, transportation and machinery sectors. Over the years, the government has taken several initiatives under the ‘Make in India’ scheme to boost domestic manufacturing and compete with China as a global manufacturing hub.

India’s exports to China rose marginally to $16.67 billion in FY24 from $16.61 billion in FY20. Its imports have, however, surged to $101.73 billion in FY24 from $65.26 billion in FY20. India’s trade deficit with China had ballooned to $85.06 billion in FY24.

Indian industry is also worried that if the US increases tariffs on imports from China, Beijing could dump goods in other markets.

Surendra Singh, Associate Professor of International Business at Jindal School of Liberal Arts and Humanities, O.P. Jindal Global University, says India’s trade deficit with China has doubled in the last five years since it decided to stay out of the Regional Comprehensive Economic Pact, a free trade deal between China, the ASEAN bloc of countries, Australia, New Zealand and Japan, along with a few others.

Based on actual investments in India, China remains a marginal player. Lifting restrictions on foreign direct investment (FDI) by China will have minimal impact on the ground. Between April 2000 and September 2024, FDI equity from China added up to $2.5 billion or just 0.35% of the total FDI equity inflows. Singh believes the recent improvement in diplomatic relations with China will unlikely lead to improved business and investment.

“India remains sceptical of investments from China and the nature of such investments. Over the last few years, India has received several large investment proposals from Chinese firms but has not welcomed most of them,” Singh says. The academic said there is enough evidence that Chinese investments in different countries have undermined the receiver countries’ sovereignty.  

A recent report by the economic think tank Global Trade Research Initiative says that expecting a surge in Chinese investments is unrealistic, even if the restrictions are eased. “China has historically shown limited interest in making substantial investments in India, particularly in sectors that require technology transfer or strategic collaboration,” it says.

Chinese investments may flow into labour-intensive industries such as garments or shoes and undermine Indian manufacturing further, the report warned.

In high-tech sectors such as electronics and electric vehicles, Chinese companies could assemble products in India with up to 90% of the components sent from China. “This would only deepen India’s dependence on Chinese supply chains,” the report said.

So the official weather forecast is bleak: “No showers of Chinese FDI. No clouds on the horizon”.

Let’s hope the weatherman is wrong. And that Chinese FDI makes landfall soon.

@surabhi_prasad