The economic engagement of India and China may be one of the most rapidly evolving bilateral relationships of the early 21st century. Soon after taking office in March, in an interaction with the Indian press, Chinese President Xi Jinping outlined five proposals to improve Sino-Indian ties. He said that the two countries should maintain strategic communication, harness each other’s comparative advantage, strengthen cultural ties, expand coordination in multilateral fora, and accommodate each other’s core concerns and differences.

While the five proposals were undoubtedly crafted carefully, and can be parsed endlessly, they reveal a Chinese desire to strengthen bilateral ties. Xi’s fifth point refers to thorns like border disputes, Tibet and India’s concern about protecting its downstream riparian rights. The recent Ladakh incursion issue may be behind us temporarily, but such incidents will surely recur. However, its quiet and quick resolution despite intense media glare and domestic jingoism on both sides, indicates the evolving maturity in the relationship. Maybe it was quickly resolved to avoid awkwardness during the upcoming Delhi visit of the new Premier Li Keqiang, the first stop of his maiden foreign trip. But talks worked, and bullets didn’t have to be fired.

The second point of Xi’s list refers directly to economic engagement. In a short span of 10 years, Indo-Chinese trade has grown by more than twenty times. China’s goods exports to India have grown at a compound average growth rate of 39% since 2001. India’s importance in China’s export markets is gauged by the fact that India’s rank moved up from 19 to seven from 2001 to 2010.

In the reverse direction, India’s exports to China have also grown, but at a slower pace. So, India’s importance in the Chinese import basket is at the same low rank today as it was in 2001. This has led to a widening trade gap between the two, and Chinese imports into India are roughly twice as large as India’s exports.

This asymmetry is compounded by the nature of goods flow. India tends to export primary materials such as ores, minerals and cotton, whereas Chinese exports to India are mostly capital and manufactured goods. Xi referred to harnessing each other’s comparative advantage. This implies that the Chinese must open their doors to India’s pharmaceutical and agricultural products.

A much bigger opportunity lies not in trade, but in an investment alliance. China’s three-decade-old export-led growth model has resulted in huge foreign exchange reserves. These are estimated to be about $3 trillion. Most of these reserves are invested in US treasury bonds. Given that interest rates will eventually rise, these bonds will lose value. Even now, the dividend yield is very low. Additionally, the Chinese fear that an appreciating renminbi against the US dollar reduces the gains further. No amount of artificial controls can keep the renminbi from appreciating. Since July 2005, the renminbi is stronger by more than 20%, reflecting a corresponding loss in China’s bond investments. On a widening base of $3 trillion, this loss is a huge amount.

India, on the other hand, has usually run a current account deficit (CAD). The flip side of a constant deficit on the external account is that it has been consistently funded by the optimism and generosity of foreign capital, be it in the form of portfolio flow or foreign direct investment (FDI).

The recent widening of India’s current account has made its funding a major cause of anxiety. Herein lies an opportunity to harness each others’ comparative advantage. An annual direct investment of around $30 billion is but 1% of China’s stock of foreign exchange. It will mostly wipe out the Indo-Chinese trade deficit, and will substantially ease India’s CAD concerns. By negotiating a bilateral assured renminbi denominated returns on Chinese FDI, India can mitigate concerns about losing value because of the renminbi strengthening. Such FDI should initially be confined to long gestation, infrastructure projects with a sovereign guarantee of an annual return of around 7-8%. (The last instance of a sovereign guarantee to a foreign entity was Enron. Surely the Chinese government is a better credit risk.)

The benefit of such infrastructure investments into India have already been tasted by the Japanese, via their funding of the Delhi Metro, and now the Delhi-Mumbai Industrial corridor. India’s stated need for infrastructure investment is in excess of $1 trillion. The Chinese investment should initially be a purely financial one, to keep off security concerns. (There are thorny issues of funding telecom, and the issue of tied purchase of Chinese telecom equipment.)

So this is the historic opportunity: invite a tiny portion of China’s forex stock into India’s infrastructure, reduce the trade deficit, and reward it with an assured return. China has the finance, India has the hunger for long-term funds. This is the bilateral comparative advantage referred to by President Xi. In case the bilateral deal is difficult to initiate or sell to domestic constituencies, then route the first round of investments through the newly proposed BRICS bank.

That will remove any ideological taint from the money flow. Hopefully this money flow will be a precursor of greater flows across the border of the waters of Brahmaputra too.

Ajit Ranade is chief economist, Aditya Birla Group. Comments are welcome at