India’s latest standoff with China has once again thrown the spotlight on India’s growing trade deficit with its northern neighbour. In a recent speech in Singapore, India’s foreign secretary S. Jaishankar argued that India’s “alarming" trade deficit with China “emanates from obstacles to market access in China.

However, a Mint analysis of the patterns of trade between India and China suggests that the key driver of the trade imbalance between the two neighbours is India’s increased dependence on high-tech manufactured goods from China.

Growth in India’s domestic manufacturing sector has been slow over the past several years, and imports have been rising. It is not so surprising that much of these have been sourced from China, the manufacturing powerhouse of the world.

As the chart below shows, while India has been able to rein in the overall trade deficit (with the rest of the world) over the past few years, the imbalance in India-China trade continues to remain at an elevated level, witnessing only a marginal fall in 2016-17.

At slightly over $50 billion ($51 billion) in 2016, India’s trade deficit with China is about half the country’s overall trade deficit ($106 billion). The trade deficit with China doubled in 2006 compared to the year-ago period, and since that inflection point, has kept on rising. Much of the rise in imports is driven by India’s import of high-tech goods, including mobile phones and other electronic products. As the chart below illustrates, the bulk of such imports comes from China.

A 2014 study on India-China trade published by the Reserve Bank of India (RBI) noted that the rise in imports since the mid-2000s was driven by India’s imports of high-tech manufactured goods.

Not only Indian consumers, but Indian companies too, have benefited from cheap Chinese imports of electronic goods. China’s importance as a major supplier of imported capital goods (machinery) to India has also risen substantially since 2000.

China was the source of 44% of all machinery imported into India in 2016. As opposed to this, the vast bulk of India’s exports to China constitute commodities such as minerals.

While the rise in the trade deficit with China is largely attributable to economic shifts, Chinese trade restrictions do impede the flow of Indian goods and services to China. As the aforementioned RBI study pointed out, non-tariff barriers such as a difficult registration process and frequent changes in rules relating to standards and certification requirements hinder exports in sectors such as pharmaceuticals. However, this has not been a one-way street. India too imposes trade restrictions such as on steel imports, which seem to be quite counter-productive, and have been hurting engineering and manufacturing firms.

Engaging China is going to be a major challenge in the months to come but knee-jerk reactions such as tariff walls or outright bans on Chinese goods and services may end up doing more harm than good.

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