Let China Supply India's Public-Works Boom.

The commerce ministers of India and China meet Monday in New Delhi, and the trade balance between the two countries is set to be a matter of particular controversy. Indian leaders have become alarmed by their growing trade deficit with China. Yet this is a good time for cooler heads to prevail, and especially for the Indian side to recognize the potentially huge gains to be had from increasing trade with China.

That will at first be a tough sell. China's $56 billion exports to India last year dwarfed the $19 billion exports from India to China. Given the history of animosity between the two countries, this has sparked concern in New Delhi. In December, India's National Security Council Secretariat even suggested that the trade deficit with China may pose security concerns.

India's cabinet last month approved a 21% tariff on imports of power generation equipment into India. This appears to be aimed primarily at Chinese imports, which account for 40% of all power-plant imports into India; New Delhi couldn't target China explicitly without running afoul of global trade commitments.

But this is a profoundly short-sighted approach to the trade issue, which ignores what should be the far bigger concern of Indian policy makers—not the trade deficit with China, but the country's overall infrastructure deficit. India's chronic shortfall of electricity (witness last month's blackouts), roads, airports and the like is a major constraint on growth. Imports from China are part of a solution to this problem, not a problem in their own right.

The vast majority of imports from China consist of capital goods such as electrical machinery, nuclear reactors, boilers, ships, boats and items for civil engineering projects. Consumer goods such as toys, footwear and the like account for less than 2% of imports from China. These capital goods tend to come at a lower cost (thanks to the so-called China price), and are made cheaper still by extremely advantageous financing offered by Chinese banks.

Of course, China offers such terms as a way to boost its own industrial capacity and employment, perhaps unsustainably so. But all that should matter to New Delhi is that India enjoys more capital equipment at lower costs as a result of Beijing's industrial policies.

That boon from China trade could translate into an India boom. Given India's strong engineering skills, large domestic market, vast labor pool and low labor costs, the country can be a global manufacturing power in the same league as China. Weak infrastructure is the primary reason why it is not. Lower-cost capital goods from China help accelerate India's drive to redress this weakness.

Better infrastructure could also help India become a global agricultural power. The proportion of India's arable-to-total-land is over four times as large as China's. But an estimated 40% of India's food grain rots before reaching the market. With better roads and storage facilities, India can become one of the world's largest agricultural exporters with, yes, China as its biggest customer.

So as Indian leaders head into meetings with their Chinese counterparts, they need to be pragmatic about the benefits of their current trade deficit with China—and push for freer trade to reap even more rewards. At the moment, they are making some noises to this effect but generally in the name only of reducing the trade deficit.

For instance, in recent comments, Commerce Minister Anand Sharma said he will press China to reduce barriers to imports from India—notably in pharmaceuticals and IT services where India has recognized global strengths. Given China's record of coddling domestic industry, this would be eminently sensible.

However, India's political and business leaders should keep in mind that, in the short run, more open doors in China would have not much impact on the trade deficit. India does not currently enjoy comparative advantages in most areas of manufacturing. Even in the case of drugs, China is a much bigger exporter of active pharmaceutical ingredients (APIs) than India. In fact, India imports APIs from China.

India's pharma sector does have advantages over China's: a much larger number of U.S. Food and Drug Administration-approved plants, better ability to navigate the Western regulatory landscape, and stronger product marketing skills. However, these advantages are not particularly deployable to China. India's generic drugs would have a tough time competing with lower-cost domestic products within China.

In any case, India's worldwide exports of pharmaceutical products add up to about $7 billion. Even if China were to start importing $3.5 billion worth of drugs from India (up from about $100 million at present), it would hardly make a dent in the $37 billion trade deficit between the two countries.

More broadly, rather than chasing the Chinese away, India should encourage them to deepen their ties to the Indian economy. Companies such as Huawei, ZTE, Shanghai Electric, Lenovo, Haier, Alibaba and many others face a rapidly slowing economy in their home market and are eager to benefit from India's growth opportunities. For some of these companies, India is already their largest source of revenue after China and will rapidly become even more important. India's primary focus in the upcoming discussions should be less on trade and more on what either side can do to accelerate investment and domestic production within India by the Chinese companies.

India and China have long been political, economic and strategic rivals, and that will likely continue for some time to come. But as far as their trading relationship is concerned, this should be one instance where New Delhi is content to sit back and let economic nature—in the form of flowering trade—take its course.

Source : online.wsj.com