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China’s Economic Relations with SAARC: Prospects and Hurdles

CIIS Time: Dec 1, 2014 Writer: Liu Zongyi Editor: Li Minjie

 

Liu Zongyi

 

 

      Over the past several years, some terms, such as the “Asian Century”, the “rise of Asia” and the “rise of China and India,” have become popular in international society. For some international observers, these terms simply reflect a global tendency; but for Asian people, they are more like visions. As members of Asia, China and South Asian countries have a responsibility to make these visions into realities, and these countries are trying their utmost to do so.

 

China’s Economic Miracle and Surging China-SAARC Eco-nomic Cooperation

 

      China has achieved a unique feat in economic growth, maintaining an average annual growth rate of nearly 10 percent for more than three decades since reform and opening-up.[1] China’s GDP surpassed that of Japan in 2010, thus making it the second largest economy in the world. Today, China is the world’s largest trading nation, the second largest recipient of foreign direct investment (FDI), the third largest investor after the United States and Japan, and the largest holder of foreign exchange reserves.

The root cause of China’s economic achievement is China’s reform and opening, which has allowed for the reform of unsuitable domestic rules, regulations and laws, the absorption of foreign investment, and involvement in the world market. Now, since the Third Plenum of the 18th Party Congress, China’s reform and opening is stepping into its second chapter.

South Asia is one of China’s very important neighboring regions. China is an observer of SAARC, the regional economic integration organization of South Asia. In the 21st century, bilateral economic relations between China and SAARC countries have developed very rapidly. First, China’s trade volume with SAARC countries has grown at a fast pace over the past decade. Bilateral trade volume expanded from 6.5 billion USD in 2001 to 73.9 billion USD in 2012, registering an average growth rate of 26 percent. This expansion is even greater than China’s overall trade increase globally. The vast majority of China’s trade growth with South Asian countries, however, has been exports, and South Asia’s exports to China increased only marginally. China’s exports to the region accounted for 1.59 percent of China’s total exports in 2001, and 3.44 percent in 2012. South Asian countries’ export growth to the Chinese market has been swift, but the starting point was very low. In 2001, China’s imports from South Asian countries only totaled 0.95 percent of China’s total imports, and in 2012, this ratio was merely 1.29 percent. In short, imports and exports to and from South Asian countries are of minimal importance to China’s overall trade profile.[2]

As an additional major point, over the past several years, China’s outbound direct investment (ODI) into SAARC countries has also rapidly increased. Since the implementation of China’s “Go Global” initiative in 2001, the Chinese government has relaxed its control over foreign exchange, approval procedures, and investment restrictions. Beginning in 2003, privately owned enterprises have been allowed to apply for permission to invest outside of China. Since then, Chinese ODI has expanded rapidly, from less than 3 billion USD in 2003 to 68 billion USD in 2011 and 77.22 billion USD in 2012 (including mergers and acquisitions and the Greenfield project).[3] While state-owned enterprises continue to be the largest investors – mainly in sectors such as petroleum, construction, telecommunications and shipping – many private companies have also started to invest abroad. Although the majority of China’s ODI is focused on Asia, much of it goes to Southeast Asia. Since 2003, China has been increasing its ODI towards South Asia. On the one hand, China is looking to enhance its export-led growth strategy and expand trade routes. And on the other hand, PM Vajpayee’s visit to China improved China-India relations, which created a positive atmosphere for China to invest in South Asia, largely because India has previously been very concerned about China’s close relations with its neighbors. In 2012, China’s ODI towards SAARC was about 400 million USD, with a growth rate of 39 percent compared with 2011. South Asian countries’ real investment in China is 500 million USD. At the end of 2012, the stock of China’s ODI toward SAARC was about 4 billion USD, and the stock of South Asian countries in China was close to 700 million USD.[4]

A sizable portion of Chinese ODI has been in the form of large construction projects, mainly in the agriculture, energy, and transportation sectors. China’s 2010 and 2011 annual investment totals were highest in Sri Lanka, where Chinese firms have completed or are in the process of completing a number of large projects. These projects span multiple sectors, including transportation, a 35,000-seat cricket stadium, a large convention center, a 209 million USD international airport, and a 1.5 billion USD deep seaport located in strategic sea-lanes.[5] China has become the largest investor in Sri Lanka. During President Xi Jinping’s recent visit to the country, Sri Lanka and China reached 27 agreements, including one to start negotiations on a free-trade agreement.[6]

China has several large-scale, ongoing projects in Bangladesh. These projects are similar to those in Sri Lanka and include deep seaports in Chittagong and Sonadia Island. China also has plans to build a road and rail link through Myanmar to connect the Chinese city of Kunming to Chittagong. In addition, China has invested in Bangladesh’s agricultural sector, investing 226 million USD in the Pagla Water Treatment Plant project and 559 million USD in a fertilizer factory in Shahjalal.[7]

Similar to its portfolio in Sri Lanka and Bangladesh, China has invested heavily in the Nepalese energy and transportation sectors, including a 1.6 billion USD hydropower plant and a 1.9 billion USD railroad project to connect Lhasa to Kathmandu. Other transportation projects include the Pokhara Regional International Airport, a number of roads, bridges and container depots.[8]

China has pledged to vastly increase its investment in Pakistan’s economy and infrastructure sector. Among other initiatives, China has been helping develop Pakistan’s infrastructure sector through the construction of power plants, roads and communication nodes. China is the largest investor in Pakistan’s Gwadar Deep Sea Port, and Prime Minister Nawaz Sharif is working towards the China-Pakistan Economic corridor plan, having already approved a list of early projects including power, roads, railways, the Gwadar port, and energy projects, totaling roughly 35 billion USD. China and Pakistan are negotiating whether to put their energy projects on a fast track in the China-Pakistan Economic Corridor (CPEC).[9]

China also has a lot of active cooperation projects with India. As India’s power gear-makers have struggled to compete in terms of pricing, many Indian power companies have lately been ordering equipment from China and other countries. The Power Construction Corporation of China signed a 2.4 billion USD contract to build the second phase of a massive coal-fired power complex in southern India to help meet the region’s soaring demand for electricity. The project promises to create more than 10,000 jobs in India.[10] India’s ministry of power and China’s National Energy Administration signed an agreement that allows power equipment makers from China to set up power equipment service centers (PESCs) in India to further strengthen cooperation in the energy sector under the India-China strategic economic dialogue mechanism.[11] During Prime Minister Modi’s term, bilateral economic cooperation between China and India are anticipated to increase. During his recent visit to India, President Xi Jinping reached an agreement with Prime Minister Modi through which China will help bring India’s outdated railway system up-to-date, with high-speed connections and better railway stations. In addition, two industrial parks will be set up in Gujarat and Maharashtra, and China will make a roughly 20 billion USD investment over the next five years in Indian infrastructure projects.[12] Some Indian journalists have claimed that “China is investing in Modi’s ego.”[13]

Although economic exchanges between China and SAARC have developed rapidly over the past ten years, economic integration between China and SAARC is much lower than it is with other regional economic integration organizations, such as ASEAN and the SCO. Bilateral trade between China and SAARC is only 2.5 percent of China’s total foreign trade in 2012, and China’s ODI towards the region is less than 0.5 percent of its total ODI.

 

Positive Effects of China-SAARC Economic Cooperation

 

China and South Asian countries are linked together by mountains and waters. Even the towering Himalayas cannot block the mutual economic attraction between China and SAARC. China has a large consumption market and the fastest growing economy in the world, while South Asian countries are rich in both natural and human resources. Combined, the economic integration of China and SAARC will create a huge market with 2.8 billion people, which will bring new force for economic development to China, South Asia and the whole world.

The economic integration of China and SAARC will enhance the economic development of South Asian countries and China in at least three ways. First, most SAARC countries remain at the lower end of industrialization, and unemployment problems are pressing for South Asian governments. China is now at the medium level of industrialization, and Chinese capital is increasingly “going global.” With the restructuring of the Chinese economy, a lot of labor-intensive industries will move abroad. Although some Chinese economists assume that Africa is the best choice for these industries,[14] South Asian countries – especially those with large populations – enjoy better geographic advantages and conditions. Some countries are potentially concerned that China will shift its heavy polluting industries to their countries. But as a responsible member of international society, China would not do any such thing. Countries that accept Chinese investment must have their own environmental standards. It is of vital importance that South Asian countries resolve their employment problems, increase the proportion of manufacturing in their economies and improve economic growth. At the same time, continued Reform and Opening in China will forge a huge market for these countries.

Second, China has been playing an active role in power projects, transportation, and other infrastructure construction overseas, particularly in developing countries. In doing so, it is taking advantage of state financing as well as experience and technology acquired during its three decades of economic growth. Most SAARC countries are behind in terms of their infrastructure. If South Asian countries absorb China’s infrastructure financing and experience, this will change their national infrastructures, promote social and economic development and create better conditions for absorbing even more FDI. Prime Minister Modi’s economic priorities are infrastructure construction and labor-intensive manufacturing sectors, both of which will provide great space for China-India economic cooperation.

Third, over the past three decades of economic Reform and Opening, China has acquired considerable experience that is applicable beyond just economic development and infrastructure construction. In an era of globalization, countries must first have social stability and a peaceful periphery if they want to experience economic development. Political leaders and society should have an open mind towards the outside world, especially toward foreign investment. Political leaders must be willing to reform unsuitable rules, regulations and laws. China is very cautious when communicating with other developing countries about its experiences, so as to avoid Western countries condemning the so-called “China model.” But these experiences can be helpful to South Asian countries, along with China’s economic and technological aid and people-to-people communication. Such communication will improve South Asian countries’ social and economic development, strengthen the integration of SAARC, and create better conditions to resolve regional conflicts. Moreover, China-SAARC cooperation on international financial issues will enhance South Asia’s capability to respond to international financial crises, while benefitting the reform of the international financial system.

 

Obstacles to China-SAARC Economic Cooperaiton

 

China-SAARC cooperation does face considerable obstacles. First, there are some problems with China-SAARC bilateral trade: 1) trade imbalance. In 2012, South Asian countries’ total trade deficit with China was more than 47.8 billion USD. Every South Asian country has a trade deficit with China, and India’s trade deficit with China now reaches more than 28.8 billion USD. Trade deficits have increased constantly. In 2011, South Asia’s combined trade deficit with China totaled about 45.2 billion USD, while India’s alone was roughly 27.2 billion USD. Prior to 2005, India enjoyed a trade surplus in its bilateral trade with China. But this changed very quickly and swiftly.[15]

2) Unbalanced trade structure. Exported merchandise from China to South Asian countries mainly consists of machinery, electrical and electronic equipment and nuclear reactors, as well as other manufactured products. Imported goods from South Asia to China mainly consist of commodities such as ores, slag and ash, cotton, copper, and some other raw materials. Almost every South Asian national leader has complained about the trade deficit and unbalanced trade structure between China and South Asian countries. Many leaders believe that the current situation is unsustainable.

These phenomena are harmful to the establishment of a China-SAARC free trade area. But China has not created its trade surplus with South Asian countries deliberately. China announced the Generalized System of Preferences to many developing countries, including most SAARC countries. Perhaps China should do more to import South Asian goods into China. The main reason for the trade deficit is the backwardness of their industry. How should China attempt to deal with this issue? The only way is for these countries to open up and absorb FDI, introduce advanced technology and production means, improve manufacturing and other industries, and boost exports. Protectionism can play a role, but it cannot solve the problem at its root. It might seem like opening up and protectionism are contradictory, but they are not. Among the SAARC countries, India is China’s biggest trade partner, and India is also one of the countries that has taken the most serious anti-dumping and countervailing measures against China. Before 2005, when India enjoyed a trade surplus with China, India even proposed exploring a free trade agreement with China. But since 2006, with its trade deficit growing, the Indian government has faced considerable opposition on this issue. Both former Prime Minister Singh and Prime Minister Modi have raised the trade imbalance issue with their Chinese counterparts.

Second, there are still significant political and security obstacles. China-India relations are improving. In President Xi’s recent visit, he and Modi agreed to build a close development partnership between China and India, but the foundation of the China-India bilateral relationship is fragile. The two countries lack mutual strategic trust. Indian and Chinese troops were engaged in a face-off when President Xi and Modi held official talks in Delhi. The Indian strategic and security circle is concerned about China’s activities in South Asian countries and the Indian Ocean. Meanwhile, India has set up many restrictions against Chinese companies and Chinese investment over the past several years. It is worth waiting and seeing whether these restrictions will be abolished completely during Modi’s term. India also pays close attention to China’s economic relations with other South Asian countries in the fear that China will encircle India. Sometimes India interferes in other South Asian countries’ economic agreements with China, both openly and covertly. Some Western countries have made alienating maneuvers and rendered this situation even worse. Analysts from Booz Allen and Robert Kaplan fabricated a “string of pearls” strategy for China, and this has been widely accepted by Indian scholars. In fact, even many Western scholars do not believe the “string of pearls” strategy. Just as Emily Brunjes and her colleagues stated, “China’s economic engagement with South Asia … does not reveal activity inconsistent with normal economic interests … The “string of pearls” theory is plausible, but building ports and roads facilitates trade as much as it increases the ability to project power. … We caution against interpreting China’s activity as threatening to regional stability or Indian security.” The signing of the Border Defense Cooperation Agreement between China and India was hailed by Indian media as the country’s most significant diplomatic achievement since the US-India nuclear agreement. Prime Minister Modi agrees that “peace and stability in our relations and along our borders are essential for us to realize the enormous potential in our relations.”[16] Modi has stated that he will focus on the economic development of India, and he has emphasized the importance of enhancing China-India relations. But at the same time, it seems that Modi is also concerned about the so-called “string of pearls” strategy. In the “Joint Statement Between the Republic of India and the People’s Republic of China on Building a Closer Developmental Partnership,” signed by President Xi and Prime Minister Modi, the Indian side did not endorse China’s proposed plan to build a Silk Road Economic Belt and Maritime Silk Road.[17] The latter has been viewed by some Indians as coinciding with the so-called “string of pearls” strategy.

Thirdly, the social stability and security situation of some countries has influenced their economic relations with China. Terrorism has become the biggest obstacle to some countries’ economic and social development. Both Chinese private and state-owned enterprises will not conduct business with these countries. Even if China has invested in such countries, China will withdraw or stop investing when the situation worsens. It is already known that China National Petroleum Corporation stopped its oil project in northern Afghanistan because of disturbances from the local warlord. Sri Lanka is another good example. After the Sri Lankan government restored peace domestically, China increased its investment in Sri Lanka, and bilateral trade has grown rapidly in recent years.

Finally, the economic integration of SAARC has become fragmented. SAARC is now divided between the India camp and the Pakistan camp.[18] Among SAARC countries, transportation facilities are far from enough, let alone just connectivity. Trade volume between India and other SAARC countries is much less than the trade that is conducted with countries outside the region. Such fragmentation is the result of both economic and political factors. On the whole, political factors play much more negative roles than economic factors in SAARC. As the most influential member of SAARC, India has too many contradictions with other member states, heavily affecting the construction and development of SAARC. Although Prime Minister Modi invited other South Asian national leaders to his inaugural ceremony and showed his desire to improve relations with others, India’s contradictions with other South Asian countries will not disappear overnight, unless India abandons its ambition to play the role of “big brother” in South Asia. Furthermore, India’s economic development over the past two decades has not produced substantial spillover effects for its neighbors. Although the India camp is more integrated, India cannot play a leading role in the economic development of these countries because it lacks the financial resources.

SAARC is now in need of external forces to help drive its development and integration. Whether India likes it or not, it will be unable to prevent other SAARC countries from turning to China for financial support. As a neighboring country joined together by shared mountains and rivers, China is different from other SAARC observer countries. The peace, stability and development of South Asia are close related to the stability and development of Southwest China. For China, the security of its sea-lanes in the Indian Ocean is vital to meeting its trade and energy demands. Given that some SAARC countries are suspicious that the integration process will be dominated by India, if SAARC follows the example of ASEAN’s “10+3” system and absorbs China as a formal member, its integration will be improved and it will be able to benefit from China and India as “dual engines.” President Xi Jinping has stated that “China welcomes and supports India’s full membership in the Shanghai Corporation Organization as it expects India to support China in building relations with SAARC so that our two countries can work together and contribute our due share to regional stability and development.”[19]

 

Ways to Expedite China-SAARC Economic Cooperation

 

After President Xi Jinping and Premier Li Keqiang came to power, China’s foreign policy showed some new characteristics and innovations. Among them, two aspects are closely related to China-SAARC relations.

The first concerns the “Chinese dream.” During his trips abroad or meetings with visiting dignitaries since the 18th Party Congress, President Xi has spoken repeatedly to foreign leaders and key individuals about the importance of the Chinese dream – namely, to achieve the great renewal of the Chinese nation. The realization of the Chinese dream requires a peaceful and stable international environment, and China is committed to realizing the dream through peaceful development. Since the Chinese dream is closely linked to the dreams of other people and countries around the world, China is therefore committed to helping other countries, developing and neighboring countries in particular, with their development. China will share more development opportunities with other countries in order to facilitate the realization of its own dream. China hopes to promote and stimulate win-win cooperation and common development with the rest of the world. While working to realize the Chinese dream, the people of China are also working to realize a so-called “world dream” with the entire global community.[20]

The second aspect concerns the right approach to upholding justice and seeking interests while enhancing friendship and cooperation with neighboring countries. Inheriting the fine traditions of Chinese culture while making use of the diplomacy of New China, President Xi has underscored the need to adopt the right approach – upholding justice and seeking interests while developing relations with countries. China should uphold political justice and fairness as a guiding principle. From an economic perspective, China should pursue mutual benefit and common development. When growing relations with its neighbors and developing countries with whom it has long been friendly, China must accommodate their interests rather than seek benefits at their expense. China will follow the right approach to upholding justice while pursuing its interests and strengthening relations with its neighbors and other developing countries.[21] These principles naturally apply to South Asian countries.

As for China’s policies on China-SAARC economic cooperation, President Xi and Premier Li put forward the Silk Road Economic Belt, Maritime Silk Road Plan, BCIM economic corridor, and the China-Pakistan economic corridor (CPEC). These deals involve Central Asian leaders, ASEAN leaders, the Indian and Pakistani leaders and many others. China places a lot of emphasis on these initiatives, especially attempts to enhance the inter-connection of roads as the base for the building economic belts and corridors. During President Xi’s recent visit to four countries in Central and South Asia, a main focus was the improvement of the framework of the Silk Road Economic Belt and the Maritime Silk Road plans. With these initiatives under way, China hopes that its economy will take off together with those of South Asian countries.[22]

The Silk Road Economic Belt, Maritime Silk Road Plan, BCIM economic corridor and China-Pakistan economic corridor are all complementary initiatives. The Silk Road Economic Belt will connect East Asia and to the European Union and improve the development of Central Asia’s natural resources. In the past, the United States even suggested a new Silk Road project to connect Central Asia with Afghanistan, Pakistan and India. There is no conflict between these two plans, and now Afghanistan is very interested in China’s Silk Road Economic Belt plan. If Afghanistan’s situation stabilizes, the two Silk Road plans could potentially be combined.

The China-Pakistan economic corridor can also be connected to the Silk Road Economic Belt. Many CPEC projects will not only boost China-Pakistan relations, but also benefit the larger region, including Central Asia, Afghanistan, the Gulf countries and Iran. The BCIM is another interconnection between China and SAARC that will have wider benefits. The idea of the BCIM Economic Corridor will aid China’s Silk Road diplomacy and trade. Maybe in the future, the BCIM will be connected to the Megon-Ganga Cooperation Initiative (MGCI). We can therefore grasp that the Silk Road, Southern Silk Road and Maritime Silk Road must be understood as interrelated complementary policies. President Xi hopes that China’s westward opening will dovetail India’s so-called “look east” policy.[23]

There are several preconditions for establishing these economic belts or corridors. First of all, they require political and security stability in the region and in each country. Second, international relations among countries in the economic belt or corridors must maintain smooth and improving mutual strategic trust. A smooth China-India relationship will pave the way for close coordination on projects between many stakeholders. Pakistan must see the development of China-India relations from this perspective. The success of the China-Pakistan Economic Corridor (CPEC) greatly depends on the normalization and enhancement of China-India ties.

Political consensus must be reached. Take the BCIM, for example – former prime minister Singh and prime minister Modi expressed very positive opinions regarding Premier Li’s BCIM proposal. During President Xi’s visit to India, the two countries noted the progress made in promoting cooperation under the framework of the BCIM.[24] India has been suffering from an economic slowdown in recent years. Former prime minister Singh did not get any substantial commitments from the United States during his visit there in 2013, since Washington primarily intends to take advantage of the Indian military force in order to contain China. As a result, cooperation with China on economic development has become a realistic choice for India. What is more, this corridor is pertinent to security and prosperity in northeastern India.

There is still some opposition. India’s domestic concerns about the BCIM Economic Corridor are mainly rooted in three factors. Given the unresolved China-India border disputes, the opening-up of the northeastern area may pose a threat to the region’s defense security if conflicts were to break out. A number of rebel groups that share ethnic ties with people in Myanmar and China have been causing turbulence in this part of the country, and regional frictions are likely to turn into international conflicts if the district is opened up. Furthermore, commodities from China and some other Southeast Asian nations sell well in the Indian market, which could change amid regional economic integration.

Such concerns actually expose the fact that domestic vested interest groups in India are a severe obstruction to the country’s social development and international economic cooperation. The opening of the borderlands will bring about redistribution of social and economic interests, and directly cause a decline in the status of some interest groups. The signature of the border defense cooperation may help dispel India’s national security concerns, since such cooperation ensures that the two sides will not resort to force when addressing their border controversies. Economic integration will not only inject vitality into the region, but also weaken popular support for the rebels. India must overcome more domestic impediments than China.

 

Conclusion

 

Although economic relations between China and SAARC have developed rapidly over the past ten years, economic integration between China and SAARC is low compared to other regional economic integration organizations near China. Many scholars have demonstrated that China’s economic engagement with South Asia is not inconsistent with its normal economic interests.

At present, SAARC is in need of outside dynamics to help realize its integration. As a neighboring country joined by common mountains and rivers, China’s prosperous economy is the best driving force for the development of South Asia and SAARC integration. Meanwhile, the Chinese dream requires a peaceful and stable international and neighboring environment, and China is committed to realizing its dream through peaceful development. China is committed to helping other countries – in particular developing countries and neighboring countries – with their development while achieving its own development. China will share more development opportunities with other countries in order to facilitate the realization of their dreams.

To enhance China-SAARC cooperation, Chinese leaders have put forward the Silk Road Economic Belt, the Maritime Silk Road plan, the BCIM economic corridor and the China-Pakistan economic corridor (CPEC). In his speech at the Indian Council of World Affairs, President Xi Jinping said that in the next five years, China and South Asia will increase bilateral trade to 150 billion USD and China’s investment in South Asia will reach 30 billion USD, while providing 20 billion USD in concessional facilities to the region.[25]

The main obstacles are now domestic issues in SAARC and South Asian countries. In order to realize economic and social development and the integration of SAARC, the political leaders from relevant countries must reach consensus on their own domestic reform and opening agendas, achieve security stability in the region and their own countries, strengthen mutual strategic trust, and maintain smooth relations with other countries, including the relationship between China and India.

 

 

 


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