Why the Japan-India alliance is all about China

Lowy Interpreter

India and Japan lie at the extremes of oriental Asia, and to a casual visitor the two countries feel about as different as could be. Yet they share powerful bonds on many levels. Shinzo Abe and Narendra Modi promised their electorates national rejuvenation. The bear hug between them last week was in Kyoto, famous for its thousand Buddhas, reflecting India's ancient influence. Japan's progress likewise has inspired Indians for more than a century.

India and Japan now have a 'special strategic partnership', a diplomatic designation that India had previously bestowed only upon the USSR. Though the two countries signed no formal political agreement, loaded geopolitical descriptions like 'pivot' are headlined.

Although China was carefully unmentioned by Abe and Modi, there followed a predictably sensitive reaction from its state media making an argument that is hard to fault: Japan and India are far apart and China, standing between them, is much more important to either country. 'The increasing intimacy between Tokyo and New Delhi will bring at most psychological comfort to them.'

Yet their relationship is about far more than geopolitical symbolism. The Abe-Mode summit was primarily about business and economic development. Their joint communique promised a doubling of Japanese direct investment and economic development assistance, and US$33 billion of deals were announced (tellingly, China is offering an identically sized package for Pakistan). Japan and India are highly complementary economic partners and they need each other badly. And despite protestations to the contrary, this really is all about China.

For India, Japan is a source of capital and technology, and it pioneered the 'East Asian development model.' Deutsche Bank calculates that for India to grow at 6-7 per cent like East Asia, savings and investment will both have to rise from (an already impressive) 30 per cent to 35-40 per cent of GDP, and investment productivity will need much improvement too. India suffers from bureaucratic delays and weak human development. Gujarat state under Modi grew 2.5 per cent faster than national average last decade by getting some basics -- power, roads, red tape -- right. Gujarat punches above its weight in attracting large export-oriented projects. Modi wants India to become a superpower in exports, where China outstrips it seven times. China itself runs a stiff trade surplus with India, something Modi wants to redress.

Export earnings will help India fund the higher investment rates, but massive FDI will also be necessary. India scores badly here, with net FDI recently falling back to 1 per cent of GDP; per capita it trails far behind China and even Cambodia. The reasons why foreigners are deterred from investing are obvious: 'there is a fear, and the fear is the labour laws.' They are also scared away by price and rent controls, byzantine land regulation and arbitrary tax rulings. Indians themselves are globalising partly to evade home country restraints.

For Japan, India represents a new market, a 'China+1' diversification alternative for its supply chain, and possibly a source of labour and migrants. Across many different technologies, Japanese companies have the money, knowhow and motivation to develop Indian partners. They have been less deterred by India's investment barriers, with Suzuki, Mitsubishi, Daiichi Sankyo and DoCoMo making large investments in India (albeit with mixed success). Recognising the need to improve India's infrastructure, Japan in 2008 began funding a huge freight-rail link and hopes eventually to sell high-speed trains too. Japan and India failed to reach a civil nuclear agreement last week, but this is another area where investment, expertise and experience can be shared.

China wants to sell nuclear power stations and bullet trains all over the world too. But from India's perspective, China's agenda looks different to Japan's. Whereas Japan and India occupy different ends of the development scale, and therefore complement each other, China is competitive throughout the value chain: it is a full-spectrum competitor. Bulging with excess capital, excess capacity and its own young workers, China prefers to export, and to invest on its own terms. Upgrading India's industrial base cannot be its priority.

The largest enterprises in Modi's exemplary state of Gujarat, like Reliance's massive oil refinery and Adani's Mundra power complex, were vendor-financed by Beijing, designed and pre-fabricated in China, and assembled in India by skilled Chinese workers walled off in dormitories. Smartphones made in China have flooded India; Indian brands merely slap a badge on the outside. As China busily sets up ostensibly multilateral 'south-south' lending agencies like AIIB and the New Development Bank, India must cultivate other channels of funding and expertise.

To be sure, the India-Japan partnership need not be adversarial to China. However the commercial reality is that China's formidable competitiveness is catching Japan and leaving India trailing; China has become the prism through which both countries view their own hopes and fears. Modi himself is warily admiring of China and probably envies its authoritarian briskness. He and Abe have their own daunting domestic problems and both must embrace reform from within. But they can help each other.

Originally published by The Lowy Institute publication The Interpreter. Republished with permission.