There is perhaps no country more feared and less understood in India than China. In recent weeks Delhi newspapers and television have been awash with stories about the People's Liberation Army crossing the Himalayas to daub rocks with Chinese characters, making daredevil helicopter raids to drop (stale) tinned food on hapless farmers and trading fire with Indian soldiers.

India's Kashmir state government, apparently, said its territory was being taken "inch by inch" through such incursions. Ominously, authorities last week in Kolkata impounded a plane carrying arms from the Middle East to China.

While the foreign ministries in both countries play down the reports, there are concerns that left unchecked, things could spiral out of control.

The spat began in June. Chinese bloggers vented their fury when India abruptly announced that it would be sending 60,000 troops to bolster tens of thousands of soldiers to Arunachal Pradesh – an Indian state that Beijing claims as its own. One online poll in China claimed that 90% of respondents thought Delhi's actions posed a "threat".

At the heart of this dispute lies the Tibetan question. Historically, China says Arunachal Pradesh's 35,000 square miles was part of "outer Tibet". In a short bloody war, Chinese troops overran Indian positions in the Himalayas in 1962 before retreating. Since then the two sides have tried to discuss their way out of a problem. More than dozen rounds of talks have yielded little.

For years the dispute has rumbled on, attracting little international attention. However, that changed this summer with the arrival of fresh troops – and an Indian airforce squadron of advanced fighters – which analysts say were needed to cope with China's rising military might, especially in Tibet.

The Indian defence magazine Force points out that the PLA could mobilise four divisions – about 50,000 men – in 24 hours to the Sino-Indian border. "Awesome military projection capability by any standards," says the magazine in its latest edition.

To get a taste of how difficult things might be for India, in a diplomatic first, China "internationalised" the issue of Arunachal Pradesh, highlighting its disputed status in July. Beijing formally objected to a $60m loan for India because it would fund irrigation projects in Arunachal Pradesh. Although the loan was later approved, Chinese experts say there is still "room to change" the project.

Arunachal Pradesh has been slowly integrated into the Indian state since Delhi sent troops in 1950 carrying papers signed by the Tibetan government in Lhasa, which transferred 35,000 square miles of the Himalayas to India. Beijing rejects Delhi's claim, saying the region was subject to a crafty piece of real estate theft by British imperialists in 1914 when China was in chaos.

A solution has always been in sight: Beijing relinquishes its claim to Arunachal Pradesh and Delhi gives up its demand for 15,000 square miles of stragetically important Chinese-held mountainous land bordering Kashmir.

But Arunachal Pradesh for China is not just a territorial issue but an existential one. The state is home to the town of Tawang, birthplace of the sixth Dalai Lama, where Tibetan Buddhism's biggest monastery, after the Potala palace in Lhasa, sits.

Tawang is also the repository of perhaps the last vestige of a Tibet submerged by China's rise – sustaining the idea of religious freedom for the diaspora and keeping alive a centuries-old culture and language. In conversation, the Monpa people who dominate the local area will tell visitors that Tawang could be Tibetan Buddhism's new Rome, a base from where to spread the faith.

China is alarmed by such talk. Beijing sees Tawang not as a place of serenity but as a spiritual spy camp – ultimately challenging the ruling Communist party's control in Tibet. These feelings were heightened when the Indian government said this week it would allow the Dalai Lama to travel to Tawang, adding he was "free to go anywhere in India".

The present Tibetan leader has not been a regular visitor to the town. He passed through when he fled Tibet in 1959 but he has only been allowed back twice since: once in 1982 and then again 2003. This time around he will open a hospital he funded.

The Indian backing to the Dalai Lama comes at a critical time. The Obama administration said this week that the president would not meet the Tibetan leader during his upcoming trip to Washington – a break with tradition. George Bush and Bill Clinton met the Dalai Lama when he arrived in the American capital. Afraid that the White House was now kowtowing to Beijing before the president's visit this November to China, Tibet's government in exile openly said even the US was now "appeasing" China. This is a breakthrough for China – which is unafraid of criticising any head of state for meeting the Dalai Lama, who they see as a man determined to "split the motherland". So far 170 countries out of 193 in the United Nations have acceded to China's demands.

This leaves India in a difficult, lonely position. It already sees Chinese ports and military bases strung across the Indian Ocean – the so called "string of pearls" strategy designed to check Indian influence in its backyard. Delhi has been outbid for vital oil and gas resources by its bigger, richer neighbour. On most measures of hard power – number of nuclear weapons, economic size, population – India lags behind.

China is not afraid to flex its muscles: it blocked India's bid for a UN security council place and tried to shoot down a groundbreaking US-India nuclear deal.

Delhi says it is in the nature of development for the two large Asian nations to compete and co-operate for resources, cash and technology. China is India's largest trading partner, with two-way trade volumes crossing $50bn in 2008. The two countries, which are both home to millions of poor people, have worked together in trade and climate change – fending off advances from the advanced nations.

For both, Tibet makes it easier to be antagonists rather than collaborators. Unless both manage to work together to resolve their differences there is a chance the two populations will get bogged down in adversarial nationalism. The media war could then explode into bloodier conflict on the roof of the world.