Strategy Note /
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China and India: Himalayan friction matters

  • China-India skirmishes and tension across Asia much more likely than an all-out war (economic costs too high for both)

  • India needs China's trade more than the other way round and higher military spend may eat into its fiscal stimulus

  • But overall costs for China ratchet up if the US adds this to its list of pretexts for capital restrictions on China

China and India: Himalayan friction matters
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

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Tellimer Research
28 May 2020
Published byTellimer Research

As military friction renews between China and India in the Himalayan region separating the two countries, we offer the following context and tentative conclusions:

(1) Skirmishes and tension, not war – An extensive, full-blown war is extremely unlikely: both sides have far more to lose (economically) than to gain (in terms of territory). Nationalism plays a big role in the rhetoric of the leaders of both China and India, and both have demonstrated their ability to forcibly quell domestic dissent, but their political legitimacy is ultimately dependent on delivering economic growth. Nevertheless, both sides have crept closer to each other's territory as the buffer-zones around their land border (left behind after the British withdrawal from the region over seven decades ago) have effectively shrunk (because of greater infrastructure development on both sides) and as their rivalry extends across the region (with both competing for influence and control in Afghanistan, Bangladesh, Iran, Maldives, Myanmar, Pakistan, Sri Lanka, and Vietnam).

(2) India needs China trade more than China needs India trade – Exports to China account for a much larger share of India's global exports (9%) than exports to India do for China's global exports (3%). Arguably, India has more to lose from any spillover of military tension to trade tension. (Foreign direct investment flows between the two are comparatively trivial.)

(3) Catalyst for higher military budget in India – India spends substantially less on military defence, both in absolute US$ terms and as a percentage of GDP, than China. Similar to domestic political pressure in India seen after previous episodes of tension with China, there may be calls to raise military expenditure significantly.

(4) Another potential trigger for US capital restrictions on China – The US is obviously much more closely aligned with India and tension between China and India is yet another node of broader US-China conflict (trade tariffs and blocs, technology standards and access, influence in multilateral organisations, restrictions on capital flows, Covid-19 responsibility, independence of Hong Kong and Taiwan, 9-Dash line territorial disputes with Malaysia-Philippines-Vietnam, and the treatment of Uighurs). If China-India tensions escalate, they could act as a catalyst for US policies that target trade and capital flows to China. 

The world – and China and India's roles – have completely changed since 1987

A generation ago in 1987, China and India squared up to each other across their Himalayan border, two and a half decades after a full-blown but brief war. Those same tensions, left unresolved after 1962, 1987, and 2017, are flaring up yet again.

In 1987 the total military spending of both countries was similar. The US was relatively more aligned with China than with India (and the USSR was aligned in the opposite direction). China and India were similarly sized economies and collectively accounted for less than 4% of global GDP. As such, their friction in 1987 was far less important, on a global scale, compared to the Perestroika and Glasnost policies underway in the USSR under Gorbachev. And to the degree that a group of investors identified themselves as emerging market investors, it hardly mattered at all. The MSCI Emerging Markets index was created a year later in 1988 with no place for either India or China (because they were not sufficiently accessible for foreign investors until 1994 and 1996, respectively).

How things have changed compared to 1987! Now, total military spending of China in US$ is almost four times larger than that of India. The US is now much more aligned with India than with China (and Russia is tilted in the opposite direction). China's economy is now almost five times the size of India's and collectively they account for c20% of the global economy. China and India account for 40% and 8% of the MSCI EM equity index, respectively. In global geopolitics and emerging market investment hardly anything seems to matter as much as China. And if China is rendered offside at some point in the future as the US potentially weaponises capital flows (eg imposes sanctions or restricts portfolio capital inflow to China) then little will matter to emerging market investors as much as India. This conflict clearly merits attention.

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