Stranger in a Strange Land: India’s Economic Diplomacy in South Asia

Since the 1990s, as India's influence in world politics has grown, the notion of the "extended neighbourhood" has permeated foreign policy thinking in both political and academic circles. A wide-ranging recent work on the subject highlights the manner in which Indian leaders have come to distance themselves from what has been termed the "Indira Doctrine" of focusing solely on India's immediate neighbourhood.[i]  Officials in Delhi as well as the various arms of the Indian military—especially the navy—now envisage a role for India that stretches beyond South Asia in all directions.  This new logic is manifested in policy labels such as Look East and Connect Central Asia, as well as the notion of Indian interests radiating outward in concentric geographic circles.

Concomitant with this shift in India's geostrategic philosophy has been the full-blown advent of economic diplomacy as a major plank of India's foreign relations. Economic diplomacy refers to how states—often with the significant involvement of non-state actors—conduct their international economic relations.[ii] This practice has two aspects: first, the use of statecraft to promote a nation's economic interests; and second, the use of international economic instruments to further a nation's political or strategic interests.  Since economic liberalisation in the early 1990s, India has done reasonably well on the former but lagged on the latter.

Unfortunately, the two trends highlighted above—a shift in India's conception of neighbourhood, and the centrality of economics in Indian diplomacy—have interacted in a manner that is likely to hobble any great power ambitions that India may have in the near term.  While India's ambitions and influence have achieved global scale, its security challenges remain predominantly domestic and regional, often originating in neighbouring countries. Economic diplomacy offers India powerful instruments to address these challenges in a lasting manner, but Delhi has not risen up to the task.  While seeking economic partnerships with countries further afield, India has neglected to foster the type of economic interdependence in South Asia that is most conducive to security, i.e. one that maximises the cost of disruption to all parties involved. 

There are four principal tools of economic diplomacy that a state might use to achieve this goal: trade, investment, aid and cross-border production networks.  These channels can be ranked in terms of their substitutability; the more substitutable a channel, the less likely it is to bind nations together and thereby diminish the potential for diplomatic crises to spiral out of control.  The most common tool—trade—does not foster as much interdependence as, say, foreign direct investment (FDI), which in turn is less beneficial than cross-border production networks for creating durable mutual economic interest.  Another often-used tool, foreign aid, is perhaps best for short-term gains and in general is highly substitutable and hence less able to contribute to long-term strategic goals. With regard to South Asia, India has exhibited a focus on trade and aid (with underwhelming results), modest efforts to increase FDI flows, and the near absence of attempts to create cross-border production networks.

Over the last decade, India has pursued deeper trading relationships with South Asian countries. In addition to a Free Trade Agreement (FTA) with Sri Lanka, India has been gradually giving unilateral duty-free market access to South Asia’s Least Developed Countries (LDCs)—Afghanistan, Bangladesh, Bhutan, Maldives and Nepal—under the rubric of the South Asian Free Trade Area (SAFTA) agreement, with only 25 tariff lines remaining since 2011 and a goal of zero tariffs on all goods by 2016.[iii]  SAFTA, however, is not an agreement on services or investment, or any other form of economic cooperation, and thus falls far short of promoting trade in a region where services form a large proportion of most economies.[iv]  Even in the realm of goods, in 2012, India's goods exports to South Asia accounted for only 4.74 percent of India's total goods exports. The picture is worse for imports, with South Asia accounting for 0.5 percent of India's overall goods imports.  From the perspective of the nations in this region, India is on average not a major trading partner—Indian exports accounted for just under 13 percent of South Asian goods imports in 2012.[v]

In the realm of investment, particularly FDI, India's focus has been overwhelmingly outside its region. 83 percent of acquisitions by Indian companies abroad between 2000 and 2007 were in North America, Europe, Singapore and Australia.[vi] South Asian nations account for less than 3.5 percent of India's total outward FDI.[vii] On the recipient side, firm-level data show that between 2002 and 2006, Indian firms invested not more than $20 million per year in South Asia, which constitutes less than four percent of FDI received by these countries.[viii] Foreign aid offers a ray of hope, albeit a short-term one given its highly substitutable nature. A recent analysis of India's aid giving in the period 2008-10 found that almost 90 percent of Indian aid is channelled to South Asian countries.[ix]  Project-level data show a similar level for the year 2010, at just under 87 percent. However, figures for 2009 and 2008 were 40 percent and 49 percent respectively.[x]

Despite these developments, India is nowhere close to establishing the strongest forms of economic interdependence that exist in the world today, which are cross-border production networks that take advantage of advances in information and communications technologies to horizontally segment their supply chains across multiple geographies—mostly at the regional level—thus profiting from the respective comparative advantages of different economies while also creating less substitutable forms of economic integration between nations.[xi] The most obvious example of a state that has benefited from these types of networks, and has also been drawn closer to its neighbours as a result, is China. Indian firms have not made similar efforts at creating supply chains in South Asia due to the lack of connectivity in the region, similarities in comparative advantage, the continued prevalence of non-tariff barriers, and the absence of intra-industry trade, which is a symptom of the difficulty of cross-border investment in the region.[xii] Due to the various infrastructural, political and security challenges in the region, Indian companies would sooner invest in East Asia, Europe, or North America than in South Asia. This creates a self-perpetuating cycle where South Asia remains bad for business because it is bad for business.

The cost of India's economic inaction in the region is not immediately visible. It lies largely in the opportunity cost of low economic integration in South Asia, a ready market of 1.65 billion people and average economic growth rate of 5.4 percent in 2012.[xiii] This cost has both economic and security dimensions. While it certainly represents a tremendous economic opportunity foregone by India in its own backyard, it also leaves avenues open for third parties such as China and the United States to pursue their own economic diplomacy in order to make strategic gains at India's expense.  Prominent among these is what Indian strategists have termed China's 'string of pearls' strategy of spending considerable sums on building or upgrading ports in India's neighbouring countries, specifically Gwadar in Pakistan, Hambantota in Sri Lanka and Chittagong in Bangladesh.  Recently, China offered Iran $80 billion for upgrading port facilities at Chabahar, a vital node in India's plans for creating a commercial route to West and Central Asia that will bypass Pakistan.[xiv]

Pakistan itself remains a major strategic challenge. The impending drawdown of American troops in Afghanistan is likely to give the military-intelligence complex in Islamabad a freer hand to continue its policy of building 'strategic depth' in Afghanistan by cultivating the Taliban and other friendly militant forces, and even possibly channelling manpower and materiel into the Kashmir valley, as it had done following the Soviet withdrawal from Afghanistan in the late 1980s. India's predominant interests in the coming decade therefore lie in constraining China's influence and containing Pakistan's increased room for manoeuvre against India. Within South Asia, containing Pakistan will require vigorous diplomacy that can win over nations such as Nepal, Sri Lanka and Bangladesh to the Indian side in a potential conflict, which is most likely to take the form of a terrorist attack that may precipitate a diplomatic showdown. Building positive bilateral relations with India's neighbours is not easy given historical animosities and the mutual insecurity that accompanies relations between smaller nations and a regional hegemon (as India has been looked at by its neighbours). It is precisely to overcome such barriers that deeper economic relations are necessary. 

In a world of growing economic interdependence, India should work towards creating the conditions for peace, cooperation and mutual prosperity with its immediate neighbours. As other regions have continued to deepen and institutionalize inter-state cooperation—be it through the European Union, the African Union, Mercosur, or ASEAN—South Asia remains a region deeply divided, not just institutionally but economically and culturally as well.  India prefers to operate at extra-regional or global levels through groupings such as BRICS, IBSA, and the G-20. Left unchecked, a continued focus on the extended neighbourhood and global affairs at the expense of better relations with South Asia is likely to exact a high price in years to come.

Disclaimer: The views expressed in this article are personal.

Rohan Mukherjee, Research Scholar at Princeton University.