Evolving India-Japan Relations and the Way Forward

Introduction:
The complementary nature of Indian and Japanese economies, and their converging political and security interests have led to the enhancement of India- Japan relations in the recent times. While the emergence of a new India has opened up many business opportunities for Japan, and the world at large; the increasing threat various countries of the region feel on account of a resurgent China, has led India and Japan to strengthen their relationships in the political and strategic spheres. It has to be noted here that while the rise of the Chinese economy has opened up many opportunities for India and Japan in the economic sphere, China’s increasing assertiveness particularly in the South China Sea, and its increasing cooperation with Pakistan and Myanmar, has concerned Japan and India respectively. These concerns get reinforced from the fact that both the countries have boundary disputes with China. Both the countries also feel very realistic threat which can accrue from nuclear Pakistan and North Korea, which are being supported by China, making it a country of common concern.

The rising India-Japan relations got a boost from the launch of strategic and global partnership between the two countries in 2006. The partnership between the two countries is based on five pillars of cooperation: Political, Defence and Security cooperation, Comprehensive Economic Partnership, Science and Technology Initiative, people to people exchanges, and cooperation in Regional and Multilateral fora.
Economic:
India’s emerging buoyant economy, young and expanding population, lower costs of production, and a large market, combines well with Japan’s technological prowess, manufacturing skills, and financial resources. India provides an excellent opportunity for Japanese companies who are looking for new areas for investments and markets. India’s long term need to develop its economic and social infrastructures, in order to grow its economy; and the availability of cash with Japan at a time when other players are short of funds presents a rare opportunity for both the countries to strengthen their economic relations.

Recently, Japanese currency Yen has been strengthening in the international market affecting Japan’s export competitiveness. Due to the strengthening Yen, costs of production in Japan are likely to increase, which can further affect its export competitiveness. Therefore, it is mandatory for Japan to invest overseas in countries which provide cheap costs of production. The increasing prices of oil in the world market also make it more sensible to move production bases closer to the centres of consumption, due to the rising costs of transportation. Japan has also been facing numerous internal problems like a shrinking work force, mounting public debt, and prospects of a prolonged deflation. By investing in India, Japan can capitalize and strengthen its own economic position, and in turn help in accelerating India’s economic development.

Bilateral India-Japan trade has begun to rise from $4.1 billion in 2001 to $10.36 billion in 2009-10. But, this is very small compared to the rising bilateral India-China, or, Japan-China trade.¹ In 2009-10 bilateral Japan-China trade stood at $232.2 billion, which was about twenty times that of India-Japan trade.² In the current fiscal 2010-11 bilateral India-China trade has already crossed $60 billion, which is about five to six times that of bilateral India-Japan trade.

Nevertheless, though China has emerged as India’s biggest bilateral trade partner, India is concerned about the nature of trade and rising trade imbalances with China, and fear of China grips Indian businesses.

India has a record trade imbalance of $20 billion with China, as China of late has started exporting high-end value added products such as electrical machinery, electrical goods and components, organic chemicals, etc, to India, widening the trade deficit.³ Moreover, as India’s export to China largely consists of ores, minerals, primary and semi-finished iron and steel iron ore, China’s announcement in November 2010 to spend 30 billion Yuan ($4.5 billion) in the next five years to expand exploration of mineral deposits within the country, to reduce dependence on imports for minerals, the trade imbalance between India and China are likely to grow. (The Chinese government wants to limit imports of iron ore to 50% of consumption in China, and copper ore to 75%) Besides, India and China have also traded bans on import items from the other country, on different accounts.

Therefore, to offset any adverse impact from growing trade imbalances between India and China, India not only needs to diversify its export structure and start exporting value added goods, it needs to embark on a new phase of widening bilateral economic cooperation with Japan to take advantage of the complementary nature of the two economies. Bilateral India-Japan trade is targeted to cross only $20 billion by 2012.⁴ But, economic cooperation between India and Japan needs to be enhanced significantly to counter any negative fallout of India’s increasing dependence on China’s exports, considering the growing trade frictions, and trust deficit between the two countries in political and security spheres.

Similarly, though Japan has large trade deals with China, it cannot rely on China, given the fact that both the countries have historical animosities, and Japan feels itself marginalized in the face of the growing Chinese economy. The recent incident in the South China Sea, after which China stopped the export of rare earth minerals to Japan, highlights the vulnerability of Japan’s economy vis-à-vis China. As China accounts for 97% of the global supply of rare earth minerals which are crucial for high technology industries from mobile phones to missiles, India and Japan have decided to explore the possibilities of cooperation in the development, recycling, and reuse of rare earths and rare metals, and in research and development of their industrial substitutes, during the PM Manmohan Singh’s visit to Japan last October.⁵ Similarly, it is necessary for India and Japan to diversify and increase trade and other economic relations in all other possible sectors, to thwart any negative impact on their economies by their increasing dependence on China in the long run.

For this, the signing of Comprehensive Economic Partnership Agreement (CEPA) between India and Japan on 16th February 2011 is significant, as it is likely to accelerate trade and economic partnership between the two countries, and will act as a hedge against their increasing dependence on China in the economic sector. But, this agreement would come into force only after ratification by the Japanese diet.

Once Free Trade Area between India and Japan comes into force, as many as 9,000 products, ranging from steel, apparel, and pharmaceuticals to capital goods are expected to be traded either without duty or at substantially reduced tariffs. It will open up new avenues for deepening mutual engagement in trade in goods and services, investment, and technology. According to Japanese negotiator Takeshi Matsunaga, the EPA provides for a high level of liberalization of tariffs by both sides and places them on an equal footing. However, there will be a negative list of items on which duties will not be reduced. In this list while India will put about 8% of its tradable items, Japan would put only about 3% of its tradable items. Thus India will have a long negative list, which would be outside the pact. However, in the medium term and beyond, the list would be trimmed and rationalized to better actualize the gains from trade and investment.

The CEPA agreement is quite comprehensive, as it includes market access, tariffs, trade in services, and investments. Also built into the agreement is India’s preferred principle of free movement of natural persons. This means a free flow of professional talent in the services sector. This will benefit both countries, with India gaining the acceptance of this principle in the first place. The CEPA also covers facilitation of business environment and the rules of origin, which are used to determine the country of origin of a product for international trade. It will help India to make inroads in the Japanese market in the areas of its strength, like: Information technology and Pharmaceuticals; by ensuring national treatment for its companies in registering drugs, making it easier for them to get over this barrier, a deterrent in most countries. In return, it will help Japan to meet its demand for high quality and inexpensive generic medicines.

The conclusion of bilateral trade and investment agreement would help Japanese companies in availing lower customs duties, and other advantages similar to Korean companies in India, as CEPA signed between India and South Korea in August 2009 reflects. Earlier, Japanese companies lost to their South Korean counterparts in major sectors such as electronics, and automobiles, areas in which Japan once dominated on a global scale.

In terms of Official Development Assistance (ODA), since 2003 India has been the largest recipient of Japanese ODA. Japan provided approximately 218 billion yen (Approx US $2.58 billion) of ODA Loan to India in 2009-10. Since 2003 the total cumulative ODA Loan that Japan has given to India equals to approximately 3,400 billion yen (Approx US $41 billion).⁶ Through ODA and Special Economic Partnership Initiatives, India has embarked upon mega infrastructure projects which have the potential of transforming the Indian economy. Japanese companies are partnering with India to build Metro Rail Services in cities like, Delhi, Kolkata, and Chennai. The Dedicated Freight Corridor project as well as the Delhi Mumbai Industrial Corridor Project has also been launched with Japanese cooperation. The freight corridor is aimed at coping with the increasing demand for freight transport in India by constructing a new dedicated freight railway system, and improving and modernizing inter-nodal logistic system, which will promote comprehensive regional economic development along the freight corridor. For this, Japan has agreed to provide low interests loan of 90,262 million yen (approximately Rs.4,423 crore).⁷ India and Japan have also extended their ongoing cooperation in the development of infrastructure in India, to the southern parts, which envisions linking infrastructure, industrial, and technical bases in South India with Southeast Asia. As at present many Japanese businesses are apprehensive about the limited infrastructure development in India, these developments on the infrastructural sectors would accelerate economic partnership between the two countries. It is to be noted here that though since 1986 Japan has been India’s highest official aid giver; such enthusiasm was not met by Japanese private sector, which found China a more attractive destination.

According to the Japanese External Trade Organization, (JETRO), Japanese firms increasingly prefer India as an investment destination over China. The number of Japanese companies in India has grown three fold over the last three years from approximately 100 companies in 2006-07 to 300 in 2009-10. Japan ranked seventh in terms of cumulative foreign direct investment (FDI) in India in the period from April 2000 to March 2010, accounting for US$ 3,714 million. Out of these just in the period of 2009-10, US$ 1,183 million was invested in India, according to the data released by the Department of Policy and Promotion (DIPP).⁸ In the private sector, Japanese investments in India have been mainly in the form of mergers and acquisitions, as is evidenced from Japanese-Indian companies ties like Ranbaxy-Daiichi Sankyo, Hero-Honda, Tata- DOCOMO, etc. which have made sizeable investments in India. Japanese are finding the cost efficient Indian manufacturing capabilities in sectors such as auto, auto-component, and pharmaceuticals particularly attractive. Recently Mitsui took an equity position in an active ingredient drug manufacturer Arch Pharmalabs of Hyderabad.⁹ Takeda, the largest pharmaceutical firm of Japan, is expecting to close deals with Torrent pharmaceuticals of Ahmadabad, which would enable it to outsource research, drug discovery process, conduct of clinical trials and manufacturing to the Indian producers.¹⁰ Kobe Steel has signed up with Steel Authority of India Limited (SAIL) to explore bringing in its patented third-generation iron making technology.¹¹These investments show that there has been an upsurge in economic bonhomie between the two sides.

The two countries also signed Memorandum of Understanding (MOU) on easier visa proceedings, which will facilitate the free flow of people between both the countries. India will grant three year work permit to Japanese businessmen, thus lessening the burden of executives applying every year for extension of their visas. Together with CEPA easier visa procedures will help India and Japan to strengthen their economic relations.

Taking into account all the cooperation between India and Japan in the economic sector, it is axiomatic that economic relations between the two countries have been on a rise in the recent times, which would further get a boost with the signing of CEPA in the due course of time.

Nuclear:
To meet its energy needs, India would like to partner Japan on the peaceful uses of nuclear energy. However, while the civil nuclear agreement between India and Japan is under discussion, the negotiators face the challenging task of harmonizing a pacifist principle with a pragmatic policy. They are actively exchanging discussions about nuclear energy industries, including through business missions. As the business potential of nuclear energy cooperation is huge, there is likely to be a civil nuclear deal between the two countries, on the lines of the deals signed with other countries. Japan is under immense pressure to sign a nuclear cooperation agreement with India, from its own business lobby led by Hitachi and Toshiba. These firms see immense business potentials from the Indo-US Civilian nuclear deal, and would like to see Japan enter into a nuclear cooperation agreement with India.

Civilian nuclear cooperation agreement between India and Japan is vital also because all the US and French firms, which have bagged contracts to build nuclear plants in India are either partly or, wholly owned by Japanese companies. As Japanese firms have very advanced capabilities in the nuclear field and play a very important role in the global supply chain, it will not be possible for these companies to use Japanese technology, because of Japan’s ban on the transfer of military and arms related technology since 1976. For example, French firm Areva depends upon Japan Steel Works, the world’s main forger, and Mitsubishi Heavy Industries, for the manufacturing of equipments that are installed in Areva’s nuclear power plants.

However, as India is not a signatory to CTBT (Comprehensive Test Ban Treaty) or, NPT (Nuclear Non-Proliferation Treaty), Japan is apprehensive about signing a nuclear cooperation agreement with India. But, the discriminatory nature of NPT has refrained India from signing the treaty. As far as CTBT is concerned, India has unilaterally declared a moratorium on testing, but wants the world to move categorically towards nuclear disarmament in a credible time- bound manner. FMCT (Fissile Material Cut off Treaty), which aims to stop further production of fissile material for weapons purposes, India’s stand is that it will accept anything which is universal, non-discriminatory, and effectively verifiable in nature.

Considering India’s stand on different non proliferation regimes, it is highly axiomatic that both the countries seem to share the end goal of nuclear non-proliferation, but, differ on the means to that end. This may be because of the fact that both the countries face different security challenges, and hence prescribe different means to meet those challenges.

Both the countries supported each other in India’s plan to set up a Global Centre for Nuclear Energy Partnership, to augment and coordinate dialogue on nuclear energy cooperation; and Japan’s plan to establish Integrated Comprehensive Support Centre for Nuclear Non-Proliferation and Nuclear security. In global R&D on nuclear energy India is also part of the global International Thermal Energy Research Project in which Japan is the lead country.

Therefore notwithstanding the perceptional differences, considering the convergence of interests, the chances of conclusion of India-Japan nuclear cooperation for the peaceful uses of nuclear energy are very high. Moreover, as South Korea has outshone Japanese companies in the Indian market especially in the electronics, Japanese companies will not like to lose their clout in India’s nuclear power generation market; as India-South Korea nuclear cooperation is also on the card.

Strategic:
India and Japan are also extending their cooperation in the strategic and security sphere through bilateral and multilateral exercises, information sharing, training and dialogue, to promote their interests at regional and global level. For this both the countries signed a security cooperation agreement in 2008. Although the 2008 agreement does not sound very grand, its significance can be gauged from the fact that Japan has such a security pact with only two other countries – the United States and Australia. In the Japan’s National Defense Policy Guidelines (NDPG) 2010, India figures among the four countries/ regions with which Japan wants to enhance its security cooperation, the other countries/region being Republic of Korea, Australia, and ASEAN (Association of Southeast Asian Nations), besides its traditional ally United States. As India needs to enhance its cooperation with other countries to secure its interests in the Indian Ocean, Southeast, and East Asian region, India-Japan ties can become the pivot around which these co-operations can be consolidated.

Japan needs India’s cooperation to secure its oil supplies in the Indian Ocean, which are becoming increasingly endangered, due to the rising conventional and non-conventional security threats. In this regard, the two countries are involved in coordinated anti-piracy operations in the Gulf of Aden to combat piracy off the coast of Somalia, besides a number of other countries. Both the countries have also launched Japan-India Shipping Policy Forum, and desire to enhance their cooperation in responding to security challenges such as terrorism, maritime security, counter-piracy, humanitarian assistance, disaster relief, and other areas. In this regard the addition of a third objective to the Japan’s security policy in NDPG 2010 that is ‘securing global peace and stability and ensuring human security’ besides the earlier two objectives that is ‘to prevent and repel external threat from reaching Japan’, and ‘to improve international security environment to reduce the chances that any threat would reach Japan’, opens up huge opportunities for both the countries to widen their security interests.

India and Japan face a realistic threat from an increasingly assertive China, and need to counterbalance China to protect their own interests. Such a condition propels both the countries to design a strategy of China’s containment, which would be in the larger interests of securing peace and stability in Asia. Considering the increasing nationalistic fervour in China, which has the potential of jingoism; it is delusional to expect that China’s rise would be peaceful, more so in light of China’s resort to strong arm tactics in settling of international disputes in the recent times. This is evident from visa issue of Arunachal Pradesh and Jammu and Kashmir in India, and the fishing boat incident in the South China Sea in September 2010, in which relations between China and Japan got strained after the seizure of a Chinese fishing boat by Japan. Notwithstanding the disputed nature of the islands, China’s strategy to send fishermen to pick up a fight with Japanese coast guards is an illustration of how China’s foreign policy operates. It uses civil population as fodders to secure its strategic interests, giving the government deniability. A similar trend can also be discerned from the fact that China stopped export of rare earth materials to Japan following the incident without China’s government imposing an embargo. In case of India, China has unilaterally decided that some parts of Jammu and Kashmir or, Arunachal Pradesh are not Indian territories, and started issuing ‘stapled visas’ to the people from these regions. Though Indian government was a bit late in responding to China’s designs on visa issue in Jammu and Kashmir, it was quick to realize and protest against China’s designs in the Arunachal Pradesh.

Taking a cue from all these incidents, India and Japan need to design a strategy to counter China’s increasing assertiveness in the long run, and its desire to become the hegemon the Asia –Pacific region. As China has encircled India with its ‘string of pearls’ strategy by establishing its strategic naval presence at India’s surrounding countries like Pakistan (Gwadar), Srilanka (Hambantotta), Myanmar (Sittwe), Bangladesh (Chittagong), Maldives, and Mauritius; India needs to adopt a similar strategy in collaboration with Japan to limit China within its own boundaries, by extending cooperation with China’s neighbours both in East and Central Asia region.

The Way Forward:
Taking all economic and strategic dimensions into account it is necessary for India and Japan to enhance their relations from the nascent level it stands at present. Some scholars may be apprehensive about the efficacy of partnership with the declining economic clout of Japan. But, given Japan’s high domestic savings, a well diversified economy of $5 trillion, which is 3.5 times the Indian GDP, and a huge current account surplus, it is premature to write Japan’s epitaph. It is the only Asian country, which has excess capacity in the form of technological prowess, and the economic might which will keep it as a significant economic player in the world for a long time to come.

From Japan’s perspective it is not only necessary for Japan to hedge its stakes by investing in India, it makes sound economic sense to invest in India taking into account the increasing labour costs and near saturation of China’s market. Moreover, as a research report by Morgan Stanley had said that India could overtake China’s growth rate by 2013 and is expected to be notably ahead by 2015 onwards, this opens up huge scope for Japan.

However, to strengthen relations in the economic domain, Japanese companies are concerned about issues relating to infrastructures, taxation system, and customs clearances in India. The land acquisition is also a major obstacle to facilitate Japanese investments in India. In a report, the Heritage Foundation has held corruption responsible for choking growth in India by making it difficult for entrepreneurs to start business. India ranks 165th out of 183 countries in the World Bank’s measures of the difficulty of starting a business.¹² These bottlenecks need to be removed to facilitate Japanese and other foreign investments in India.

If the economic cooperation between the two countries becomes significant both the countries can enhance monetary and financial cooperation in the future, by transacting in local currencies bilaterally. This would lead to saving the transaction costs between the two parties as well reduce the time period of transactions. This would also lead to the emergence of Yen-Rupee exchange rate, that underlie demand and supply balance of two currencies, and would thwart any negative development on dollar in the international market. A bilaterally determined exchange rate would reflect the balance of exports and imports between the two countries, instead of being calculated as an indirect rate influenced by the movement of the dollar against these currencies. Moreover, as the bilaterally determined rate will be determined more by fundamentals, it is likely to be more stable and ensure more predictability in trade transactions. Finally, for a current account deficit economy like India, which throws up a chronic excess demand for dollars, this would effectively reduce the quantum of excess demand for dollars since the bilaterally traded transactions would go off market, which would in turn stabilize rupee-dollar rate.

As forex markets cannot operate in isolation and a bilateral transaction and settlement regime would entail changes in money market access to participants, in the future India and Japan can allow exporters and importers to have access to cash sweeps and liquidity pools, as well as time deposits and investment products in Japanese Yen and Indian Rupee. Any customer with a Japanese Yen account or Indian Rupee account may be allowed to participate in Japanese or Indian bonds issued in their countries; or, they may participate in certificate of deposits issued by the authorized institutions in their countries. Given the expected increase in trade/ projects between the two countries, due to economic complementarities and conclusion of CEPA, such an arrangement would make eminent economic sense and help in managing excess liquidity of their currencies.

Apart from increasing cooperation in the economic sector, the two countries need to enhance their cooperation in the political and strategic spheres to protect and promote their national interests, by curtailing conventional and non-conventional security threats, which they may face. For this their increasing cooperation with countries surrounding China and expanding maritime cooperation in the Indian Ocean and Southeast and East Asian region would be a welcome development. India and Japan can also become the pivot around which security interests of the Central, East, South, and Southeast Asian countries can be consolidated, which feel a very realistic threat from an increasing assertive China. For this Japan can provide India with military related technologies to connect with Central Asian region, and to enhance their maritime cooperation in the Indian Ocean region, by lifting the 1976 ban on exports of military related technologies.

India and Japan also need to develop their cooperation in the high technology sectors, such as space research, biotechnology, supercomputers, etc. as their joint efforts shall enable them to find solutions to various other problems plaguing the regional and global community.
In a nutshell, India and Japan’s failure to involve each other earlier let them lose significant opportunities to benefit each other in both economic and strategic spheres. However, the complementary nature of Indian and Japanese economy, and their converging security and political interests, make them “natural allies” with “common causes”, and therefore, mandatory partners in the long run.

End Notes:
1 : “Japan-India Relations”, http://www.mofa.go.jp/region/asia-paci/india/index.html [3], “India-Japan trade pact may not be inked during PM's visit”, http://www.thehindubusinessline.com/2010/10/21/stories/2010102153220400.htm [4]
2 : “Japan-China Trade in 2009 Declines for the First Time in 11 Years”, http://www.japancorp.net/Article.Asp?Art_ID=22517 [5]
3 : “India-China trade surpasses target”, The Hindu 28January 2011
4 : “India and Japan”, http://www.ibef.org/india/indiajapan.aspx [6]
5 : “Joint statement Vision for Japan-India Strategic and Global Partnership in the next Decade”, October 25, 2010, http://www.mofa.go.jp/region/asia-paci/india/pm1010/joint_st.html [7]
6 : “Outline of Japan’s ODA to India”, http://www.in.emb-japan.go.jp/Japan-India-Relations/ODA2010.pdf [8]
7 : “Japan extends soft loan package to India for FY2009”, http://www.in.emb-japan.go.jp/Press_Releases_Embassy/PR08-2010.html [9]
8 : “India and Japan”, http://www.ibef.org/india/indiajapan.aspx [6]
9 : “Mitsui acquires 5% in Arch Pharma”, http://economictimes.indiatimes.com/news/news-by-industry/healthcare/biotech/pharmaceuticals/Mitsui-acquires-5-in-Arch-Pharma/articleshow/6609981.cms [10]
10 : “Japan's Takeda eyes Torrent Pharma”, http://timesofindia.indiatimes.com/Business/Japans_Takeda_eyes_Torrent_Pharma/articleshow/3307903.cms [11]
11 : “Kobe Steel, SAIL sign MoU”, The Hindu, December 1, 2010
12 : “Indian state “biggest culprit” for rampant corruption: think tank”, The Hindu, December 8, 2010
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Published Date : 11 March, 2011