Recent signs of improved relations between India and China, such as progress in border dispute talks and a more open stance toward Chinese investment, suggest a tactical shift rather than a fundamental realignment in India’s geopolitical strategy, Capital Economics said in a note.

The changing relations between the world’s two most populous countries underscores a broader trend among emerging markets (EMs) that are increasingly courting Chinese investment to strengthen their positions in the evolving global economy, even as they continue to lean towards the West.

Unlike the Cold War era, where the world was divided into two ideological camps of socialism and capitalism, since the start of the 1990s everyone is a capitalist. However, as the leading emerging markets have developed over the last three decades they have started to flex their geopolitical muscles, which has led to tensions. Capital Economics earlier described this as a fractured world where countries have coalesced into two groups centred on the US and the Sino-Russia alliance.

In this new world India has historically sought “strategic autonomy” and strives to keep a neutral non-aligned position, but in the current geopolitical landscape, it is increasingly aligning with the West, driven by both security concerns and economic opportunities, Shilan Shah argues, the deputy chief emerging markets economist at Capital Economics.

The long-standing border dispute in the Himalayas with China, particularly the tensions that escalated in 2020, has reinforced India's wariness of its northern neighbour. Additionally, the US offers significant friendshoring opportunities as global supply chains shift, particularly in sectors like mobile phone and semiconductor manufacturing, where India has seen a surge in its global market share.

But more recently India has warmed to both Russia and China in defiance of international pressure to make Moscow a pariah. Modi was in Moscow in July, where he was warmly greeted by Russian President Vladimir Putin and negotiated for long-term oil and fertiliser supply deals. Modi shrugged off the muted criticism from the West for his Moscow visit, highlighting that he would act in what he saw as India’s best interests, irrespective of how that is perceived in the West.

Likewise, Indian policymakers appear to be warming to the idea of more Chinese investment to fuel the rapid development of India’s economy, which is also leading to better relations with Beijing.

Another consequence of Russia’s war in Ukraine and the resulting extreme sanctions regime has been to push the Global South countries closer together as they seek safety in numbers in the face of increasing aggression by the world’s leading powers. This change was manifest in both of last year’s G20 summit and the expanding BRICS+ group, but not limited to these two.

Both China and India have indicated a willingness to resolve their border issues, with the creation of five "buffer zones" where troops have been withdrawn and patrols ceased, marking a rare moment of cooperation.

And Delhi has reversed its hesitance to host major Chinese industrial investments. A year ago, it blocked BYD’s attempt to establish an electric vehicle factory in India. India’s flagship Annual Economic Survey noted that “developing countries will have to figure out a way of… boosting domestic manufacturing capabilities, sometimes with the collaboration of Chinese investment and technology” – a sentiment that was recently repeated by Finance Minister Nirmala Sitharaman.

“Some have suggested that these developments indicate a shift in India’s geopolitical alignment. This isn’t unheard of: over the past couple of years, a number of EMs including Saudi Arabia and South Africa have moved towards China’s sphere of influence with their own strategic interests in mind,” says Shah.

While some observers suggest these moves could indicate a shift in India’s geopolitical alignment, this interpretation seems premature, says Shah. The border negotiations remain fragile, and any miscalculation could reignite tensions. India remains deeply concerned about China’s military presence in the Indian Ocean and its alliance with Pakistan. At the same time, India is equally annoyed with the US, which also maintains cordial relations with Pakistan, and incensed Delhi by agreeing to a deal to supply Islamabad with advanced F-16 jet fighter planes last year, which has only reinforced its strategic autonomy policy.

And India is hedging its bets with China too. Part of the talks between Modi and Putin covered an order for Russia’s advanced S-400 missile system that India has already paid for, but yet to receive, which it intends to install all along its border with China. Likewise, China has been building dozens of “border guardian” settlements in the Himalayas at the end of any traversable valley and paying people to go and live there, partly as a regional development programme, but also as a passive early warning network to protect against invading forces. The settlements have also been built on the borders with Bhutan and Nepal, according to a recent The New York Times (NYT) investigation.

Moreover, India’s membership of the Quad – a security dialogue that includes the US, Japan and Australia – along with its stringent policies against Chinese smartphone apps, reaffirms India’s ongoing mistrust of Beijing.

The slight warming in Sino-Indian ties does not negate the advantages of aligning with the US, particularly in capturing the benefits of friendshoring. For example, India’s global share of mobile phone and semiconductor exports continues to grow, underscoring the economic benefits of this alignment. However, India’s engagement with China reflects a broader strategy seen in several EMs, which are balancing relations with both China and the West to maximise economic benefits. This approach, exemplified by India’s potential acceptance of Chinese investment in infrastructure, aims to enhance its appeal as a manufacturing hub while carefully managing geopolitical risks, says Shah.

Elsewhere, countries like Morocco and Hungary are also benefiting from Chinese investment, particularly in green technology and electric vehicles, while maintaining strong economic ties with Europe and the US. Hungary, for instance, has seen a surge in Chinese foreign direct investment (FDI), making it one of the top recipients globally, despite its alignment with the US bloc.

In Central Asia, the five ‘Stans, squeezed between Russia and China, have been a lot more cautious to keep China at arms-length and will search for other investors and creditors first to diversify their exposure, only accepting Chinese investment if no other viable alternative can be found.

As China’s domestic growth slows, its firms are likely to continue investing overseas, driven by the need for higher returns and the desire to bypass Western protectionist measures. For some EMs, this presents an opportunity not just for capital inflows but also for the transfer of technological and managerial expertise.

However, the balancing act could become more challenging if the US, China rivalry intensifies.

“Courting both sides could become harder for EMs if the US and China become more aggressive in pushing to exclude each other’s inputs from their supply chains. For example, if the US were to prevent goods containing certain Chinese components from being sold domestically, then firms anywhere hoping to sell to the US would have to exclude them too,” says Shah.

There are some signs that this is already happening. For example, Indonesia is attempting to reduce Chinese investment in new nickel mining projects in order to qualify for tax breaks in the US. The US has also introduced smart sanctions on Russia in December, where Office of Foreign Assets Control (OFAC) is increasingly targeting third countries supplying Russia with “priority goods” and threatening their companies with secondary sanctions.

“Only time will tell if this is the direction that fracturing will take. But for some EMs, greater Chinese investment now could prove fruitful, not only in terms of higher capital spending but through the transfer of technological and managerial know-how,” concludes Shah.