The run-up to this Diwali, India’s festival of lights, has witnessed an unusual social media campaign to boycott Chinese-made products. In the wake of China’s continued support for Pakistan, the campaign has also found support from some sections of India’s political establishment. While there is hardly any reliable data on the impact of this campaign on India’s actual imports from China, there is enough data to indicate that the fortunes of the two Asian giants are entwined far deeper than ever before.

A terror attack on an Indian army base last month by militants based in Pakistan has drawn China into the volatile politics of South Asia as China is seen as a steadfast ally of Pakistan.

A Mint analysis shows Indian stocks have increasingly begun moving in tandem with Chinese markets while India’s dependence on China for technology-heavy imports has been rising sharply.

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It is certainly possible for India to reduce trade with its largest trading partner (even if that entails a steep price for the country) but the force of financial contagion is unlikely to spare India when Chinese markets tumble.

As the chart below illustrates, the Indian and Chinese stock markets have been increasingly moving in tandem in the wake of the financial crash of 2008. Since that year, the correlation between Indian stocks markets and their Chinese counterparts has increased.

In purchasing power parity terms (at constant 2011 prices), China has already surpassed the US as the largest economy of the world, latest World Bank data shows, and it is little surprise that the fortunes of other major economies of the world are increasingly getting tied to China. A Chinese economic shock can thus have serious spillover effects on other economies, especially on Asian markets such as India.

The spillovers can occur in several ways.

For instance, any devaluation in the Chinese yuan will hurt the export competitiveness of many of the Asia-Pacific economies, which can lead to adverse reaction in the respective countries’ stock markets. This is what happened in August 2015 when China sharply devalued its currency, triggering losses in global equities. In the one month since the devaluation, China’s equity benchmark fell around 20 per cent and India’s fell by around 10 per cent.

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China’s outsized share in the market for many commodities (especially metals) lends it another lever through which it influences the global economy. Any fluctuations or expected fluctuations in Chinese economic fortunes has an immediate and decisive impact on global commodity markets. When China faces an overcapacity in its steel and aluminium sectors, India faces a deluge of those products, which hurt domestic producers. It is perhaps not surprising that India’s infrastructure and metal stocks have a greater correlation with Chinese equity indices than other stocks, as the chart below shows.

A prolonged Chinese slowdown might also create opportunities for India, as it can step in to replace China as the factory of the world. India being a commodity importer is also likely to benefit from any prolonged fall in commodity prices. But any sharp fluctuation in the fortunes of the Chinese economy is unlikely to leave the Indian economy, or for that matter, any major economy unscathed. While India might benefit in the long run from such a slowdown, the immediate aftermath of a Chinese meltdown will be tumultuous even for India.

A recent paper by researchers at the Bank of International Settlements (BIS) shows that the financial markets in the Asia-Pacific region, including India, are increasingly being influenced by movements in Chinese markets. The then governor of the Reserve Bank of India, Raghuram Rajan, had voiced similar concerns in May, when he remarked that “financial market losses in China can heighten the risk premia that industrial country investors will charge for investing in our region (Asia-Pacific), and the result could be capital outflows”.

The latest World Economic Outlook report released by the International Monetary Fund (IMF) also suggests that spillovers from China into financial markets across the world might increase in the days ahead as China eases capital-account restrictions and deepens its financial linkages with the rest of the world.

While a Chinese hard landing may please the hearts of the boycott-China brigade, their joy might be short-lived as any turbulence in the Chinese market is likely to have unpleasant repercussions on Indian stocks, BIS and IMF researchers suggest.

The boycott-China group is, perhaps, also unaware of the profound dependence of the Indian economy on Chinese imports, especially in high-technology imports.

Trade data also show that India’s ambition to be the factory of the world is unlikely to materialise without Chinese imports. As the chart below illustrates, many of our factories run on imports from China. Of all the capital goods imported by India last year, 42 per cent came from China while 14 per cent of imported industrial raw materials were sourced from China.

Even if it does not enjoy the economic clout of the US yet, China today has become too big to ignore. It is impossible to escape its influence, either in finance or in trade. Engaging China is of course going to be a major challenge in the days ahead but knee-jerk calls for boycotts and protectionism may end up being self-defeating. Whether such calls come from social media campaigns or industry lobby groups, they often tend to hurt the Indian economy.

Just consider the policy of putting in a minimum import price (MIP) to protect Indian steel manufacturers from cheap Chinese imports. At first glance, the policy appears ”nationalistic”. But when one considers the impact on the overall economy, it appears pointless and even counterproductive.

In fact, Reuters reported in August that the MIP regime for steel has hit engineering firms especially hard. The report noted that these mostly small- to mid-sized companies together account for almost a fifth of India’s merchandise exports. Hence a policy designed to protect Indian manufacturers of steel against cheap Chinese imports has possibly ended up hurting those firms that account for a substantial chunk of India’s export earnings.

It shouldn’t surprise anyone if the biggest losers of the boycott-Chinese-goods-for-Diwali campaign are Indian traders left with unsold stocks rather than Chinese firms which produced them.

Reprinted with permission from the Mint