President Hu Jintao's visit to India this week has been billed as the high point of the “year of friendship” between the regional giants. But on the eve of his visit, the legacy of the brief border war won by China 40 years ago has cast a shadow over the occasion and underlined the continuing strains in their relationship.

Pranab Mukherjee, India's foreign minister, was forced into a rebuttal of comments made by Sun Yuxi, the Chinese ambassador to India, restating Beijing's claims to the Indian state of Arunachal Pradesh. The north-eastern state was an “integral and inalienable part of India”, Mr Mukherjee said.

The long-standing border dispute, combined with competition over energy and deep-seated doubts in India that domestic businesses can match their Chinese counterparts, makes for uneasy economic relations. Although two-way trade has started to boom, rising to $17.6bn (£9.3bn, �3.8bn) in 2005 from $260m in 1990, both countries have yet fully to engage with each other.

Even the trade figures do not tell an entirely happy story. According to Chinese statistics cited by the Confederation of Indian Industry, India's exports to China in the first half of this year fell by 4.3 per cent.

Although India has signed up to a target of increasing two-way trade to $30bn by 2010, New Delhi remains hesitant about a free-trade agreement with a country it accuses of manipulating its currency and subsidising exports. India's corporate lobby groups say businesses facing the disadvantage of poor infrastructure and nonsensical labour laws need continued protection.

For Chinese analysts, the Indian objections are puzzling. “A free trade agreement will benefit both sides,” says Ma Jiali, of the China Institute of Contemporary International Relations in Beijing. Mr Ma adds that most Chinese exports to India are from private companies and are not subsidised. “If they are not profitable, they will go out of business.”

The defensiveness of the Indian business groups stems from the fact that India's exports to China are low value-added and weighted towards unprocessed natural resources. China's top exports to India, on the other hand, are electrical goods and mechanical appliances. “If one looks at exports, 50 per cent of it is iron ore,” says Deep Kapuria of the Confederation of Indian Industry. “Why can't we do the value addition in our own country . . . and diversify into value-added products?”

D.K. Nair, secretary-general of the Confederation of Indian Textile Industry, points out that India's textile exports to China have been flat for the last five years at around $70m-$75m, less than one-fifth of the value of India's fast-growing textile imports from China, which stand at around $375m. The confederation complains of China's currency manipulation and subsidies but also blames shortcomings in India.

“In India we have serious problems, with our roads, ports and power. These have to improve so that we can be on an even ground with China,” Mr Nair says. “We also have labour laws which everyone says are unworkable, even the prime minister, but no one seems able to do anything.”

Such frustrations are strikingly similar to Chinese complaints about the travails of doing business in India. “Look at the road to the Taj Mahal from New Delhi,” says Mr Ma. “It is called a highway but it is full of tractors and carriages drawn by horses.”

The Chinese are even more agitated by Indian barriers to investment. New Delhi is mulling adding China to a special list of countries posing a national security threat. “There's no question of discrimination on principle against investments from China, nor is there any intention to do so,” says Ashwani Kumar, minister of state for commerce and industry. “However, every country is entitled to have a closer look when certain issues of security are raised. It is only when those issues of security are raised that the government takes a closer look.”