KATMANDU, NEPAL -- India's south Asian neighbors are watching closely as, once again, the giant of the region has come into confrontation with one of the smaller countries on its borders -- in this case a virtual trade blockade by New Delhi against tiny Nepal. As a result of the action, Nepalese in this capital city are now being forced to stand in long lines for scarce kerosene and gasoline, and to struggle to find life-saving medicines. Independent economic experts have said that if conditions continue, Nepal's economic growth will plummet from a healthy 5 percent to zero, and inflation will jump from 8 percent to 20 percent. While the confrontation appears to be over trade, the real fight, according to officials from both sides and diplomatic observers, is over how much independence land-locked Nepal will have to conduct its own policy -- especially with China -- given its economic dependence on India. Nepal is situated between India and China, the world's two most populous nations. The powers fought a brief and indecisive war in 1962 over border disputes that remain unresolved. Since the war, India has maintained a tough military posture toward China and is wary of what it sees as improving Nepal-China relations. While Nepal has long been caught between India's and China's competing interests, the current confrontation began to surface only after Nepal turned to China a year ago for the purchase of antiaircraft guns and other small-scale military equipment. On March 1, the Indian ambassador in Katmandu, in a letter, told the Nepali government in formal terms that the treaties that governed the flow of everything from fruit and vegetables to drugs and petroleum products between the two south Asian neighbors for nearly three decades had expired. Nepal, it said, would have to fend for itself. "It came as a surprise to us. No one ever thought India would act the way it did," said a Nepali official close to the royal palace. The letter turned out to be the first blow in a battle between unequal adversaries. To drive its point home, India shut down 13 of 15 border crossing points into the land-locked Himalayan kingdom on March 23 and said that all trade between the two countries that had been conducted under the old treaties must end. India, a burgeoning power with 800 million people and the world's fourth largest army, says its security interests must prevail up to the mighty Himalayan Mountains that separate the Indian subcontinent from China. Nepal, with 17 million people and an army of slightly more than 25,000, says it agrees -- but only up to a point, and that point has been reached. India has long been involved in the affairs of its much smaller neighbors, and in the past two years, it has extended its influence to the south. In Sri Lanka, tens of thousands of Indian troops are trying to put down an insurgency that India had no small part in starting. They are there under an accord negotiated two years ago that also gave India a say in major Sri Lankan foreign policy concerns. A few months ago, New Delhi showed its military muscle when Indian soldiers put down a coup in the Maldives Islands. India absorbed the small Himalayan kingdom of Sikkim in 1974, and Bhutan, another Himalayan neighbor, has its foreign policy and security interests determined by India under another treaty. "The Indians always forget that our nationalism is older than theirs," said a Nepalese Foreign Ministry official. "We resisted expansion by the British empire and we fought the Chinese, too. The Chinese also have at times considered this a part of their territory." "Since India's independence from the British, it is the first time relations have degenerated to this extent," the official added. From Colombo to Islamabad to Dacca, Nepal has found public sentiment on its side. In an editorial entitled, "Blackmail by the Big Bully of South Asia," a Sri Lankan newspaper, the Island, recalled the Indo-Sri Lankan agreement that "was forced upon Sri Lanka," and said the "Indian action amounts to a naked threat against a helpless country which no modern country -- certainly not a so-called founding father of nonalignment -- would have dreamed of performing." In Islamabad, the capital of Pakistan, India's traditional enemy, the independent newspaper the Muslim took up the same theme. "What is worrying," it said, "is that India's playing the role of the regional bully suddenly has acquired sinister connotations ever since Sri Lanka and the Maldives experienced a diminution of their sovereignty due to Indian actions. Now it appears that New Delhi is using a similar strategy although it is an economic weapon this time against Katmandu for achieving the same goals." Even Bangladesh has jumped into the fray, agreeing to send 1,000 tons of petroleum products to Nepal -- if India will allow the shipment through its ports. "Relations with India always have been important to Nepal, but the real symbol of their ability to run an independent foreign policy is relations with China, and they have spent 30 years working hard at it. They are not about to give it up," said a well-placed Western diplomat. "India has flagged from the outset that they wanted to redefine relations," the diplomat said. "The Indians said, 'We have a special relationship. That is fine, but you have to acknowledge our interests. You say that you want a balance, but that is not realistic. China is farther away. It does not share values the way we do. If you still want a separate equality, fine, you can have it, but you will have to live with the consequences.' " An Indian official expressed similar sentiments, saying, "Over the years, Katmandu has enjoyed certain advantages -- advantages denied to any country in the region -- and we expected Nepal to show sensitivity to our security concerns. We have found the Nepalese response to be inadequate. This has been conveyed to Nepal for the past two years." A Calcutta newspaper, the Telegraph, put the issue more bluntly in a recent editorial: "India has been for too long a victim of a con game by some of its neighbors. On the one side, they keep up a blistering propaganda aimed at painting India as a big brother out to destabilize if not destroy the smaller neighbors. "And, on the other, they seek the maximum concessions on bilateral matters. . . . One wonders what would happen if India would behave in the manner {its neighbors} keep accusing it of. A little taste of it might be a good idea." Nepalese officials have acknowledged that India has given a great deal to Nepal since the countries signed a peace and friendship treaty in 1950, creating a virtual open-door policy under which goods and people moved unhindered across their 1,000-mile frontier. "India as a close neighbor has assisted us a great deal and we are grateful for this," said Foreign Minister Shailendra Kumar Uphadyaya. "But what is behind" the current differences? "It is a question of perceptions. They said {the arms purchase from China} creates a new level of friendship between Nepal and China. We say perceptions of security are up to each nation. We know your perception of China is different. You have your reasons. We have a different view. Please don't push your perception on us. You have to work out your own relations with China." Now that the issue has been forced, Nepalese officials appear determined to cut the Indian umbilical cord, although they acknowledge it could be painful. While Nepal's foreign trade patterns have shifted in the past decade, it remains closely tied to the Indian economy. Ten years ago, 65 percent of Nepal's trade was with India. Today it is 35 percent. In addition, more than 3 million Nepalese now work in India under an old arrangement in which Nepalese could get jobs even in parts of the Indian civil service. About 40,000 Nepali gurkhas are in the Indian Army. And many Nepalese youths are educated at Indian universities, providing the technical backbone for Nepal's fragile economy. All of this could change if the confrontation is not resolved, and key segments of Nepal's business and financial elite are worried about such a prospect, according to well-informed sources. For now, however, political considerations are dominant. "We will have problems in restructuring," said an official close to the royal palace, especially in areas such as fuel supplies, completion of major development projects and the country's vital tourism industry. There are abundant food stocks, however, the official said, and the country has a year's foreign exchange reserves. Moreover, the official said China would be "forthcoming in certain areas, particularly in the fuel area. They have provided help in the past and will do so in the future." The official acknowledged that the Chinese have been conspicuously silent on the matter, but he said, "It is done through consultations. A public statement by China will aggravate the situation. Quiet diplomacy is something else." How far such confidence and nationalist feeling will take the Nepalese against a large and determined adversary remains to be seen. "They really don't have a card to play in this one" except appealing to international opinion, said one diplomatic observer. "The Indians can run rings around them politically," he said. "In a lot of ways, they are babes in the woods."