Should investors head for China or India?

India

Pankaj Chopra

Chief Executive Officer, Reliance Wealth Manager

“If you want one year of prosperity, grow grain. If you want 10 years of prosperity, grow trees. If you want 100 years of prosperity, grow people” – Chinese Proverb

Ironically, the biggest Achilles heel for the Indian and Chinese economy – their large population and the steady increase year on year, is now their greatest asset.  A stark difference, however, exists.

China implemented a single child policy some years back and today faces an increasing dependence ratio.

On the other hand, India still has very favorable demographics. The time has come for India to reap the rich “Demographic Dividend”. India’s efforts in the last couple of decades to open up its economy have placed its 75 per cent of its population  - which is under age 35, largely educated and English speaking - on the global opportunities map.

Leading global names are ramping up offshore development centers in India, while Indian players are gobbling up client facing business across the globe. Both looking to benefit from the cost arbitrage and scaling up possibilities that India has to offer.

Led by a quantum jump in personal disposable income, this change has made the population a potent consumption machine. Increasing incomes are leading to an unparalleled consumption explosion. Coupled with very low per capita incomes and consequent under penetration of most products, India is today perhaps the biggest latent demand market in the world.

Urbanisation and the subsequent advent of nuclear families is further fuelling demand for consumer products and need for housing, power, education system, roads, mass and rapid transport system and airports.

In the next five years alone, the total infrastructure investment is estimated at $475bn (€327bn). This will not only fuel direct growth but also indirectly build up related industries. We believe as India implements the required changes to investment policy in the coming years, this could lead to a hastening of FDI into the country, further accelerating our GDP growth. Goldman Sachs, in its latest BRIC update, estimates India to grow far more rapidly than China over the next 40 years to reach $15,000bn in GDP from the current $1,000bn.

The demographic advantage also ensured that India has very low dependence to global economic cycles.  

With exports as a percentage of GDP still below 20 per cent, the country continues to be driven by domestic demand. This was clearly evident during the recent global financial crisis, during which large parts of the world slipped into recession but India slowed down only a couple of percentage points to roughly 6.7 per cent GDP growth.

In contrast, at 30 per cent+ of exports to GDP, China has become a significant trading partner from Asia to the US and other developed countries, exposing it to volatility in growth of these economies.

A century old stock market, with more than 7,000 companies listed and a combined market cap of about US$1,200bn, Indian equity markets are a trove of opportunity.

With compounded average annual returns of 18 per cent plus over the last 30 odd years, the markets have had an enviable long term track record. With more and more drivers to growth emerging, we find it difficult to believe these long-term returns can deteriorate sharply from here on.

Our confidence in the sustainability of high returns from Indian equities is also endorsed by the sustained double digit growth in earnings delivered by a large swathe of the listed corporates in India.

The three broad themes that appear as key drivers to growth going forward are: domestic consumption, infrastructure investments and global outsourcing. Businesses that leverage off these opportunities are likely to do well. Structural growth stories are available in sectors like consumer discretionary, consumer durables, automobiles, capital goods, engineering and IT & IT Enabled services. This apart, given the wide range of business listed on the exchanges, India continues to be a bottom-up, stock picker’s market.

The risks we see relate to the macro- environment, more particularly the fiscal deficit of the Government and high inflation and interest rates currently. An acceptable resolution of these issues is critical for the full potential of the economy to be realized.

To conclude, the Indian markets present an opportunity that is large, fast growing and sustainable over a long period of time. We believe these factors are hard to ignore and current foreign institutional investment of roughly US$ 250bn in the Indian equities can only go up from here.

Private investors can benefit from the opportunity presented by the Indian markets by allocating investments for the long term. Given the prior track record, the possibility of absolute attractive returns is high in a three year plus time frame. Private clients have much more flexibility to choose allocations that suit them, as compared to institutional investors. It may be pertinent to predict how the world markets will look five or 10 years from now and invest accordingly, rather than benchmarking with current weights in a world index.

China

John Ng

Head of Research, Bank of Singapore

China or India?  If forced to choose one over the other, we would be biased towards the prospects for China. There are many arguments to be both positive and negative on China.  But the question of the time horizon plays an important consideration in the discussion of whether China should be a strategic investment. Obviously in the short term (4 to 6 months), there remain some lingering uncertainties. But the longer term macro outlook (the next 5 to 10 years), are pretty consensual, with expectations of China becoming the world’s largest economy in about 40 to 50 years.

The Chinese government’s attempt to cool the economy with various and numerous measures since late 2009 is synonymous with tapping on the brakes several times rather than jamming on it in one go. Talks of a hard landing have not happened. China’s inflation stands at about 5.2 per cent versus India’s 9 per cent. For China, food inflation accounts for 30 per cent of total CPI (consumer prices index), while for India, 46 per cent. Core inflation in China stands at only about 2 per cent, and China ranks 27th versus India at 51st  in terms of global productivity (ref: World Economic Forum 2010-2011 rankings). With food price inflation a greater and immediate social threat in China than an economic one, any sort of case for China is weakened if the government fails to first manage this problem. Slowing economic growth down to single digits without maintaining food price stability will still fail the overall objective. Fortunately, recent data on food prices point to a peaking.

Inefficient food distribution is a bottleneck and a primary cause of such inflation in many emerging countries. Between China and India, the former’s infrastructure is far superior.  Improving India’s logistical infrastructure will help to ease such constraints, reduce inflation and increase economic growth rates, but the implementation of such projects has proven more difficult due to India’s political structure. The case in China, being a one-party, centrally planned economy, allows such structural projects to move ahead much faster, and dealing with any problems much quicker.

The discussion on China’s currency has also been hotly debated. This appreciation will be managed slowly, and we do not believe that the government will permit a haphazard, or big-bang approach simply because of pressure from the West. In any case, with China reporting a Q1 fiscal deficit, though admittedly small, may still be the start towards a gradual narrowing of the trade gap, and consequently easing the politically motivated arm-twisting for a much stronger Yuan, much sooner. The use of the Chinese Yuan for foreign trade is also growing, with the amount of Yuan-denominated deals accounting for 7 per cent of foreign trade, which is a big increase from about 1 per cent about a year ago. Any increasing acceptance of the Yuan for international trade can only lead China further along the road to greater market prominence over the longer term.

China has Hong Kong, an internationally recognized and prominent financial center. At the same time, it is developing Shanghai as the on-shore equivalent. While access to mainland assets remains somewhat controlled, investors do have options, such as the China H-share and offshore CNH markets. In the short term, investments in public Chinese equities may be volatile due to the daily newsflow and opposing commentary in relation to some of the issues mentioned above. However, from a fundamental basis, market valuations are historically attractive for both China A and H shares. China A-shares rebounded in mid-2010 after sliding at the commencement of tightening measures, drew back in Q4 2010, but since the start of 2011 has been moving higher again. With the passage of time, as government measures progressively cool the economy, steady and manageable growth should lead markets higher than where they are today. We do not think Chinese growth will hit a pot hole as, apart from private investments, government spending from public housing to high tech industries will ensure that growth remains reasonable. Equity markets are therefore positioned to improve and could come sooner as the lagging performance of the Chinese markets and current price levels, has already priced in policy tightening measures. In any case, as with all investments, security selection should form the basis of the investment rather than a broad macro outlook of the market.

The growth of the Chinese bond market has also begun to evolve and is growing larger each day. Offshore CNH deposits and bond issues are all the rage as this asset class is still in its infancy and investors hungry for such exposure. With both good and poor corporate issuers now accessing this market, making a discerning choice remains important. Nevertheless, the evolution of a deeper and more liquid international Chinese bond market will only serve to raise its importance as an influential player in global capital markets.

Other ways to participate in China’s emergence in not limited to domestic Chinese assets. As the country continues to move from an investment to a consumption-driven economy, other options are available to tap the China growth “story”. The demand for luxury goods from Western branded handbags to German cars, and the collection of Chinese arts and antiques, typically auctioned at international art centers, provides alternative avenues. Indeed, resource-rich countries and related companies have also benefited greatly from China’s growth.