Should investors bet on India or China?

For several years China has been the shining light in the global economy, but this year’s GDP slowdown, accompanied by plummeting stockmarkets and currency devaluation, brought anguish to the investment community.

India, on the other hand, has enjoyed accelerated growth, reined in inflation significantly, benefiting from falling commodity prices, and is now firmly on asset allocators’ radars, although the slow pace of reforms by Narendra Modi, the prime minister, remains a concern. 

Foreign portfolio investor ownership of Indian stocks is at all-time highs, and India’s GDP growth rate is predicted to surpass that of its larger neighbour in 2015 to become the world’s fastest growing economy, according to the IMF.

“India is today where China was 20 years ago, as all the growth engines are firing,” states Sukumar Rajah, CIO Asian Equity for Franklin Local Asset Management Group and manager of the Franklin India Fund, based in Singapore.

Favourable demographics are a key growth driver, with India’s age dependency ratio expected to decline until 2040, while China’s has already reached the bottom. Also, labour productivity is going to be driven by urbanisation, education and general progress in society.

While capital invested as a percentage of GDP is expected to increase in India over the next couple of decades, in China it is going to fall, as the country shifts from an investment and export-led growth towards a more domestic consumption-driven economy.

Capital productivity has deteriorated in China, whereas in India it is expected to improve thanks to reforms and infrastructure investments, believes Mr Rajah.

“Even if the pace of reform remains gradual, the process is headed in the right direction.”

The Goods and Services Tax, which promises to harmonise what is currently a patchwork of sales tax regimes legislation across the Indian states, in favour of a single national sales tax, may significantly boost industrial and business activity as well as states tax revenues, but is currently stalled in parliament. The Land Acquisition Bill is expected to be a long-term growth catalyst, but is delayed. 

“I think slow pace of reforms is an alibi,” he says. “People will forget about reforms when earnings growth picks up.”

Price/earnings multiples, which measure stock valuations, are at long-term average levels but earnings growth, which has been flat over the past couple of years, is expected to pick-up, and revert back to its long-term average of 15 per cent over the next few years.

On the macro-economic front, twin deficits (national budget and foreign trade) seem to be under control, inflation has dropped significantly since 2014, and improved currency reserves indicate less vulnerability in case of flight of capital.

Therefore, the country appears to be better placed to deal with the impending Fed rate hike than in mid-2013 when taper concerns started rising, says Mr Rajah.

Moreover, given that exports make up just 23.6 per cent of India’s GDP, according to the World Bank, a downturn in global growth or a hard landing in China is likely to have less impact on the country’s economy, which is more domestic consumption driven. Also, goods exports to China represent only around 4 per cent of India’s total exports with exports to the US accounting for more than three times as much.

Unlike net commodity exporters such as Brazil and Russia, India is a key beneficiary of a weak commodity-price environment, as a net importer.

But what are the key risks of investing in India?

A return to populist governments would hamper the country’s growth rate, but this is unlikely, believes Mr Rajah.

“In the past, elections were based on promising a lot of freebies, but people’s lives didn’t improve beyond that.” The nature of politics has changed, he says, as voters’ profiles changed, with first-time voters representing a larger percentage of the voting population. “People are increasingly asking for better infrastructure, labour power supply, better education and job creation.”

Given India’s structurally high dependence on oil – the country imports more than two thirds of the oil it requires – an increase in oil prices would be an issue, but the changed demand/supply dynamics of the oil market means this risk is also unlikely.

Mr Rajah particularly likes private sector banks, which are expected to grow faster than the overall banking system in India, which is growing at a rate of 12 to 15 per cent per year.

Private sector banks represent the largest overweight in the Luxembourg-domiciled Franklin India fund, which has gathered $3.6bn (€3.4bn) in client assets since it was launched 10 years ago. The fund employs a bottom-up approach and invests in large and mid-cap stocks, which the firm has been holding for more 20 years through its other funds.

“Private sector banks will continue to gain market share thanks to better quality customer service, very dynamic management, investments in digital initiatives, as well as risk controls and higher profitability,” states Mr Rajah.

Companies with sustainable competitive advantage and good quality management in the IT and pharmaceutical sectors also represent top holdings of the fund.

India vs China allocation

Global private banks have dissimilar views on Chinese and Indian equities, which are reflected in their asset allocation strategies.

“India is one of our most favoured emerging markets and Asian country allocations over the medium term,” says Alex Marshall-Tate, head of third party research at Citi Private Bank. This is largely driven by expectations of GDP growth pick-up, and figures just released by the Indian government confirm growth accelerated to 7.4 per cent in the third quarter. However, the institution believes the main risk remains the government’s modest track record in implementing reforms.

With negative views on emerging markets as a whole, Citi favours developed over developing stocks, while its slight overweight in emerging market equities is driven by a targeted overweight on Asia, on countries better positioned in this low energy and oil price environment. The bank’s focus is on a few selected north Asian countries, including Taiwan, India and China, with a neutral position on South Korea, while it has no allocation to other emerging Asian countries.

Last year, for the first time in history, China’s GDP surpassed that of the US, as measured by purchasing power, and over several years China has been the main emerging market attracting investors’ interest, states Mr Marshall-Tate. “This had left India somewhat by the wayside in investors’ minds, especially given the inflationary challenges the country was dealing with several years ago, prior to the collapse of the commodity bull market.

“The story has now reversed to a degree, with clients increasingly seeking some exposure to India, but we have not reached a stage as yet where they are seeking dedicated exposure to India,” adds Mr Marshall-Tate.

To clients seeking exposure to India specifically, Citi recommends specific Asian-based investment teams and investment strategies that “have more an inherent and more sizeable exposure to India, alongside additional targeted exposure to other countries on which we are positive”. Indian equity funds are also available on the bank’s platform. Citi’s high conviction idea is an India fund managed by an asset management firm with a strong track record in Asian equities, high quality bias and stock selection criteria.

The bank’s recommended allocation to India is double weight compared to the usual strategic allocation, but remains pretty small at 1 per cent.

JP Morgan Private Bank also favours developed versus developing markets, but is more cautious towards both India and China.

“We started the year overweight both India and China, but we changed our stance over time, downgrading them both to neutral,” says Guillaume Chatain, head of equities solutions, Asia at JP Morgan Private Bank in Hong Kong.

Weak corporate earnings and poor reform momentum and concerns on what is considered a “crowded trade” drove the bank to downgrade Indian equities in May. The bank also downgraded Chinese equities to neutral during the summer, when the government lost credibility as the stockmarket fell, implementing unfriendly market measures.

“Poor communication about devaluation of the currency was another big mistake which translated into panic for the global investment community,” says Mr Chatain.

Although China’s slowdown is stabilising, it is going to take time for markets to regain confidence in the Chinese government and for the money flow from investment managers to revert.

“The Chinese market is being driven mainly by retail investors today and is going to remain extremely volatile,” predicts Mr Chatain, adding JP Morgan will remain neutral on China for the foreseeable future.

On both markets it is important to be selective and invest through managers specifically focused on India or China, with research teams on the ground and having “superior stock selection process in order to generate alpha,” says Mr Chatain. The bank prefers to use country-focused managers rather than Asian or global equity managers.

Two-speed economy

UBS brings a different perspective. Having been overweight India, because of “its cyclical tail wind” and neutral on China for more than a year, in November the global bank went overweight Chinese equities and took Indian equities down to neutral.

Min Lan Tan, UBS

“In India we see small scale reforms coming through, which are removing red tape and making it easier to do business, but the government has been unable to push big-ticket reforms,” says Min Lan Tan, head of UBS’ Asia Pacific investment office, based in China. “We don’t see a lot of progress in the next six to 12 months, on that front.”

China’s government, on the other hand, has been more determined in its reform path and the country looks more interesting now that economic data has stabilised for the past two months.

“China is one of the key markets where the GDP growth may surprise us on the upside relative to our initial expectations,” says Ms Tan, explaining that the economy could grow at about 7 per cent this year.

Macro-economic conditions remain fragile, says Ms Tan, but the economy is not falling apart, and there are sufficient policy options to prevent a hard lending. This is defined as a GDP growth of less than 5 per cent per annum for two consecutive quarters.

 “Also, the narrative on China tends to be very binary. If it is not blue skies, it must be collapsing, but actually it is a lot more nuanced than that,” she says.

China is essentially a two-speed economy, there is an ‘old economy’ and a ‘new economy’, she explains. The old economy, comprising sectors such as resources, property or heavy industries, may only be growing at 3 per cent. The new economy, favoured by UBS, is growing at a “healthy rate” and includes sectors such as e-commerce, internet, healthcare insurance, environmental engineering and alternative energy.

“In many ways, China is still a catch-up economy. It is the largest economy in the world in GDP terms, but per capita income, for example, is only 12 to 13 per cent that of the US, so there is tremendous scope for catch-up.”

Urbanisation is a key growth factor, as the country aims to raise its urbanisation rate from 54 to 60 per cent. “And a six percentage point move on 1.37bn population is big,” comments Ms Tan.

There is still scope for China, she says, to deliver that 6 per cent growth required to achieve the doubling of per capita income between 2010 and 2020, which is the government’s goal.

India will grow faster than China, believes Mark Mobius, executive chairman of Templeton Emerging Markets Group, speaking at the recent PWM Global Private Banking Awards ceremony in Singapore.

In India, privatisation is expected to be playing a big role in fuelling growth. “If Modi is able to unify the tax system, we are going to see tremendous growth in India,” predicted Mr Mobius.

“But China is still a giant,” he said. Growth of 10 per cent in 2010 added roughly $800bn to the Chinese economy. The recent 7 per cent has added around $900bn as the base is getting bigger, according to the emerging markets guru.

“My feeling is that China will grow at faster rate than people anticipate, as statistics today underestimate the service sector,” said Mr Mobius. Some companies are overleveraged and banks, burdened by bad loans and with no growth prospects, remain an issue, but this should not deter investors.

 “Investors should be invested in both India and China and take a long-term view,” concluded Mr Mobius.