While the two giants of Asia differ in many ways, China and India share massive populations and significant rates of economic growth to tempt equity investors
India and China have many things in common but just as many differences. Both are huge countries with massive populations and impressive rates of economic growth. Both have also attracted very significant levels of interest from equity investors seeking to capitalise on that growth.
However, while India is the world's largest democracy, China retains a one-party autocratic system. And while China has become the centre of global mass manufacturing, India has developed a highly competitive IT services industry. Shanghai has seen dramatic improvements in physical infrastructure while Mumbai remains underdeveloped. So, how should these two Asian giants be judged?
In terms of sheer scale, China has a big lead over India. It began major economic reforms as early as 1979 and has been enjoying very high economic growth (in excess of 10% in 2005 in real terms) ever since. Per capita gross domestic product (GDP) is $1,500 (£858) against $600 in India. Much of this growth has been driven by investment spending, including foreign direct investment, which is running at around $50bn per year. Exports have also grown dramatically, resulting in a huge trade surplus and frictions with the US. The economy is dominated by the manufacturing sector but excessive investment has led to extremely competitive conditions and often poor profitability. The banking sector is still state-owned and has a poor track record of lending with proper regard for risk and return.
Indian reform is more recent, beginning in earnest in the early 1990s. Entrepreneurial spirit was never extinguished in India, even under a quasi-socialist government in the 1970s and 1980s. The country has blossomed again with reform. However, India's growth has been hampered by poor infrastructure and excessive bureaucracy.
The former is being addressed through a huge programme of road building, port and airport development, and other projects, many funded either with private money or through public-private partnerships. The bureaucracy will arguably take longer to fix, although improvements have been made and foreign direct investment is starting to pick up. The fact is, decisions take longer in a democracy, but there does now seem to be a consensus across political lines in India in favour of economic reform.
India's external accounts have been bolstered by the development of vibrant IT services and back office processing business, which have led to sharp reductions in the current account deficit - but it is still a deficit. Indian economic growth, which was 8% last year, is largely driven by consumption demand. The banking system is relatively efficient at allocating capital. So both China and India are exciting economies that will continue to grow rapidly and draw much attention. Their progress will have profound effects on commodity prices, on prices of goods and services in the developed countries and on the sworld economy.
But what about their stock markets? For individual investors, both countries are difficult to access because foreign ownership is limited to institutions, although a growing number of Chinese companies are listed in Hong Kong where access is freer. However, funds investing in these markets have been attracting much interest and inflows and many new companies are coming to the market from both countries.
The key difference is that almost all listed companies from China are state-owned enterprises, whereas in India most are private companies, often with substantial controlling shareholders (called promoters in India).
Profitability and returns tend to be higher at Indian companies, particularly with strong growth prospects that has resulted in a strong bull market with the Sensex Index up over 250% since early 2003. That said, the price earnings (P/E) ratio of Indian stocks at around 15 times forward earnings is hardly excessive for a market where corporate earnings are growing at over 15%.
Chinese shares have not had such a smooth ride, in part because returns have been much more erratic at many Chinese companies. The Shanghai 'A' share market (restricted to domestic investors until recently) is actually down 25% since early 2003. 'H' shares (listed in Hong Kong and available to foreign investors) have fared better, and are up nearly 200% since early 2003. The Chinese market is cheaper than India on around 12 times forward earnings but earnings growth is also lower at around 11%.
taking centre stage
What were once highly esoteric markets at the edge of investors' radar screens are now right at the centre of attention, and for good reason. The developments in India and China in recent years have captured the imagination of many. Who would have thought that a decade ago most of our basic manufactured consumer goods would be made in China, or that the call centre operators for many well-known companies would be talking to us from Bangalore or Hyderabad? Many investors have some exposure already, often in global emerging markets, Asian or Bric (Brazil, Russia, India, China) funds. In the future, we believe exposure to these (and other emerging markets) is likely to become even more common as these countries become more prominent in the world economy.
2006 will represent a more challenging year for equities globally, after having experienced spectacular returns in 2005. With oil prices hitting new highs and geopolitical tensions increasing, concerns revolve around the pace of economic growth globally. Against this backdrop, there is one cautionary note - India and China are volatile markets, and although returns can be very attractive, investors do need to take a long-term view. However, pockets of volatility should be treated as investment opportunities, since the fundamentals are in place for a sustained uptrend in the longer term.
China began its reforms in 1979, more than a decade before India
Chinese GDP is 2.5 times larger than India's
Indian companies are mostly private, with higher returns than state-owned Chinese companies
Both nations have volatile markets but are likely to become more prominent in the world economy
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