As Sam Mahtani explains, these two emerging global forces are doing many things right but still have some way to go in terms of economic reforms
Emerging markets have seen two years of stellar returns where larger markets, such as India and China, have driven performance. We continue to be positive about the asset class for 2005, though we expect more modest returns this year.
India and China, the world's two most populous countries, have been hitting the headlines for some time now as regions ripe for investment. They are riskier than their more developed counterparts, but they also offer greater potential returns. Emerging countries, as a whole, account for the majority of the world's population, land and natural resources, but it is improvements in education and infrastructure that are helping countries such as China and India to tap into their latent potential. For example, 10 years ago, 56% of the Chinese population had either completed primary education or partial attendance. Only 6.8% had completed secondary or tertiary education. By 2014, Credit Suisse First Boston (CSFB) projects that only 21% of the population will be in the former category while 29% will have completed secondary or tertiary education. Changes in levels of education are certain to instigate changes in consumer preferences as well as openness to new tastes and experiences.
Emerging markets are typically economies where GDP per capita is lower than that of the developed world, China and India remain low in GDP per capita but are catching up rapidly. Indeed, the economies of China and India are two of the fastest expanding in the world with 7%-8% GDP growth expected from both over the next two to three years. China, for example, is currently the world's seventh largest economy in US dollar terms, and if it continues to grow at its current rate China could be the world's fourth largest economy in 2014, only slightly behind that of Germany, with India coming in at tenth place. And by 2050, the economies of both China and India are expected to have overtaken that of the US, with the size of China's economy anticipated to be the first to surpass the US.
It is impossible discuss economic development without taking population growth and demographics into account. The evolution of the Chinese and Indian consumer lies at the heart of population trends. The growing middle classes are getting rich and are starting to spend, and the impact of this on consumer-facing companies worldwide is likely to be felt for the next 10 years and beyond.
For 2004, CSFB estimates that the US dollar value of Chinese household consumption spending US$704bn. This represents only around 9% of US consumption spending, although this is set to change with estimates suggesting that this will represent 37.3% of US consumption spending in 2014. With the incremental annual gain most likely to be larger than that of US household consumption spending - by this time - Chinese consumers are likely to have displaced US consumers as the primary engine of global economic growth.
India's demographic profile also provides many advantages. India is home to a quarter of the youth of the world - half the population is aged below 25. As the population matures, spending power is certain to increase. A recent KPMG International report highlights the valuable demographic advantage which India currently holds. Its working age population will continue to grow for the next two decades, at least, while China's is now beginning to decline.
In today's global economy, demographics drive growth as there is a positive correlation between long-term growth rates and the low dependency ratios associated with youthful populations. This means that public finances can come under less strain making infrastructure investment easier. In addition, there is an increasing number of affluent Indian consumers with the disposable income needed to make India itself more of an attractive marketplace. Recent figures showed that there are expected to be six million households classified as 'rich' by 2005-06 (income of over R215,000); up from three million households in 2000. If this growth continues it should result in an enormous consumption surge in what is still a remarkably undeveloped consumer marketplace.
In terms of foreign direct investment (FDI), both China and India have benefited with the former being allocated $60bn and the later receiving $5bn annually. Though FDI into India is dwarfed by that into China, India is already proving its worth in terms of tangible returns on investment (ROI). The Confederation of Indian Industry reckons that the average ROI is 19%, compared to 14% for China. According to the KPMG report, the higher return is a reflection of the higher value-added manufacturing investment which India attracts.
At least one executive interviewed for the KPGM report The China vs India debate comes down to what is being delivered now, as opposed to what is promised, saying: "Every dollar we have put into India has earned a very good return. Every dollar invested in China promises a terrific return but it is still only a promise."
On a macro level, this result may be in part owing to the fact that China classifies items that would be treated as government current spending as investment spending. However, on a micro level, annual net profits on the approximately 1,400 stocks listed in the Shanghai A Shenzhen A and Hang Seng Mainland Composited Indicies amount to US$37.4bn, which is only 7% of the profits of the S&P 1,500 Super Composite or 12% of the profits of the Bloomberg European 500.
Though the ROI is good in India, the growth in infrastructure is not matching the growth in the economy. The road network, ports, distribution networks and, more specifically, the power supply were all identified as barriers to entry for investors into India in the KPMG report.
India is by far the largest democracy in the world but the communist state of China has been far more efficient in passing and implementing reforms. India has seen great improvement in terms of dismantling onerous regulation which may have previously dissuaded investors; however, the pace of reform in areas such as labour regulation, business bureaucracy and taxation reform needs to keep pace with the rapid rate of growth currently being experienced in India. While policy and rhetoric appear business-friendly, it is another mater for these to filter down to the operational level at which businesses can actually feel the benefit. The combined deficit to the Federal and State governments is running at around 10% of GDP - severely limiting spending on long-term infrastructural improvement.
In some respects, China has made some progress. Private entrepreneurs are now welcomed into the communist party, the government is happy to list state-owned companies on the Shanghai and Hong Kong stock exchanges, and private company numbers are growing rapidly. The government does still retain huge control over parts of the economy, for example, it is still a majority owner in most listed companies. The crackdown on fixed asset investment in 2004 suggests the government still looks to manage the economy quite tightly. Overall, reforms by China in terms of relaxing state control, moving to join the WTO and encouraging FDI have been successful in developing trade and driving the economy.
The economies of China and India are two of the fastest expanding in the world.
It is improvements in education and infrastructure that are helping countries such as China and India to tap into their latent potential.
Chinese consumers are likely to have displaced US consumers as the primary engine of global economic growth.
Claim from SocGen's global markets division
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