India is NOT the next China

Mugunthan Siva

The exciting story surrounding emerging markets has been the rise of two economic powerhouses, India and China. Whilst both countries share some basic similarities, they differ in many significant ways, most importantly stock market returns. In this wire, we articulate how they differ and what investors should expect going forward.

Stock Market Returns

Whilst both countries have experienced strong economic growth, stock market returns for investors have been far from similar. The chart below shows the growth of $100,000 for an Australian investor since 1993. Over this period, India has outperformed China by 542%! If you’re concerned about volatility well don’t be fooled by the chart. Firstly, if you are a long-term investor it’s hardly relevant and secondly, China’s volatility over this period is in fact higher.

Source: MSCI India and China Indices in AUD terms, India Avenue Research

So why has the relationship between strong GDP growth and stock market returns only played out in India and not China? Well let’s look at the earnings growth chart below of the two countries over the long term. Looks familiar to the chart above right?

Source: MSCI India and China Indices, India Avenue Research

We feel the major reason for this is that many companies in China are state owned enterprises or quasi government organisations, where profitability and/or maximising shareholder wealth is not a priority. This is in contrast to many listed companies in India that are motivated by profitability, especially since the original founders remain as significant shareholders. In fact, more than 70% of companies listed in India are private sector companies. It’s part of the reason why India’s stock market return on equity is one of the highest in the world.

Demographics

Together, India and China command 40% of the global population. Whilst India’s population of 1.31bn is slightly behind China’s 1.37bn, it is expected to surpass China as the world’s most populous country by 2022 and reach 1.69billion people by 2050 according to the United Nations. Furthermore, India enjoys one of the youngest populations in the world with a median age of 27, compared with China’s 37. Every month, 1 million people turn 18 in India and there are more 9-year old’s than the population of Australia. With such a large and vibrant new generation, consumption demand is likely to be unparalleled to anything we have witnessed before!

Source: United Nations

Economic Liberalisation and Reform

India’s economic liberalization began in 1991, in three phases (decades)

  1. The economy moved, through reforms, to be market-oriented and reduced controls on foreign trade and investment
  2. The second decade of reforms was directed to foster resource management and reducing foreign trade bottlenecks
  3. The next wave of reforms by the Modi Government is already underway targeting even higher levels of foreign participation and an increasing focus on manufacturing in India, via its Make-In-India campaign

Whilst the impact of the latest round of reforms is unobservable as yet, the success of the initial reforms may be gauged from the table and chart below which highlights the relationship between GDP growth and foreign direct investment (FDI).

Source: World Bank, India Avenue Research

China on the other hand initiated major market driven reforms in 1978, 13 years before India, and was able to quickly implement these, being a communist state. China’s reforms were also far more comprehensive, resulting in unprecedented growth for over 30 years. A major reason for growth divergence between China and India has been comparative advantages in manufacturing exports and attracting FDI, which have been the two key drivers of China's success story. The link between FDI and GDP growth is illustrated below.

Source: World Bank, India Avenue Research

Foreign Trade

China is a net exporter, with growth coming particularly from export of cheap manufactured goods. In contrast, India’s major export has transitioned over time from agriculture to services. India still remains a net importer, largely due to the fact that it chose to import rather than industrialise, effectively opting out of the boom of mass market manufacturing. This left China in an almost monopolistic position to reap the benefits of demand from developed economies. In fact, Chinese growth has been driven by consumption of US households, not by Chinese households.

GDP – Where has it been and where is it going?

China is now the 2nd largest economy in the world, at $11 trillion, compared to India at $2 trillion, ranking 5th. Interestingly, the two countries were of the same size in 1980, but since then have grown at different trajectories. Although China is expected to continue growing at a brisk pace, especially relative to advanced economies, it is likely to slow down, given weakening export demand and lower fixed asset investment and domestic consumption.

According to the IMF, India is expected to grow significantly faster than other developed and emerging economies and has already overtaken China as the fastest growing major economy.

Source: IMF World Economic Outlook

We feel over the next few decades India’s growth will accelerate relative to China’s, driven by;

  • Private consumption as India’s GDP is driven more by household consumption than China’s, compounded by favourable demographics and urban migration. (Refer to the table below)
  • Private sector growth given India’s entrepreneurial culture giving rise to new company listings whereas private sector growth in China has been largely the result of state owned enterprises, utilising high levels of debt
  • Increasing FDI in India as economic reforms and positive sentiment attract more capital
  • We feel rising GDP in India will translate into higher equity returns as companies in India are focused on generating high return on capital. Furthermore, domestic consumption via consumer, industrials and financials stocks which have a healthy representation in the share market

Source: World Bank

Conclusion

India and China have differed in terms of the speed, timing and pattern of their growth. Over the past four decades China has been more successful in generating economic growth, given a focus on manufacturing and exports. Whilst undoubtedly both countries will be very prominent in the future in terms of contribution to global growth and trade, they are at different points in their long-term economic cycle. In an age of technology, India’s comparative advantage in human capital, along with favourable demographics leading to increased spending from both private and public sectors and rising household wealth, means that India is likely to have strong structural tailwinds in its favour and most importantly reward investors via its stock market.


Mugunthan Siva

Mugunthan Siva is Managing Director of India Avenue, an Australian based boutique asset management company with offices in Sydney and Mumbai. He has over 20 years experience in Australia and is lead portfolio manager for the India Avenue Equity Fund.

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Graeme Holbeach

This article makes a lot of good points. However the stock market return is very much a function of what starting point you use. If any starting point from year 2000 on had been chosen, the returns would be about equal. Incidentally, this is another example of how arithmetic scale charts can be very misleading when applied to long term returns.

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Ben Heap

Excellent piece Mugunthan

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Mugunthan Siva

Thanks Ben - much appreciated

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Aran Nagendra

Hi Graeme, you are right, the starting point does make a difference for any historical analysis. You can negate this by looking at rolling periods. We did this on a 3 year forward basis every month over the long term and it shows India outperforming China 69% of the time. However the point of the chart was to show the relationship between stock market returns and earnings growth and how they have differed between the two countries.

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