When people consider investment opportunities in Asia, China is frequently at the top of the list. Those not paying attention to Japan’s debt and demographics may additionally be attracted to Japan. But India does not usually come up until 3rd, 4th or 5th position.
I have written extensively about Japan over the previous few years –about why it is an accident waiting to happen — so I won’t go there now.  I’ve also recently written about why China looks frothy and ripe for a considerable correction. In fact some well-known market players have in the past few days come out in favor of outright shorting China.  I’m not getting that aggressive. This article suggests India looks more attractive than China from an investment perspective.
It is easy to understand why China garners so much attention. Economic growth there has been miraculous for the past decade. But China is addicted to growth from capital projects (buildings, roads, etc). Unfortunately with China’s inefficient system of allocating capital, it is apt to waste a lot of it –especially on capital projects. Plus and a disproportionate amount of profits go to the central government versus citizens or business owners, so there is reduced incentive to innovate and take risk.
The sustainability of long term growth for an economy depends more on consumption by the middle class than consumption by government. Despite China’s many impressive statistics, this is one area where China falls short. Approximately 33-35% of the Chinese economy is driven by their consumers. India, on the otherhand, has roughly 65% of its economy driven by consumption. This is more in line with western economies and considered to be sustainable and ideal for long term growth (though I think 65% may be a little high). These figures are not surprising, given that China has roughly 150M middle class citizens, whereas India has roughly 300M — and both countries have similar populations — approx 1.2 -1.3B citizens.
China’s currency has been linked/pegged to the US dollar in an attempt to hold down the Chinese currency (the Yuan) and make their exports cheaper. This is something of a crutch and will need to be addressed at some point in time (many think very soon). Having this policy makes imported goods more expensive and impedes domestic spending and consumption. India on the other hand allows its currency – the Rupee – to float on international currency markets and does not have this issue.
India has a myriad of small businesses — many times the number of small businesses of China. Despite the chaos of operating in India, its army of small business owners are adept at operating from very small budgets and allocate capital very efficiently in comparison to the Chinese model with local bureaucrats (kleptocrats). Just as in the USA, small business drives economic growth faster and more efficiently than government. So unlike China where a large portion of profits end up in government coffers, in India a large portion of profits stay with small business owners (risk is rewarded).
Perhaps one of the starkest comparisons in India and China is the state of the 700M rural poor in each country. China’s rural poor have seen very little economic progress, have seen poverty and illiteracy roughly double in the past decade. Juxtapose this to India where the rural poor’s illiteracy and poverty levels have almost been cut in half in the past decade (like Brazil as well). In fact the rate of economic growth in rural India over the pat decade has been 40% faster than the rural areas — and now accounts for half of India’s GDP. China’s rural area accounts for a third of GDP and only 15% of GDP growth.
India has a tremendously innovative culture. (Free markets encourage this after all). India is the home of constraint-based design a.k.a. frugal design. In essence frugal design is about focussing on innovation that delivers:
  • reduced costs
  • simplified use / ease of use
  • durability
  • reduced impact on the environment
Frugal design also focuses on business processes and business models and enables game-changing competition to thrive. An example is Bharthi Airtel – an Indian mobile phone company:
  • it charges some of the lowest fees in the wireless industry.
  • everything is contracted out except the core business of selling service.
  • Network Operations is contracted out to Ericsson.
  • IBM does the business support.
  • management of towers to another contractor.
We need to always be aware of the risks in the assets we own / consider owning. So here are some notable concerns I have about investing in India’s equity market now:
  • as with all equities: we are overdue for at least a 10% correction. This is a reason to tread cautiously and look for a buy opportunity. Given that Indian equity will be more volatile than the US, a 10% correction in the S&P might cause a 15% correction in a broad Indian equity ETF. Of course, this is justified by the much higher future returns in the next decade in India vs. the USA.
  • last year saw one of the worst/weakest monsoon seasons in history. This left India with reduced water supply and a poor crop season. This is in turn pushing food prices up which has inflation running high (9.9%). The solution to this will be rising interest rates –which will slow economic growth.
  • India’s interest rates were raised this week to slow inflation and keep a lid on GDP growth –expected to be 8% this year. The higher interest rates announced this week and the combined impact of raising bank reserve requirements are also the beginning of the central bank mopping up the liquidity / stimulus applied over the past year. That same mopping up process needs to be done here in the US yet. We’re still fighting deflation.
  • India’s budget deficit needs to be addressed. The 2010 Indian budget deficit is roughly 10%.  As a result of the high debt, February saw India’s long term sovereign debt rating lowered.
  • infrastructure is very poor and limits economic growth. India is embarking on a vast national infrastructure improvement program. Infrastructure development won’t progress as fast as it does in China, but the funds are well timed, and the projects are well needed.Over 10,000 miles of India’s 46,000 miles of roads are barely driveable.
  • recent (this week) bombings and skirmishes between rebels and the Indian armed forces. Add to this, on-going risk of conflict with Pakistan.
The rest of this article is for clients. This is where the details and investment recommendations are.