Most investors remain convinced that China will continue to outperform India during the coming decades. After all, your email inbox is not filled with Indian newsletters touting triple-digit percentage profits from the “Indian miracle.” But the lousy performance of Chinese stocks this year is forcing investors to take reapprise the “China miracle.” And for all the attention lavished on Beijing’s Olympics and the Shanghai World’s Fair, Indian Prime Minister Manmohan Singh still believes that “slow and steady will win the race.” Certainly, for investors in the local stock markets, that may turn out to be the case.
The Chinese Hare
Chinese economic development has outpaced India’s by just about every measure. The Chinese have built the biggest dams, the longest bridges, and the most impressive skylines. The images of China’s shiny new (although sometimes empty) cities and wide freeways contrast sharply with the dilapidated infrastructure of India’s New Delhi and Mumbai.
China’s fast-acting mandarins carry out new policies with seeming omniscience. This includes the biggest economic stimulus in history that has helped jumpstart economic growth in not only China, but also the Asian region and the world. On top of the government’s sharp jumps in infrastructure spending, Beijing spurred China’s banks to double the amount of new loans they made in 2009 to $1.4 trillion — representing almost 30% of gross domestic product (GDP).
But just more than a year into the fragile global recovery, cracks are appearing in the Chinese wall. Beijing’s easy-money policies have fueled a property-price bubble. Selected real estate projects in Shanghai and Beijing have plummeted 30% to 50% in a matter of weeks. The lending explosion in China’s banking system — which now boasts four out of the world’s top ten banks — has raised questions about loan quality. The Chinese government has conceded that as much as 20% of its banks’ loans will be nonperforming. A more realistic number of 30% of loans turning sour could bankrupt the entire banking system. Even conservative estimates put bad loans at a staggering 8% of GDP — more than double what the savings and loan crisis amounted to in the United States.
Equally importantly, the Great Recession has revealed that the engine of China’s growth during the past 30 years — selling exports to the West — is yesterday’s game. Western economies no longer can absorb an endless supply of goods from East Asia. The key question for investors is which countries can transition to a post-mercantilist world. For China, that transition will be tough.
The Indian Tortoise
The Indian model could hardly be more different. India’s democratic system is noisy, slow-moving and chaotic. This may be a watershed year. In the past, India never could compete with China on top-line economic growth. China is slowing its economic growth to about 9%, while India is expected to hit 9.2% in 2010. If Western economies do flirt with a double-dip recession, 2010 may mark the first year that India grows faster than China.
India’s economy also is rebounding from the global downturn in better shape than China. Like China, India’s government cut interest rates, introduced tax breaks and increased fiscal spending to combat the downturn. But India’s government stimulus totaled only 3% of GDP, compared to China’s, which hit 6%. This has much to do with the different structures of the economies. Exports represent only 24% of India’s GDP, compared with 35% of GDP for China. Consumption accounts for 57% of GDP in India, compared with only 35% in China. As a result, India’s domestic economy is much less subject to the whims of U.S. shoppers at Walmart.
And unlike China, India never put its banking sector at risk to save its economy. Whereas Chinese banks couldn’t shovel enough money out the door fast enough in 2009, credit growth in India was actually slower in 2009 than in 2008. As a result, there is no sign that the assets of Indian banks were deteriorating. Nor did India’s monetary policies send prices of Indian real estate to bubble levels. The bottom line? India’s growth of 9.2% in 2010 stands on firmer ground than China’s equally eye-popping growth number of 9%.
China vs. India: “Order vs. Chaos”
Russell Napier of investment bank CLSA has warned investors not to get fooled by China’s superficial order and India’s apparent chaos. Napier makes a compelling argument for why you are more likely to make money investing in India than China. India has a far more established private-sector financial system. Chinese banks still are acting as the long arm of the Communist Party, funding pet projects and state-owned enterprises. India uses capital much more productively than China. India’s driver of economic growth is consumption instead of volatile exports. India has achieved its successes with a market-based exchange rate, while Chinese companies tremble at the prospect of a revalued yuan crushing their razor-thin margins. India even is making progress on infrastructure. The recently opened New Delhi airport compares favorably with the world’s best airports. Equally importantly, it took only 37 months to build — faster than the 45 months China spent to complete the terminal in Beijing that opened in time for the 2008 Olympics.
A handful of Chinese moon shots notwithstanding, the Chinese stock market has been one of the worst performers in the world during the past 12 months — and has trailed India’s stock market by a substantial margin.
China’s Shanghai Composite versus the India’s BSE Sensex (12 months)
The performance of the popular iShares FTSE/Xinhua China 25 Index (FXI) has scarcely been better. This has left investors scratching their heads. But it turns out that there is little correlation between economic growth rates and stock market returns — especially in markets like China. China’s economic model of state-owned enterprises, ultra-cheap exchange rates and a near total dependence on export growth and investment tend to make for lousy investments.
The verdict? Over the next 10 years, look for the Indian stock market to outperform China- for India’s tortoise to over take the Chinese hare
Disclosure: No positions