|India’s Economy – Why Go With India Over ChinaThe Investment U E-Letter: Issue #434
Friday, May 6, 2005 India’s Economy – Why Go With India Over China: Part 2
By Dr. Steve Sjuggerud, President, Investment U
[Part 2 of a 2-part series on investing in India]
Rahul believes India’s economy is much better suited for investing than China’s – and that it will be for a long time to come.
He might be right, as you’ll see today.
When we left off last time, Rahul was about to give the four key reasons he believes India’s economy will outperform China’s as a place to invest in coming years.
Let’s get right to it…
The Four Factors Making India’s Economy a Superior Place to Invest Now
Steve Sjuggerud: Rahul, please tell us more about the four factors, and provide some insights on each
Rahul Saraogi: The first one is respect for capital India has a very vibrant capital market, and the market drives allocation of capital to economic activities. The government is burdened enough by its complicated finances to have virtually no power in directing capital allocation or economic activity.
China on the other hand has very active central and local governments directing economic activity. It has taken the legacy of its planned economic system and modified it to suit the new environment, which it claims is “market driven.”
While planned and directed investments have the ability to create China’s “wow” affect, it exponentially increases the potential for mal-investments and gross misallocations of capital. Look at the old Soviet Union. History has shown us repeatedly that although the market is an unpleasant mechanism of capital allocation, it is phenomenally better than any individual or groups of individuals at it.
When one visits China, the first thing that catches the eye is the world-class and large-scale infrastructure. Pudong near Shanghai is spoken of in the same breath as New York or London. The questions that cross the mind are, “Is this a developing country?” “Where did everyone else go wrong?” But showmanship is part of the Communist ideology; it is the only way the Communist party stays in power. Again, look at the Soviet Union.
However, when one finds out that over 50% of buildings in Shanghai are vacant, or that only two of the 25 gates at the Pudong airport are in use, one begins to wonder who is paying for it all.
Getting to Jim Rogers [and his caveats about India's infrastructure], unlike China, India has grossly under-invested in infrastructure. Everything in India is full. Period. But the reality of the situation today is that India is putting infrastructure in place. It is still not government directed; all infrastructure investments have some element of private participation and are driven by return considerations. That is why India is building the remunerative infrastructure (telecom, power, ports, airports, buildings) more rapidly than the less remunerative ones (roads and urban civic infrastructure).
Steve Sjuggerud: And how about the importance of respect for intellectual property?
Rahul Saraogi: The Chinese understand physical assets and commodities. They just don’t understand the knowledge industry and intellectual capital. India is miles ahead of China in the development of its knowledge industry. While the Chinese score over the Indians in basic primary education, India is miles ahead in higher education.
India has vibrant IT-, Pharmaceutical- and Engineering-based knowledge industries. Indians understand branding and consumer choice. It has a vibrant music and entertainment industry. Its media and advertising industries are world class. 50% of India’s GDP comprises services. China on the other hand commoditizes everything. It does not nurture innovation and is driven by imitation of foreign R&D. China is goods, India is services.
Steve Sjuggerud: And the idea of India having a superior banking and monetary system?
Rahul Saraogi: One out of two loans in China is probably bad. India, on the other hand, has net NPLs [non-performing loans] in its banking system of 3.5%. China’s bad loan problem is a legacy of its state-directed lending practices. Interest rates are completely controlled by the PboC, and the big four banks that control over 95% of banking assets have no credit scoring or credit risk based pricing mechanisms in place. It’s unbelievable.
India on the other hand has a vibrant domestic credit market with an active corporate and government bond market and interest rate and credit derivative markets. Indian interest rates are market determined, and the banking system definitely knows how to price credit.
China’s asset markets are very similar to the Japanese. They are very heavily leveraged and are primarily fueled by property speculation. The Chinese property market coupled with its leveraged and insolvent banking system is a very big accident waiting to happen. India has no such issues.
Steve Sjuggerud: Break down the difference between India entrepreneurship and profit motivation versus how it’s done in China
Rahul Saraogi: The drivers of economic activity in China are the state-owned enterprises, the quasi-state owned enterprises, and foreign enterprises. While the Chinese are phenomenal entrepreneurs abroad, inside China they [entrepreneurs] are a minority.
India is totally and completely private-enterprise driven. Entrepreneurship permeates the Indian social fabric to the grass roots. India has the second highest number of entrepreneurs per capita after Thailand, and given its population, it has the highest number of entrepreneurs in the world.
There are over 6,000 companies listed on the Bombay Stock Exchange, and one finds a representation of every imagined economic activity. There is only one thing that drives the Indian entrepreneur and that is ‘Profit.’ That is more than can be said about China. China has a history of dubious economic objectives and has been known to create gross mal-investments in its quest for global supremacy in a given sector, industry or product.
These factors in our understanding make India a more tenable place for sustainable economic development and activity.
Steve Sjuggerud: Okay, you’ve laid out a nice case as to why India can outperform China in the very long run. But why should I be interested right this second? Emerging markets are struggling, and India is still, from an outsider’s perspective, a big mess. The change is hard to see Again, why India versus China, right this second?
Rahul Saraogi: Yes, I gave you the big picture. But there are short-term factors as well that make it attractive. The first is India’s well developed financial system. India has a large and active domestic retail and institutional investor base. The investing public understands the market system.
As a foreigner, you want to be able to exit the market. In China, it’s hard. The Chinese stock markets are a recent development. China does not have a developed investor base, and there are numerous structural problems, to say it politely.
The Bombay Stock Exchange, founded in the 1870s, is the oldest stock exchange in Asia. With 6,000 companies listed from every imaginable industry, it’s simply easier to participate in India’s growth. China does not have nearly as many stocks listed and the representation is very narrow. A disproportionate share of its market cap is taken up by state-owned enterprises.
The other big plus in India’s favor right now is its relatively low export dependence. Only 10% of India’s economy is dependent on international trade versus 40-50% of China’s economy. India also has numerous listed companies that are participating in its domestic growth. There are numerous opportunities in small and mid-cap stocks here.
What I’m getting at is, if there is a problem in the western consumption economies, China will be impacted severely. While India may be impacted in the immediate aftermath, I think that money will flow to India – rather than China – to participate in its domestic growth opportunities that are more insulated from international events. Those are stocks I’m interested in
Rahul makes a good case for India. Emerging market stocks are currently in a downtrend right now. If Rahul is right, when the tide turns, India’s economy might just outperform China’s over the long run
Dr. Steve Sjuggerud