x Abu Dhabi, UAESaturday 22 July 2017

Awe of an emerging Chindia

Despite unprecedented growth, investors are advised to be cautious in China and India.

China will outperform the West for the next 20 years, says one adviser. It is already the world’s fastest-growing major economy, averaging 10 per cent growth for the past 30 years.
China will outperform the West for the next 20 years, says one adviser. It is already the world’s fastest-growing major economy, averaging 10 per cent growth for the past 30 years.

China and India boast the two biggest populations on the planet, with more than one billion people each. They can also boast two of the hottest economies, which are shifting the global balance of power from West to East, perhaps irrevocably. Put them both together and what have you got? Chindia, the biggest investment opportunity of the age.

The world sees them as sleeping giants, but in the past decade they have been stretching out their limbs, and it has been an awe- inspiring sight. You only have to look at the numbers.

Let's start with China, a country of 1.35 billion people, the world's largest population. If the US is the number one global economy, China is unquestionably number two, with a total GDP of more than US$5 trillion (Dh18.3tn), having overtaken Japan this year. It is also the world's second-largest trading nation, and the second-largest importer of goods.

In many key respects, China is already number one. It is the world's fastest-growing major economy, averaging 10 per cent growth for the past 30 years. It is the largest exporter, shipping out $1.2tn worth of goods every year. Finally, it is also the largest creditor nation in the world. The US alone owes it $847 billion.

It also has the world's largest labour force, with an astonishing 812 million people.

Its total GDP still lags far behind the US, whose economy is worth about $14tn, but that will change. If China grows 12 per cent a year (against 5 per cent in the US), it will become the world's biggest economy in 2025, with GDP of about $31tn.

The US will fall to second place, but not for long. By 2043, it will have been overtaken by India, which will have been promoted from the 11th-largest economy in the world today, to become the new number two.

With a population of 1.15 billion and 500 million workers, India has numbers on its side. Since liberalising in 1991, its economy has grown rapidly, and it is now a world leader in telecommunications, textiles, chemicals, steel, mining, information technology and pharmaceuticals. Its services sector, which provides back-office services to big multinational companies, is now worth 60 per cent of the economy. If you dial a call centre in the UK, you often get India.

India's GDP is growing at 8.8 per cent a year, just behind China at 11.1 per cent. That compares with a meagre 1.7 per cent in the US, 1.2 per cent in the UK and 1 per cent in the eurozone. "China and India are the story of our age," says Mark Dampier, head of research at Hargreaves Lansdown, a UK-based independent financial advisory. "They are spearheading the historic shift of wealth from West to East, and are becoming as crucial to the world economy as the US."

But it won't be a smooth rise to power. "They are still emerging countries with huge challenges, such as massive poverty, poor infrastructure, political corruption and environmental damage. Investors can expect a bumpy journey, but they should get there in the end."

Over the past 10 years, China has delivered average returns of 18.5 per cent a year, while India has delivered 15.8 per cent, according to figures from Standard & Poor's. This compares with just 2.6 per cent in the UK, -0.9 per cent in the US, and -2.3 per cent in Japan. Can this stellar outperformance continue?

China will continue growing faster than the West for the next 20 years, says Henry Flockhart, an assistant fund manager with Matterley, a division of the London-based stockbrokers Charles Stanley. "The Chinese government is determined to keep its GDP growing at current rates. It needs to keep its huge population happy by helping them emulate the lifestyles of western countries. If it doesn't, it could face major social unrest."

Investors shouldn't confuse GDP growth with investment growth. "Many companies are state owned or privately owned, and are focused on boosting market share rather than profitability, so you might not always get the returns you expect. This could change in future, however, if companies become more profit-orientated," Mr Flockhart says.

One worry is that the massive stimulus has inflated a property bubble that could burst and bring the China growth story to a sticky end, but Mr Flockhart denies Chinese borrowers are overstretched. "The average buyer in Shanghai borrows only 30 per cent of the cost of their property, compared to 70 per cent in the UK. So even if prices do fall, they should weather the storm."

India is also well placed to continue growing, says Sam Mahtani, the director of emerging markets equities at fund manager F&C. The economy is built around services, manufacturing and agriculture, and for the first time in years, all three have turned positive at the same time. "Indian GDP is expected to grow by 8.4 per cent in 2011 and 8.5 per cent in 2012. From 2013 onwards, we could be entering a new range of 9 per cent or 10 per cent annual GDP growth."

He says India has plenty of high-quality large companies with strong balance sheets and a focus on shareholder returns, particularly in pharmaceuticals, automobiles, banks and technology. His top tips include Bajaj Auto and TVS Motor, and pharmaceutical manufacturer Lupin Laboratories, which has benefited from new product launches in the US.

Mr Mahtani calls India "a high-conviction play", which is fund-manager speak for "he likes it" .

But stock markets in China and India are no longer cheap, as measured by the price/earnings (P/E) ratio. The higher the P/E ratio, the more expensive the investment, with anything above 15 starting to look expensive.

China is currently trading on a P/E ratio of 15, while India is trading at 20. This compares with 13 in Brazil, and just 7 in Russia, making Chindia more expensive than the other two countries in the BRIC gang of four.

They may look expensive, but that is largely because investors have priced in future strong growth rates.

Mr Mahtani says India's startlingly high P/E ratio can be justified by its strong domestic market and an earnings per share growth of 15 per cent to 20 per cent a year.

Chindia is a catchy name, but it is misleading because there are major differences between their economies. China is an export powerhouse that has built its economy on free-spending western consumers, particularly in the US. But those consumers aren't spending as much as they did, and China is dangerously exposed to a double-dip recession.

India is different. It already has a large middle class of an estimated 300 million people and much stronger domestic consumer demand. Its exports are worth just £177 billion (Dh1tn) a year, small fry compared with the Chinese. This gives it much greater protection against a double-dip recession.

China is also under growing political pressure from the US, which happily imported deflation from the mainland before the credit crunch, but doesn't like importing mass unemployment now.

The recent quantitative easing in the US is aimed at reversing this trend by devaluing the dollar against the yuan, and other currencies, to give exporters a chance.

If it works, China is vulnerable. It urgently needs to rebalance its economy to boost domestic consumer demand to take up any slack.

The two country's demographics are also different. India is much younger: one in four of the world's under-25s live there, while the country's total fertility rate (TFR) is a robust 2.81 children per woman, well above population replacement rate of 2.1.

China's one-child policy, implemented 30 years ago, has left the country with an official TFR of 1.8, well below the replacement rate.

Worse, 120 baby boys are born for every 100 girls because so many female babies are aborted by parents who want their one child to be a boy. By 2020, that will leave a surplus of more than 40 million Chinese men who will never marry or have children of their own, forcing the fertility rate even lower.

Can China's economy keep growing at 10 per cent a year when its population is ageing, or will it soon start creaking at the knees like Japan? India has the opposite challenge. Its population is expected to hit 1.53 billion by 2030, the biggest in the world, and this contains "the largest concentration of the poor, the illiterate, the sick and the unemployed in the world", according to its National Commission on Population. This is putting intense pressure on the country's natural resources, especially arable land and drinking water, and its infrastructure is inadequate.

Despite their massive growth, both countries are poor by western standards. China's per capita income is a mere $6,778 a year, according to IMF figures, placing it a lowly 97th in the world, below Algeria, Tonga, Albania, El Salvador and Bosnia and Herzegovina. India's per capita income is $3,015, putting it 127th in the world, below Mongolia, the Philippines, Iraq and the Republic of Congo (Brazzaville). Both countries face major challenges closing the growing wealth gap.

Most private investors will want to spread risk by tapping into Chindia via mutual investment funds. Steve Gregory, the managing partner at Holborn Assets, a financial services company in Dubai, says there are several attractive funds available for investors in the Middle East. His favourites include the aptly named Ashburton Chindia Fund, and two funds specialising in each country: JPM JF India Trust, which has returned 34 per cent over one year and 133 per cent over five years, according to Trustnet.com, and First State China Growth, up 32 per cent over one year and 250 per cent over five years. "You must understand the risks of investing in these potentially volatile countries and only set aside money you need for at least five or 10 years," he says.

Mr Gregory is confident that both countries offer huge growth prospects. "Where would you rather sell mobile phones, in the UK, where everyone has one, or in China, where a few hundred million people don't use one yet? Prospects for household and high-end goods are enormous. There are said to be more Ferrari drivers below the age of 40 in Shanghai than any other city in the world."

Mr Dampier, of Hargreaves Lansdown, suspects India will prove the better long-term bet than China. "It is more self-reliant, and isn't so dependent on demand from the West. It also has a much younger population, which helps. Neither country is a one-way bet and you must brace yourself for future volatility. It is safer to invest regular monthly amounts than throwing in a single lump sum."

The Chindia growth story won't run forever. In March 1950, the US recorded a record GDP growth of 17.2 per cent, a feat it is unlikely to repeat. One day, the same will also happen to Chindia. But that day is a long way off. You've got maybe 20 years.

 

pf@thenational.ae