#Market Strategy — 09.01.2017

“Chindia “ - Extremely Complementary Markets

Roger Keller & Prashant Bhayani

Growth is accelerating in India, driven by infrastructure spending and manufacturing. Meanwhile in China, growth is stabilizing in rebalancing mode, driven by services and consumption. India is a growth story; China a value story. Both are the least exposed in Asia to US protectionism. Adding all these parts makes for an attractively balanced investment theme.


Extremely complementary

Growth is accelerating in India and stabilizing in China. The working age population is expanding in India and, since 2014 has been contracting in China. Growth in India is expected to be driven by infrastructure spending and manufacturing; in China, consumption and services should become the growth engines. India is a growth style investment, whereas China is a value-style investment. An advantage of pooling India and China together is that India has little exposure to China’s economy, with exports accounting for just 0.5% of GDP (Gross Domestic Product) and just 1% of value-added exports. Both countries have the lowest level in Asia of value added exported for US final demand, as a percentage of GDP (apart from Indonesia); this is an advantage in view of the huge uncertainties over US protectionism going forward.

India: on a journey towards middle-income class status

India is the fastest-growing economy in the world, and it will be a major driver of global growth for several years. This potential comes from 1.4%e per annum growth in the working age population between 2015 and 2025 - the fastest among the 10 biggest economies - and the anticipated strong improvement in productivity. Today, India’s productivity per hour represents 42% of China’s.

India has a lot of catch-up potential: its GDP per head is just 11% that of the US, versus 25% for China; the manufacturing share of GDP is 17.5% compared with 39% in China.

To capture this catch-up potential, reforms are proceeding at a good pace (accelerated infrastructure investment, introduction of a goods and services tax, consolidation and recapitalization of the banking sector, greater openness to foreign direct investment, etc.). As a result, India posted the strongest gain in the World Economic Forum competitiveness index in 2016-2017 and increased 16 places to rank 39th out of 138 countries. The strongest progression was in “goods market efficiency” whilst labour market efficiency also made an outsized progression. The recent decision to scrap large denomination banknotes will ultimately help India’s public finances, by reducing the size of the informal economy and boosting tax collection. Another attraction of India is its relative insulation from trends in the world economy. This is always a good factor in the construction of portfolios as it offers a decorrelation.

China: a shift in growth model

Fiscal support is allowing China’s economy to grow by at least 6%. All measures will be taken to support this trend as in 2017 there will be a rejuvenation of the political elite. Eventually, consumption and services will take over investment and exports as the main growth drivers, after a decade of China benefiting from an undervalued currency and WTO (World Trade Organization) membership.

Leading indicators are sending positive growth signals, which should help translate into better earnings growth figures. Another sign that the situation is improving is that the PPI (Producer Price Index), which had been in deflation territory since early 2012, finally turned positive in 3Q16.

Given that valuations are low by historical comparison, China’s stock market is well positioned to deliver attractive returns in 2017.

In 2015, the service sectors reached 50% of contribution to GDP, and this share will continue to grow as the rebalancing of growth within the economy gathers pace.

The existing and former China indexes track mostly the old economy.  The new drivers of China economy - consumption and services - are under-represented in the former indexes. New indexes are now available to play this shift in the growth model theme.

Risks to our base case

The Modi administration is taking courageous measures to “make India a global manufacturing hub”, according to the words of the prime minister, and to modernize the economy. This means that there are high risks of encountering hurdles, but the rewards are also high. Another hurdle is valuation, at least when compared with other emerging markets or the rest of the world, because it is undeniably high. However, it is justified by a substantially above-average ROE and Indian stocks are trading close to their long-term average

We have reservations about China, mainly that the resolution of the debt issue is continuously being postponed and reforms are progressing at a snail’s pace, jeopardizing medium-term growth opportunities. It is important to highlight that authorities have the means to resolve structural issues. The main question is the timing of related decisions. Clearly, the authorities want to ensure that the renewal of the political elite in the second half of 2017 goes ahead as smoothly as possible. We note that bolder reform steps are normally taken in the second 5-year term of the government.