India or China: Top of the Pop(ulation)s

China remains a dominant part of the MSCI Emerging Markets and Asia Pacific ex Japan equity indices, comprising around 30% of each. India is also a large weighting, if smaller, at around 15% of each. As such, what happens to China’s market affects the performance of these indices more than any other individual market. Some Chinese exposure in portfolios  seems sensible, but we should consider whether we’d prefer to be overweight or underweight the benchmark weightings in China and India.

China’s demographic situation looks challenging. China’s one-child policy, in place between 1979 and 2015, slowed population growth to the extent that the population is set to fall. While the policy has been relaxed, and today couples are incentivised to have more children, fertility rates remain low. Notwithstanding a big change to immigration policy, it’s too late to shift China’s demographics in a meaningfully more favourable direction.

This stands in contrast with India, where the average age is 28 (compared to 38 in China). India has 254m 15-24 year olds – the world’s largest youth population - whereas China has 151m. India’s middle class is growing quicker than almost anywhere else in the world and is expected to increase 153% by 2040, compared to an increase of 18% for China, according to figures from HSBC. This rising middle class is set to be a key driver for long-term consumption and economic growth.

Since the beginning of then US President Donald Trump’s trade war with China in 2018, relations between China and the US (and hence the West more broadly) have been under increasing pressure. The popularity of a tougher stance in the US has seen President Joe Biden keep his predecessor’s tariffs in place on $350bn worth of Chinese imports, along with introducing the CHIPS Act, which aims to reduce China’s import of cutting-edge semiconductors. These measures are affecting the Chinese economy - trade between China and the US, its largest trading partner, fell 15% in the first half of 2023 from a year earlier. Tensions have also increased over China’s claim to Taiwan, which is of strategic importance to the US and the rest of the world. Taiwan produces around two-thirds of the world’s computer chips.

India, in contrast, has managed to tread a more careful line. In September it hosted the G20 summit, and has worked with China and Russia on one side, and the US and Europe on the other. It is a preferred partner of Western powers who would like to see it become a regional counterweight to China. This is likely to see India receive preferential treatment. It has already been a beneficiary of the ‘friendshoring’ trend, where companies move manufacturing facilities to territories deemed to be more politically compatible, with Taiwan’s Foxconn, who assemble Apple’s iPhone, recently establishing a base in the country. However, recent accusations of India’s involvement in the death of a Sikh activist in Canada serve to remind that geopolitical challenges can still feature, even in an otherwise favourable environment.

The Chinese economy faces some significant headwinds. There remains a lack of consumer confidence after the lifting of pandemic restrictions. Equally, the hoped-for big stimulus measures have not (yet) materialised, with policymakers seemingly wary of exacerbating problems in the real estate sector. Real estate, which has represented around a fifth of GDP in recent years, was one channel authorities had favoured for stimulus, along with infrastructure projects.. Over the long term, demographics will exert a significant drag on growth. All these factors mean China is unlikely to regain its previous levels of growth.

In contrast, economic growth forecasts for India are much higher, with demographics providing a long-term tailwind. The country has moved from having the world’s 11^th largest economy to the 5^th over the last decade. By 2030, India’s economy is expected to grow around 10% annually, while China is expected to grow at 6%. India can grow at this higher rate from a lower base, and is being helped by domestic policy. Longstanding issues with poor infrastructure and the electricity grid are being addressed, along with a drive for digitalisation of the economy, including better electronic payments and digital IDs,  an initiative praised by the International Monetary Fund.

There’s no doubt that some of the pessimism around China’s future growth is reflected in the current price of Chinese equities. The Indian stock market is significantly more expensive, with price to earnings ratio of around 20, compared to 10 for China. This valuation gap is not a recent phenomenon and has been persistent and widening over the last 15 years. Since 2020, earnings per share (EPS) growth for companies in India has been significantly higher than that of companies in China in aggregate, reflecting better quality companies able to achieve higher returns on capital.

One area where China does have significant competitive advantage is technology. In green technology, for example, China has a strategic presence in the supply chains for equipment the world needs for its long-term transition away from fossil fuels. It dominates other areas, too – a study by the Australian Strategic Policy Institute (ASPI) published in March this year found that China was the world leader in research in 37 of 44 technology areas. The ASPI study focused on high-impact and often-cited research papers published in leading scientific journals, across areas like materials, Artificial Intelligence, biotechnology, energy and quantum computing. In the seven fields where China was not dominant, the US was. India ranked further down the list in all areas, along with the UK, Europe and Japan. This competitive advantage should be reflected in higher productivity in the economy over the long term and is a strategic strength for China.

Pressure from demographics and geopolitics is likely to weigh on China’s future growth and bring it down from high historical levels. India is at a very different development stage and its demographic dividend will likely translate into continued relative economic strength. It is a preferred partner of the West, and notwithstanding the high valuation of its stock market, we prefer to have a strategic tilt towards India over China within emerging markets.

[1] https://www.cnbc.com/2023/08/31/china-says-drop-in-trade-with-us-is-direct-consequence-of-us-moves.html

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