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Crouching tiger or hidden dragon?

Aug 31, 2005

Both India's and China's popularity amongst foreign investors as preferred investment destinations is growing. To rationalise as to which of the two would continue to remain on the investment radar in the longer term, we did a SWOT analysis of the Asian giants. We base our arguments on China from our discussions with experts who understand the Chinese economy better.Strengths

India: Indian corporates have historically delivered a higher return on capital (both in terms of return on assets and return on net worth) in comparison to their Chinese counterparts. Most of the Indian companies, being listed entities, have an obligation to investors in terms of focusing on profitability. Most of the Indian corporates now seeking overseas listing have also begun to adopt globally accepted accounting standards and corporate governance norms.

China: Efficiency in low cost manufacturing and escalating industrial growth rates distinguishes China from the rest of the developing world. It must also be recalled that huge government investments in infrastructure and large FDI inflows have helped China strengthen its stand in the industrial world. A high rate of domestic savings (leading to sufficient liquidity) and lower cost of capital have also facilitated budding entrepreneurs.

Weaknesses

India: The prime constraint in India's growth appears to be insufficient investments. This most commonly cited constraint is the result of time lag in policy implementations and tardiness at the bureaucratic levels, as contrasted with the "single mindedness" on the Chinese side.

China: Given the communist economy that it is, the Chinese government seems to be finding it difficult to do away with 'favors' that have been extended to the state owned enterprises. Most of the capital concentration is amongst PSUs with even the state-owned banks being made scapegoats for funding the perennially leaking enterprises. This has not only resulted in Chinese banks bleeding with poor assets but has also left very little capital to be accessed by the private sector players.

Opportunities

India: India's prowess in the service sector is comparable to that of China's in manufacturing. Rightly called 'the world's back office' (though moving away steadily from low value-add services), India's distinction as an outsourcing hub has helped it garner much of the world attention today. However, as has been proven in innumerable economic theories, a country's economic growth engine cannot sustain without steady growth in industrial production. Thus, to increase pace in India's industrial growth machine, higher investment in infrastructure (by government and corporates) and higher FDI inflows are essential.

China: China dominates in manufacturing and also has a strong domestic market size and spending power to complement this. However the country's service sector leaves a lot to be desired. Overcoming the 'language barrier' will enable it to ably compete with its other Asian counterparts and make a strong foray in BPO and other service related industries.

Threats

India: Tardy government policies, red tapism, corruption and political instability continue to be a threat to the country's economic revival. Redressal from each of these deficiencies will not only help the country attract sizeable foreign investment but also sustain it for the longer term.

China: Poor banking and capital market infrastructure poses a serious threat to the sustainability of the Chinese growth trajectory. While the banking sector is fraught with poor assets and high rate of delinquency, lack of public confidence in the capital markets also does not augur well for the country's long-term prospects as an investment haven.

Common to both: The oil shock of 2005 is expected to have "double whammy" effect on the developing world, given that the developing economies are the most energy-intensive consumers.

Developing Asia in general - and China and India in particular - need to be singled out for special attention as far as the direct effects of an oil shock are concerned. Over the past decade, the developing economies of Asia accounted for about 40% of the total increase in world oil demand i.e. larger than the 35% share going to the OECD developed world. Not surprisingly, about three-fourths of developing Asia's increase in oil consumption was concentrated in China and India. These countries also have extremely high oil intensities with China's being 2.3 times the OECD norm and India's 2.9 times the same. Moreover, both China (35% of domestic oil demand) and India (70% of the domestic oil demand) are heavily dependent on imports. Finally, both of these Asian giants heavily subsidise domestic prices of retail energy products. This means acute fiscal pressures.

Crouching tiger or hidden dragon?

China (hidden dragon) has been growing at roughly 9% a year with an investment to GDP ratio of around 40%. India (crouching tiger) has been clocking an average GDP growth of about 6% p.a. with an investment to GDP ratio of about 25%. This indicates that India is using capital more efficiently, in the sense that it is delivering more for the investment made. The reason for this disparity is quite simple. India's growth driver has been 'services', which is typically less capital intensive than 'manufacturing', on which China has relied to a greater extent.

India can accelerate its growth rate if its manufacturing sector makes a larger contribution. For this to fructify, several policy changes including labour reforms, facilitation of investment in infrastructure (particularly power and transport) and a dedicated political will are a must. Thus, India's GDP growth can soon catch up with that of China, but it needs to break through some rather imposing barriers to do so. The good news is that these are man-made and can be dismantled by the right policy interventions. Keeping in mind the above pros and cons, we give investment in Indian equities (from a long term perspective) a thumbs up!

  • Read our other special story on India and China.

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