Why You Should Not Worry About Foreign Money Flowing from India to China

One out of every five electric vehicles on Indian roads are Chinese.

Well, it is not just in India. China accounts for six out of every 10 electric vehicles (EVs) sold worldwide.

This dominance is due to China's sprawling global supply chain. Chinese companies not only have access to critical raw materials and technology for EVs, they also get huge state subsidies to build the EV ecosystem in the country.

China's automobile industry is not the only attraction for foreign investors. The massive investments in the electronics supply chain are also alluring.

So, it's possible that foreign institutional investors (FIIs) could find their way back to Chinese stocks if the frothy valuations of Indian markets seem unappetising.

In other words, the 'Buy China - Sell India' trade is not a distant possibility for FIIs.

In fact, over last two weeks, Shanghai's stock market rallied close to 30% from its September lows. This is after the Chinese government embarked on an all-out effort to revive economic growth.

Until few weeks back, multinational firms were taking money out of China at a record pace. Also, global economists were trimming their forecasts for China's economic growth.

So, has the gloom over the Chinese economy gone for good? And will global investors once again queue up for a pie of China's growth.

Well, the ground realities of the Chinese economy have not changed.

China's real problems range from half-built houses to bad debts. But it also reflects growing mistrust of information about China. The government is widely believed to be forging data and suppressing sensitive economic facts.

Over the past few years, China's monetary stimuli have become political rather than economic decisions.

Documents and the annual reports of China's mega-banks are well guarded and away from international media. Foreign journalists are treated as spies. The strict vigilance on entrepreneurs, even successful ones like Alibaba's Jack Ma, makes the allocation of capital in China very difficult.

This comes at a time when China's workforce is shrinking. And manufacturing productivity is dwindling.

The country needs to pivot away from cheap credit and construction to more innovative industries.

That is why investor capital is pouring into electric vehicles, semiconductors and AI led technologies. Yet, if the investments are based on sustainability of the economic boom, there could be more shocks in the offing.

China's real estate bust, for instance, has left behind tens of millions of empty housing units. The historic glut of unoccupied property is colliding with China's shrinking population, leaving cities stuck with homes they might never be able to fill.

The country could have as many as 90 m empty housing units, as per The Economist. Assuming three people per household, that's enough homes for the entire population of Brazil.

Another measure of the unbalanced state of China's economy is the size of the credit market bubble. According to Harvard professor Kenneth Rogoff, housing now constitutes a third of the Chinese economy. And exposes it to massive risks.

Also, Chinese private sector credit has increased by around 100% of its GDP in the past decade. To put things in perspective, that rate of credit expansion is larger than that which preceded Japan's lost economic decade in the 1990s. Also, that which preceded the 2008 US housing and subprime credit market bust.

Yet another measure of the unbalanced state of the Chinese economy is the quantum of state funded investment. This accounts for as much as 42% of China's GDP. That is approximately double the rate of the advanced economies.

So, China now has a major problem of excess manufacturing capacity. With domestic household demand unable to fully absorb its manufacturing output, China has become dependent on foreign markets to take up its manufacturing surplus.

Without curtailing excess debt and investments, China could experience a Japanese-style lost economic decade. And that could have major consequences for the world economy given that China is the world's second largest. Moreover, it continues to remain the largest consumer of international commodities.

So FIIs have a lot to ponder over before taking the Buy China - Sell India trade too seriously. Nevertheless, such a strategy could work well in the near term as valuations of Indian stocks seem frothy.

A deeper correction in Indian stock markets could be possible only if the money that FIIs pull out is higher than that which domestic investor pump in.

For investors looking to buy the long-term India story, here are the kind of stocks that they should consider buying:

• Companies with asset light balance sheets and a history of growing shareholder returns.
• Companies set to ride a big wave of profits due to regulatory, policy, and demographic changes.
• Companies that have been cash rich and consistent in sharing profits with minority shareholders.
• Companies that are inherently resilient to economic and geopolitical shocks.

Stay tuned to know more on such stocks.

Warm regards,


Tanushree Banerjee
Editor, StockSelect
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)