Global Market Commentary

February 23, 2015

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India and China: India Ascendant

The Chinese market is cheap, but economic growth will continue to slow, since China has become too big to grow as rapidly as it did for the first two decades after its reforms. India may be poised to take the growth baton.

To write about China and India is to write a study of great contrasts. We all know the China story. Poor, isolated, and economically mismanaged China was an economic basket-case at the time of Mao’s death. Mao’s economic strategy had done nothing to expand China’s economic power or increase its peoples’ wellbeing. Deng Xiaoping, Mao’s ultimate successor, was purged twice by Mao for his economic ideas.

Deng, however, outmaneuvered rivals to succeed Mao, and in the period from 1978 to 1992 he managed China. Beginning in 1981, he changed China forever. Under his policies, which married socialist ideology with pragmatic market-based economic strategies, he opened China to foreign direct investment, and began to allow limited competition from private enterprise.

At the local level, he allowed farmers to make more money by selling products at free market prices. This made him popular with the masses. He championed the concept that “to get rich is glorious” and he championed export-led growth.

Starting with small-ticket items that Japan did not want to export anymore, he turned China into an export machine. Although he retired in 1992, his successors have maintained his economic policies. Over time, China has gradually moved up the value curve, exporting more and more sophisticated and valuable products.

China exploded from poverty and isolation to become the world’s second-largest economy over the last 34 years. Now, though, China is no longer growing as it once did. It has gotten so big that even a growth rate of 5 to 6 percent is more growth in annual GDP than the 10 percent growth of a decade ago.


Over the last 34 years, India has followed a much different path. Today India’s economy is the world 10th largest, and per capita it is 1/5 the size of China’s.

In August of 1947, India became independent of the UK after about 200 years of British rule.

From 1947 to about 1992, India was governed on a socialist model. Although India was a non-aligned state, their closest ally was the Soviet Union, and they adopted the five-year plan model from the Soviets. There were two distinct sectors. The private sector was allowed to own small- and medium-sized businesses and industries that were protected by the government. Almost everything else was state-dominated, including communications (radio, telephone, and TV), consumer services, education, healthcare, rails, airlines, and defense.

india china

After Reforms, China’s Per Capita GDP Growth Has Far Outstripped India’s Data Source: Federal Reserve Bank of St. Louis

India had a largely uneducated population and a democratic political system. The government tried to offer services and employment using socialist principles, and progress was very slow and halting.

By late 1991, the Soviet Union, India’s major trading partner and the supplier of India’s low-cost oil, had collapsed. Now India had to pay market prices for oil, and India’s economy was in bad shape. Unemployment, inflation, and poverty were rising, and remittances of Indian workers abroad in the Middle East were keeping India’s foreign exchange reserves in balance. However, when the Gulf War began in 1990, many Indian workers had been sent home. Without the foreign currency income from those workers, the government relented and submitted to IMF and World Bank offers for help.

In exchange for loans, the IMF and World Bank demanded the end of many of India’s Soviet-style economic policies. This was agreed to 1991. India introduced many new policies, but they did not go nearly as far as China’s changes. There was relaxation of the rules governing foreign direct investment, and technology transfer rules were dropped. Foreign investment poured in, and India’s GDP growth rate expanded from virtually nothing to about 6 percent per year.

Indian GDP growth could be much faster, but it will be hard to grow more rapidly until the bureaucracy and the strange ideas of some policy makers and politicians are corrected. To his credit, Prime Minister Modi is trying, but India’s fabled bureaucracy has not disappeared. It still exists, and it is peopled by many who believe that their role as rule-makers and regulators is critical, both to the nation and to themselves. Many Indians covet a government job because they can collect large bribes for approving projects, and if the bribe is not paid, they just slow down the process, often for years.

Like China, India has grown as the result of direct foreign investment, but the inflows of foreign cash have been much smaller. Foreign companies blame impenetrable bureaucracy and the Indian government’s previous habit of making retroactive changes to its regulatory and tax structures. Prime Minister Modi says that will not happen again while he is in office. There has been growth in the Indian consumer sector, and due to excellent math and science education in India, the computer and pharmaceutical sectors have grown.

Obstacles For India

India faces two major obstacles:

1. Many Indian planners and economic strategists think that the low-value-added manufacturing that made China into an export powerhouse is too undignified, and believe that India can leap-frog over this stage directly into high-tech, high-value-added industries. We believe this view to be deeply mistaken.

2. Much of India’s infrastructure, especially transportation and power transmission, is sub-par.

With respect to low-value-added manufacturing, all of the Asian success stories (China, Korea, Thailand, Singapore and Taiwan) went through making humble products before developing their world-class manufacturing expertise. In fact, there has never been a successful transition from agrarian economy to high-tech powerhouse without an intermediate period of low-priced, low-value-added manufacturing, and a gradual development towards more sophisticated products.

India has 1.25 billion people — only slightly less than China’s 1.35 billion. In India, 25 percent are illiterate, versus about 6 percent in China. Most of India’s illiterates are in poverty. This class needs to be brought into the modern world — and they could be employed and raised up by low-end manufacturing. History tells us that there is no other path.

We Are Bullish on India

In spite of the problems, India has great promise. Modi is moving ahead on many fronts: infrastructure is improving, bureaucracy and corruption are gradually being tamed. Modi’s party did poorly in the recent elections in Delhi (India’s capital, which represents a small part of the country’s population — about 1.5 percent). The entrenched bureaucracies of the Indian capital do not like his cleanup campaign. In fairness, some in Mr. Modi’s party are corrupt too, and he must stop them. New land acquisition laws and a “Made in India” campaign, along with some liberalized foreign ownership rules for certain industries, are attracting foreign investment.

Investment Implications

Given its growth rate, India is trading at a fair valuation, and we see the Indian market as attractive. Infrastructure will improve. Businesspeople in India and abroad are encouraged that the bureaucracy may be gradually tamed. Global corporates will increase their direct foreign investment, and the Indian stock market will rise. The rise will be solid, but not stunning, unless India starts to focus on bringing in more low-end manufacturing to improve the outlook for the 22 percent of Indian citizens who are in poverty. If that is done, the Indian market will move much higher. We recommend the PowerShares India Portfolio (NYSE: PIN) to buy on dips.



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