India vs. China: where to invest?

India's bragging rights were inconceivable just a few years ago. As recently as June, 2003, The Economist magazine ran a cover story “India v China: a tiger, falling behind a dragon.” In that article, the magazine indicated that in 1980, India's GDP was greater than China's and its per capita income was some 60% higher. Yet by 2003 the situation had reversed, as China's economy soared ahead of India’s and its per capita income was around 50% higher. But in recent years India's economy is rising again and the tiger is making a run at the dragon.

Investor confidence
The sudden interest in India has boosted the country's self-confidence. Grant Thornton, a leading international audit and consulting firm, carried out a survey of business confidence of more than 7000 owners of medium-sized businesses from 30 countries. Surprisingly, India was ranked first, ahead of the G8 economies, China, and Europe's ‘Celtic tiger,’ Ireland. India lags China in the hard infrastructure of roads, airports, and real estate, but it leads in the soft infrastructure of democratic institutions, free press, and an independent judiciary. What other factors favor India?

Banking and finance
India's long experiences with free market enable it to gain significant expertise in lending and raising capital. This is not the case with China, where until recently banks were in business to funnel loans to woeful state-run enterprises. There were no incentives for these loans to be repaid, and now banks are crippled with an estimatedU.S.$213 billion of non-performing loans. In contrast, India's major banks are thriving and ICICI Bank, India's second largest, is considered as one of the best run banks in Asia. More than 6,000 firms are listed on the Bombay Stock Exchange, far outnumbering the number in China and even most major global markets. Furthermore, investors in China's two main mainland stock markets, Shanghai and Shenzhen, have experienced poor returns over the past decade as overpriced stocks flooded the markets. In contrast, Bombay's stock market has been booming.

Business relationships
Trust is certainly an important component of any business relationship. However, one aspect of the Chinese culture that is disturbing is the existence of networks of business and social relationships among various parties who are expected to exchange favors regularly and voluntarily, called guanxi. Although it is wrong to interpret this practice as bribery, since these exchanges need not involve money, they can be used to shut out those that do not fit into an approved Chinese social circle. Guanxi, when combined with the corruption that permeates the Chinese economy, could make the creation of a truly competitive economy difficult, if not impossible, to achieve. For India, these social networks and corruption are less of a problem. To be sure, dishonesty still exists in government service, but high level corruption is being vigorously rooted out by a free press, something that is absent in China.

Perhaps the greatest strength of a free market economy is its openness to doing business with anyone who has the qualifications and desire to do a job, regardless of ethnic or social backgrounds. The United States is highly attractive to so many immigrants who have been shut out of opportunities in their own homelands because of its openness. Guanxi combined with the uncertain new laws defining private property and business contracts in a still-Communist China should be a source of concern for investors.

Demography
Perhaps the most positive aspect of India's future is its demography: India is a very young country, while China, because of its one-child policy, is rapidly aging. According to the U.N. demographic Commission, by the middle of this century the most densely populated age group in India will be those aged between the ages of 40 and 50, while in China it will be those aged between 55 and 65. This means that China will soon start to suffer the same problems that Japan, Western Europe, and the United States are experiencing, or about to experience: an excessive number of retirees relative to the working population.

The young have the flexibility to adapt, absorb, conceptualize, and innovate. This is the key ingredient of technological and economic progress. China has a large supply of new workers for private enterprises, but these workers are leaving state-owned enterprises and are older and not as adaptable as the young labor market in India. The late management guru, Peter Drucker, said that demography is the "future that happened." Population trends are not easily reversible, and here the advantage goes to India.

India or China?
With all these points favoring India, the answer to the question, "where should your money go?" may seem like a forgone conclusion: India seems to have the best prospects for investors. As far as the future for investors is concerned, we should bear in mind that there are two issues that an investor needs to take into consideration when deciding where to invest. Firstly, you must size up the prospects of the firm, the sector, or the country. On this point, India scores some high marks. Secondly, you must evaluate the price that you are paying for these prospects. India's investment climate looks ripe for growth, but the markets have recognized this and have pushed stock prices upward. The Sensex 30, India's best-known stock market index and analogous to Dow-Jones Industrial Index, was around the 3300 mark in December 2002 and has now broken through the 10,000 barrier.

A question of value
The price-to-earnings ratio on this index has reached 21, while Chinese stocks on the Hong Kong Stock Exchange are selling for only 15 times earnings, which denotes that India is roaring!