Why amid a short-term rush to China, investors should still buy India

The ‘buy India, sell China’ trade has gone into reverse in stock markets, following Beijing’s faster-than-expected unwinding of ‘zero-Covid’
However, the confidence in China’s ability to pull off an orderly exit is low, while India has good growth prospects – if the global outlook holds up

Nicholas Spiro

Published: 9:30pm, 15 Dec 2022

Why you can trust SCMP

This has been an annus horribilis for stock markets the world over. The MSCI World Index, a gauge of shares in advanced economies, is down 16 per cent, while its emerging market counterpart remains in a bear market, having lost 21 per cent.

Equity markets are not alone in having suffered sharp declines. Every major asset class, with the notable exception of commodities and the US dollar, has been pummelled by a combination of steep rises in interest rates, stubbornly high inflation and the threat of a global recession.

Given such a bleak economic and financial backdrop, the rapid ascent of India’s stock market, which hit an all-time high on December 1, is striking, potentially presaging a major shift in asset allocation in emerging markets in the coming years.

The BSE Sensex, a gauge of India’s biggest companies, has risen 7.6 per cent this year. Although the MSCI India index, which is tracked by international investors, delivered a negative return of 2.6 per cent in dollar terms in the first 11 months of 2022 due to the plunge in the rupee, this compares with a negative return of 19 per cent for the benchmark MSCI Emerging Markets Index.

There are several reasons for India’s stunning outperformance. Strong domestic demand – turbocharged by the reopening of the economy following last year’s devastating Covid-19 outbreak – has kindled optimism about corporate earnings. Retail investors have poured money into India’s stock market, helping offset the largest ever annual withdrawal of capital by foreign institutional investors. Moreover, many investors are attracted to secular trends driving growth in Asia’s third largest economy.

Yet, the factor that has worked in India’s favour the most this year has been the dramatic deterioration in sentiment towards China, India’s biggest economic competitor. The damage wrought by Beijing’s zero-tolerance approach to the Covid-19 pandemic – which added to concerns over regulatory crackdowns and escalating geopolitical tensions – coincided with growing evidence that India is benefiting from a series of reforms and shifts in the drivers of global growth.

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Despite the surge in foreign outflows this year, global investors have been steadily allocating more capital to Indian stocks partly as a hedge against risks in China. While China’s weight in the MSCI Emerging Markets Index has fallen from 39 per cent in 2020 to 30 per cent, India’s has shot up from 8 per cent to 15 per cent.

However, the “buy India, sell China” trade has gone into reverse following Beijing’s faster-than-expected unwinding of its draconian pandemic restrictions, scrapping nearly all internal curbs and leaving only strict border controls as the last vestige of the “zero-Covid” regime.

Since October 31, the MSCI China index has soared 35 per cent. Many Wall Street firms, which had been looking for reasons to be more optimistic about China, are now outright bullish. According to a survey of fund managers conducted by Bloomberg between November 29 and December 7, 60 per cent of respondents recommended buying Chinese stocks.

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The shift in sentiment away from India is accentuated by the waning appeal of the country’s shares, mainly due to lofty valuations but also because of domestic and external pressures that are taking their toll on India’s economy.

The MSCI India index’s forward price-to-earnings ratio stood at 22 at the end of November, compared with 15 for its global counterpart and only 11 for its Chinese equivalent. Furthermore, the combination of sharp rises in borrowing costs, persistently high inflation, a sizeable current account deficit and a marked slowdown in growth pose acute dilemmas for Indian policymakers.

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Still, even some investment banks that are bullish on Chinese shares are advising their clients to hedge against the risks of a disorderly exit from zero-Covid given Beijing’s failure to prepare the nation for a huge outbreak. While there is a lot of excitement over China’s reopening, the level of conviction that Beijing can pull it off is low.

The immediate risks in India, on the other hand, stem mainly from external factors, in particular energy prices, given that the nation imports 85 per cent of its crude oil requirements.

However, when it comes to long-term growth prospects, the case for buying Indian stocks is compelling. In a paper published in October, Morgan Stanley said the conditions were in place for the economy to thrive over the next decade.

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Unlike most other major economies, including China, India benefits from disruptive global forces related to demographics, deglobalisation, digitalisation and decarbonisation. By adopting a more East Asian-style growth model that encourages investment and leverages exports, India “will be increasingly relevant for global investors in a similar way that China is today”, Morgan Stanley argued.

Right now, China has the upper hand in stock markets, particularly from a valuation perspective. Yet, it is not going to be China’s perilous reopening that takes the shine off Indian equities.

A sharper global downturn next year – which is more likely following the Federal Reserve’s signal on Wednesday that its tightening campaign has further to run – is the main risk. However, given India’s attractive growth story, there are grounds for optimism.

Nicholas Spiro is a partner at Lauressa Advisory