Could India be a better investment than China? Michael Wilson investigates.

What do Brazil, Russia, India and China have in common? Yes, that little group of emerging economies that Goldman Sachs once christened the ‘BRICs’ – the fast-growing markets that were going to keep our portfolios healthy with the sheer unstoppable power of their own domestic demand. The supposedly ‘decoupled’ economies, that wouldn’t care too much what happened if the Western economies were to stall.

Well, we have some good news and some bad news. The good news is that they’re all still growing strongly. India is shortly to announce a healthy 8.6 per cent economic growth figure for 2009, followed by at least 8 per cent in 2010. China looks like it’s notching up another year of 9 per cent growth in 2010, Brazil is forecast to make 8.4 per cent and Russia is on course for 5 per cent – as long as the oil price holds up.

The bad news is that all four BRICs have disappointed their investors this year. Just like Britain, Germany, Australia, the USA, Canada or Japan, they’ve all been watching their stock markets stall or fall slightly.

India’s stock market was down by 3 per cent in mid-May, China’s Shanghai B and Brazil’s Bovespa indices were both down by 6 per cent and Russia’s RTS was down 2 per cent. So what happened to that ‘decoupling’ business? There certainly isn’t much sign of it at the moment.

Nobody is very sure why all this should be happening. Is it just that India and the rest have frozen up while they wait to see how the Western world copes with a euro crisis, a steadily appreciating Chinese currency, a new government in Britain and an upcoming mid-term election in America that’s going to be especially hard fought?

Experts believe that the BRIC stock markets have just reached a point where they’re looking ‘fully valued’ – or, in other words, that their share prices have risen far enough for the time being and are plateauing while we wait for the next phase of economic growth to kick in.

There’s a growing body of opinion out there that India will be the first of the four BRICs to get moving again when things improve. Bombay’s stock market is only about a quarter the size as those in China, but it’s quite a lot less volatile than the other BRICs. Only about a tenth of India’s stocks are ‘churned’ (bought and sold) in a typical year, compared with 60 to 70 per cent in China.

That suggests that India’s investors tend to be more faithful to their stocks. Although it might also mean that they don’t use fancy derivative products so much as the Chinese. Either that or fickle foreigners don’t spend so much time nipping in and out.

The Indian alternative
One thing we can say for sure is that it’s a mistake to suppose that India and China are similar just because they both happen to be vast and growing quickly. Remember, India is essentially an exporter of commodity products (food, fabrics, some minerals), whereas China is a massive importer and consumer of nearly every kind of essential input. That ought to mean that India is much better placed than China to benefit from the coming cyclical improvement in raw material prices.

But India and China do share one problem – they’re both struggling with shortages of electricity and a generally poor rural transport infrastructure. Around 90 per cent of India’s population has only mud roads, which makes it very hard to get long-distance goods into the shops – or to get locally made goods out again. And that in turn is holding back development in both countries. But their respective approaches to fixing this structural problem have been tellingly different.

In China, the local authorities are usually charged with building the rural infrastructure, on the tacit understanding that they may use ‘inventive’ and sometimes downright extortionate ways of getting funding from the banks. In India, on the other hand, the growing practice these days is to persuade large commercial corporations to build the roads, the ports and the business parks, in return for government favours which might include, for instance, a sole licence to operate in a particular area for a specified period of time.

Vast companies such as Reliance Industries (oil and chemicals), Tata Engineering (steel, cars, ships), Bharti Airtel (communications) and NMDC (raw materials) are all regularly asked to help with creating a modern transport system. Tourism companies, including foreign ones these days, are receiving similar approaches.

Is that a wrong thing to do? Is it perhaps even a bit corrupt? Hardly. It allows the Indian government to build facilities that it could not otherwise afford. And it’s not so very dissimilar to the way that South Korea’s favoured chaebols were encouraged to develop their own country in the 1960s and 1970s. It works. And it may help to explain why India’s budget deficit is only 5 per cent of gross domestic product, compared with 10 per cent in the 1980s.

First-rate leadership
India has come a long way in 20 years, and much of it is down to prime minister Manmohan Singh, who has an outstanding financial record in his own right. A former governor of the Bank of India, he was finance minister between 1991 and 1996, and he was generally credited with launching the reforms that put the country on its modern path. He became prime minister in 2004 and was re-elected last year, making him the first premier since the 1950s to secure two consecutive terms. And last month TIME Magazine voted him among the 20 most influential people in the world.

But India will need all the sound economic policy it can get in the coming decades. It’s not simply that its population is set to explode from 1.15 billion to 1.53 billion by 2030 – thus overtaking China, with 1.46 billion. It’s also that maybe 500 million migrant workers are likely to desert the villages for the urban centres, where they will all need to be housed, employed and fed. China has already found out how angry people can get when they are hungry and jobless, and India won’t want to see the same on its own streets.

Fast growth, then, is a headache for India as well as an exciting opportunity. The question is: is it an investment proposition for you? Well, we need to juggle the usual problem with developing markets.

On the one hand, Indian stocks are technically expensive at present – Reuters reckons that an average company is trading on a price-to-earnings ratio of 21, which is even steeper than Wall Street’s 17. But with an economy that is likely to double in the next ten years, the chances are that time is on your side. It may well be worth putting away a small investment for the long term.