Foreign markets to watch

With China and India now firmly established as the world’s growth engines, exposure to these emerging markets will play an important role as investors seek recovery from the global financial crisis (GFC).

But most Australian investors are underweight in these two countries, particularly India. This makes little sense given India and China’s low correlation with Australia and other developed economies (and each other) provides investors with an opportunity to reduce risk and partake in the upside potential of these economic giants.

I believe the time has now come where India and China deserve an increased direct allocation separate from other emerging markets or BRIC (Brazil, Russia, India and China) funds.

China and India need to be considered extraordinary cases whose power and influence across the globe will grow over coming years, and whose massive populations will fuel domestic demand and keep gross domestic product (GDP) growth high.

If anything, the GFC has only underlined how important it is to have exposure to other economies with a low correlation to Australia and other developed markets in reducing the overall risk of a portfolio.

While many emerging markets, including India and China, experienced steep stock market falls during the GFC, they bounced back quickly; India’s share markets experienced stunning growth during the first half of 2009 and led the recovery.

In fact India has outperformed the Australian share market over the last five years. In the short term it will always be more volatile than Australia, with India underperforming on market declines and outperforming on recoveries, but over the long term there is a case for growth.

You could argue that India has actually emerged from the financial turmoil in a position of strength: its economy showed resilience as domestic demand kept growth alive and the general elections in May had a tangible impact on confidence (ING’s Dashboard Sentiment Index for the third quarter 2009 has India as the most optimistic nation in the region).

The elections saw the United Progressive Alliance Government returned to office with an increased majority for the next five years.

The alliance centres on the Indian National Congress led by Sonia Gandhi. India’s reform path has been strong over several different governments since 1991, but this election proved that the people have embraced this direction. We can now expect the pace of reform to quicken.

Markets responded strongly to the election result, with the Bombay Stock Exchange 200 index up 18 per cent in Australian dollar terms in the first week following the election, and it has remained strong.

China, too, has passed through the economic storm relatively well, with its domestic demand providing a cushion of sorts from the fall in exports. In short, India and China have shown remarkable resilience and deserve another look due to the following factors.

Resilience

Consider the following:

• India’s domestic consumption as a percentage of GDP is now the highest in the Asia Pacific region, according to McKinsey Global Institute, coming in at 57 per cent of GDP;
• China’s domestic consumption is 37 per cent of a much larger GDP;
• Indian auto sales are up by 14.51 per cent from April-September 2009 (Society of Indian Automobile Manufacturers);
• Chinese auto sales have reportedly outpaced the USA for the first time in 2009, with 1.11 million vehicles sold in March 2009 alone, according to the China Association of Automobile Manufacturers;
• China is experiencing increased consumer demand with retail sales rising approximately 14 per cent to 15 per cent a year;
• Indian mobile phone subscriptions continue to rocket and are forecast to top 700 million by 2012, in fact there were 44.5 million new mobile phone subscribers in the first quarter of 2009 (Telecommunications Regulatory Authority of India);
• China’s mobile phone subscriptions already top 700 million and are going strong;
• McKinsey Global Institute has forecast India to become the world’s fifth largest consumer market by 2025; and
• the Asia Development Bank says the China, Hong Kong and Indian equities markets are the three largest in the emerging Asia region.

Higher foreign investment

Both countries are now experiencing good foreign investment levels after a difficult 2008 where foreign institutional investors were forced to withdraw funds; this was damaging for the Indian share market during 2008, but recent figures show a turnaround occurring.

India experienced a net foreign institutional investment gain of US$7.45 billion in equities during the period July-September 2009, according to the Securities and Exchange Board of India.

Cumulative inflows for the Indian financial year (April 1, 2009 — March 31, 2010) were approximately US$13 billion at the end of September 2009, a dramatic increase on the same period in 2008 when capital was being withdrawn.

Foreign direct investment into India has been strong, with inflows for the first four months of the financial year US$10.49 billion.

In China, foreign direct investment rose 18.9 per cent in September compared to the same period last year, giving the economy’s growth a major boost. This was a major turnaround after foreign investment declined for the previous 10 months due to global economic turmoil.

In fact, the United Nations Conference on Trade and Development this year ranked China number one for global foreign direct investment and India third.

Diversification

As the global financial crisis exposed the interconnectedness of the world’s economies, countries with high domestic demand such as India have become more attractive. It means that India’s growth is less reliant on the growth of others, and this has major diversification and performance benefits.

China is a more export-oriented economy but domestic demand is growing and expected to become a key economic driver.

While we cannot argue that an economy can completely ‘decouple’ from others — because all economies are vulnerable to negative global sentiment — emerging markets’ diversification power is a key benefit of broadening investment horizons.

A case for returns

In emerging markets it is all about high GDP growth levels, which are attracting foreign money and translating into good returns on the markets.

Again, India and China are a special case. GDP growth for both economies has surprised on the upside in the short term, and is expected to stay strong over several years. China is on track to overtake the US as the world’s largest economy sometime in the 2020s. India is already the third largest economy in Asia.

Growth in middle income consumers in these markets is happening now, and will equate to hundreds of millions of people over the next two decades, according to the World Bank.

However, India is different again because it has a young population, often referred to as its ‘demographic dividend’. Of its 1.1 billion people, approximately 54 per cent are under 25 years old, setting it apart from ageing populations such as Australia and China. This young population is becoming increasingly educated, more eager to spend than conservative older generations, incredibly aspirational and expected to drive the economy over the long term.

The GFC was a wake-up call to investors in many ways, including the realities of being overexposed to developed economies that fell into recession. Australian advisers and investors can benefit by looking to the developing economies for diversification — and they need look no further than China and India.

John Pereira is managing director of Atlas Capital Management and chief executive of India Equities Fund.