Ravenous rivals

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With hungry economies and populations of one billion or more, China and India are commanding investor attention. But is enough capital available to satiate both?

David Lake

The expanding troupe of players on the emerging markets stage these days has, to a large degree, been relegated to a supporting cast for two superstars: China and India. As the 21st century approaches, these two capital-thirsty titans, each with thousands of domestic companies lining up for stock exchange listings, massive requirements in foreign direct investment (FDI), and a combined trillion dollars earmarked for infrastructure, will be increasingly competing for investor attention.

This capital competition is well understood by both countries. Indian Prime Minister Deve Gowda, during a recent speech to business leaders, wondered aloud why "communist China" attracts more capital than "democratic India."

Though China has jumped out to an enormous lead in FDI, India's equity markets have shown surprising magnetism. The PRC is looking to stretch its world-leading direct investment numbers past the $40 billion mark. But foreign investors pumped $1.4 billion into the Indian market in the first quarter of 1996, bringing total investment to around $7 billion. In the end, India hopes to eat away at China's FDI lead, while China wants to raise more equity through its alphabet strategy in the B, H, N, S, and Red Chip share markets.

"There is one simple question being asked in boardrooms around the world: India or China?" notes John Elliott, the Delhi-based author of Asia's New Giants: Stepping Stones to Prosperity (Rajiv Gandhi Institute for Contemporary Studies). "The world's two most populous nations have both missed out on the rapid growth of the Asian economy in the 1970s. Today, they have emerged as the world's most challenging markets, and the balance of factors affecting whether one invests in China or in India is shifting rapidly."

"Both these economies clearly do not have the money they need to finance economic growth, especially in the area of infrastructure," says Ranjan Pal, Hong Kong-based director and chief regional economist for Jardine Fleming. "They are competing for a limited capital pool, and investors are looking where to head first. At the moment, India has entirely too many regulations, whereas China is more accommodating to foreign capital. Everything is on the table in China. Having said that, once you put something on paper in India, you are usually home free. In China, the promises made on paper do not always hold long-term."

Despite systemic differences, there are many similarities between China and India. Both are experiencing booming growth and major social change. With populations of around one billion or more, both have the potential to be economic dynamos. Both are restructuring industry and welcoming foreign investment, while reducing trade tariffs and opening the financial services sector. And both are trying to sort out the troubles of their loss-making state enterprises, as they look for ways to attract foreign investment to bolster failing infrastructure.

India should have the advantage in the capital competition. Its stock market dates from 1875, and now includes over 8,000 listed companies with $145 billion in market capitalization. It has established legal, accounting, and financial systems and institutions; entrenched property rights; and a thriving private sector. With English as the language of business and government, working in India is far easier for foreign companies and investors.

Despite these advantages, investors often regard India as a trouble spot, and it suffers from an image as an unpredictable place to do business. "India continually shoots itself in the foot when it comes to investment," notes Elliott. "China does not have the basic advantages, but neither does it have the poor image-investors give the country more of a chance. Whatever businessmen achieve in China is notched up as a success. Whatever they do not quickly achieve in India is considered a black mark. While China is shrouded in mystery, it is believed more orderly than India."

China has stolen the lead in one vital area: economic reform, which began in 1979 and accelerated to a feverish pitch in 1992. After initial reform proposals in the early 1980s, India moved ahead only in 1991. China opened its market to foreign capital with enthusiasm, but India has never been quite sure about foreign investment. Nor will foreign direct investors soon forget the case of energy giant Enron, whose contract for a multi-billion dollar power project was abruptly withdrawn by the state government for renegotiation.

On top of its lead in reform, China has three other factors working in its favor when it comes to attracting capital. First, it is seen as an unexplored market that must be dealt with right away. Second, Hong Kong is a good conduit for capital and partners. Third, the PRC enjoys considerable support from the 50 million-strong overseas Chinese community. Overseas Chinese are one reason why China has enjoyed a tremendous lead over India in FDI. They account for an estimated 70% of the $95 billion flowing into China between 1983 and 1995.

Rajiv Lall, the Hong-Kong based economist of the Morgan Stanley India team, predicts India's FDI will rise to $5 billion a year, but that is not anywhere near what China has already achieved. "India's day is coming," he says, "but it is not here yet. It is easier for India to attract foreign portfolio flows than FDI at the moment. While the Indian capital market is relatively well-designed, the country has a difficult FDI policy environment. Investors prefer stock positions which they can walk away from over FDI risk. China is precisely the opposite."

India has indeed lured its share of portfolio investment. In Global Depositary Receipts, the global equivalent of American Depositary Receipts, the equity issuance market is surging. There are now some 60 Indian GDRs trading, more than 12 on the London Stock Exchange and the remainder listed in Luxembourg.

"In the past, Indians have employed the GDR structure to enter the market, using Rule 144a placements to tap US investors," says Andrew Zelter, vice president of international marketing at the Bank of New York in London. "Early on, the large percentage of Indian offerings were placed in Europe, with a limited amount heading to the US. Therefore, the 144a format was well-suited to meet the needs of the initial wave of transactions. Yet, Indian offerings are now active in the US secondary market, and we have seen a flow of GDRs into the US. For that reason, the US market has taken on a greater emphasis. Now we have Indian companies looking closely at a direct listing on a US exchange."

Prior to last summer's election, India enjoyed a spurt of investment. Net inflows from foreign institutional investors rose to a crescendo of $435 million in February, according to Morgan Stanley. First quarter net flows totaled $1.4 billion, greater than all of 1995, and net exposure crossed the $7 billion mark. Times have been tough since then. While the State Bank of India managed to pull off a $350 million GDR issue in October to tepid investor demand on the heels of ICICI's $220 million and Telco's $200 million issues in August, earlier issues for Saw Pipes and GACL had to be withdrawn from the market due to lack of interest.

"The reform process in China has gone faster and further," says Pal. "In India, you have a democracy with vested interests, whereas in China it is more or less government by decree. Still, one must not downplay the political risk of a country like China. When the regime changes, as it will, it is difficult to predict how it will happen. The fact is that no one has ever correctly predicted the course of Chinese politics. The consensus is that everything will be all right for the next decade, but I would be cautious with that. Look at the history of the region. At some point, economic change is always followed by political change."

Both China and India are setting the stage to attract ever greater amounts of foreign capital. In India, investors will be watching developments on the political front in the short-term to see whether a coalition government can rule the nation. They will want to see clearance and settlement issues ironed out, and they will want Indian companies to use funds in a more responsible manner.

China will have to carry out the reintegration of Hong Kong, and investors will be watching to see whether managements in both China and India can increase the flow of information between their companies and investors. At this point, it is not clear which country will rise to the occasion. Perhaps both; perhaps neither.