China and India

Shifting Trends, Outsized Potential

Executive Summary
Despite the impact of the recession on the global economy, China and India
continue to develop as emerging market superpowers, avoiding many of the
negatives that have plagued other countries during the same time period.
Peter Soo
Managing Director, Head of Asia
ex-Japan Equities, Hong Kong
Elizabeth Soon, CFA
Managing Director, Portfolio
Manager, Asia ex-Japan Equities,
Hong Kong
Kheng-Lai Tan
Managing Director, Portfolio
Manager, Asia ex-Japan Equities,
Singapore
Natasha Smirnova
Senior Analyst, Emerging Markets
Fixed Income, London
Andressa Tezine
Vice President, Senior Research
Analyst, Emerging Markets Fixed
Income, London

These two BRIC nations sometimes referred in the same breath as Chindia
have managed to achieve consistent, uncorrelated growth based on dramatically
different governments, cultures and economic strengths.
This paper examines how both nations differ by outlook and opportunity set, and
their changing prospects for future cooperation and conflict as each pursues
its individual and joint path to economic progress. Based on this continuing
convergence, the European Central Bank (ECB) refers to China and India as
TheTwin Titans for the New Millennium.1
In examining their current trajectories, as well as each countrys tantalizing
future potential, investors may enjoy more benefits through a combination of
China and India opportunities, providing an optimum balance of risk, reward
and diversification. China and India appear to be an especially attractive play in
2010-2011, given the halting but sustained recovery that continues to play out
in the US, Europe and Japan.

Huzaifa Husain
Head of Equities-India, Portfolio
Manager, Mumbai
Ruchir N. Parekh
Portfolio Manager, Fixed Income,
Mumbai
Siddhartha Singh
Head of Product DevelopmentIndia/Product Specialist, Mumbai

1 European Central Bank, Occasional Paper: Twin Titans for the New Millenium 2008

The China India story is one that unites three of the

most prevalent themes in emerging markets:

Strong export activity

Extensive investment in development,
including roads, ports, utilities, other
infrastructure projects and factories.

Clearly, Chinas current economy is fueled by exports

and domestic investment, while the Indian economy is
driven by consumption and domestic investment. But,
the story behind these two success stories begins with
the sheer enormity of numbers.
As the two most populous countries in the world, China
currently ranks #1, boasting more than 1.33 billion
citizens,2 while India is closing in quickly, ranking in
the #2 spot with 1.15 billion people,3 although it is
expected to surpass China by 2030.4 Jointly, China
and India account for more than 37% of the worlds
total population.5 By contrast, the United States runs a
distant third with 309 million people, representing only
4.54% of the worlds total population.6
A recent UN population study indicates that these
trends will continue at least for the time being. Chinas
population and workforce will continue to swell over the

2 Chinese Official Population Clock, 5 April 2010

3 indiaonlinepages.com, 5 April 2010
4,5 Population Division of the United Nations Department of Economic and
Social Affairs, 1 July 2009
6 U.S. Official Population Clock, 5 April 2010
7 Population Division of the United Nations Department of Economic and
Social Affairs, 1 July 2009
8,9 Bloomberg, 12 April 2010
10 AsiaNews.it, 2008
11 Sulekha.com, April 2010

200

Dec-09

Dec-08

Dec-07

Dec-06

Dec-05

Dec-04

100

Dec-03

300

Dec-02

India

400

Dec-99

China and Indias continued emergence can be directly

attributed to these top three growth drivers:

Market Growth

Strong commitment to investing for development,

expansion and improvement.

Local demand fueled by a

burgeoning middle class

MSCI India
MSCI China

500

Consumption by a huge, growing middle class

China

600

Dec-01

Favorable demographics in the form of

population size

China-India Equity Market Growth

31 Dec 1999 to 31 Dec 2009

fIGURE 1

Dec-00

Similar Attributes for Success

Source: Bloomberg MSCI Index-India and MSCI Index-China, 12 April 2010.

Re-based to 100 at year-end 1999. Past performance is not indicative of
future results.

next decade, even with the strictly enforced One Child

rule, and potentially level off to zero population growth
within 30 years. During the next two decades, Chinas
working population those aged 15 to 64 will reach
approximately 1 billion people.7
Chinas population is also steadily becoming more
affluent:8 Already, the worlds third largest, Chinas
economy expanded by almost 12% in the first quarter
of 2010 (11% in the fourth quarter of 2009) after a 4
trillion yuan stimulus program, including US $1.3trillion
in new bank lending at record-low interest rates that was
originally enacted in 2008. Although Indias market has
grown a remarkable 216.65% in the past 10 years, China
has delivered a strong 94.16% growth during the same
period (FIgure 1).9
All of these factors are expected to lead to greater
production of goods and services, additional disposable
income, increased domestic demand for food and
resources, as well as enhanced export activity. On the
downside, it is estimated that Beijing will soon have to
find jobs for 33 million people, as certain industries,
such as textiles, steel, toys and construction materials
(specifically cement), have been hard hit by plummeting
global export activity and increased adherence to global
quality standards.10
In both nations, the middle class is also expanding
at ameteoric pace, fueling a wave of domestic
consumption that has still not begun to ebb. Adding
tothe positive outlook for continuing momentum, about
half of both the Chinese and Indian populations are
under age 45 presumably with many good buying
years ahead of them.11

fIGURE 2

By 2020 China GDP Is forecast to be

over US $12tn and India at US $3.4tn

(US$tn)

14

70
India
China

60

Chindia as a % of US (RHS)

10

50

40

30

20

10

1990

1995

2000

2005

2010

2015

2020

% of US GDP

US GDP

12

Source: IMF, World Bank, UN, National Statistics Offices, CLSA AsiaPacific Markets, June 2010.

In China, for example, promotion of private consumption

remains a high priority, and a long list of government
initiatives includes health care reforms and increased
spending on education, pension programs and
affordable housing. In India, thousands of young people
return to their homeland every year after studying or
working abroad, and that trend continues to grow.
The youthfulness of both nations also represents a key
source of low-cost labor for business growth, industry
expansion and infrastructure projects. Industries that
benefit from being able to draw on a large, stable mass
of younger workers include construction, consumer
goods manufacturing, agriculture, textiles, apparel
and energy. Service industries, including call-center
operations, accounting and basic medical analytics,
could also benefit.11
Partially as a result of these favorable demographics,
China enjoyed strong 8.45% GDP increases in 2009,
while India lagged only somewhat with steady 6.7% GDP
growth. Over the next few years, these growth rates
are predicted to pick up and reach 10% in China and
7-8% in India.12 These figures are even more impressive
when compared to other emerging economies that have
shrunk in response to recessionary forces, including
Brazil and Eastern Europe, as well as struggling
developed nations. (Figure 2)

China has also been able to attract favorable attention

through the recent 2008 Beijing Olympic Games more
than 4.7 billion viewers watched the Games worldwide
according to Nielsen, making it the largest global TV
audience in history and India is increasingly being
recognized for its innovation in both the pharmaceutical
and automotive industries. In 2009, for example, Tata
introduced the US $2,400 Tata Nano car, designed
to make automobile ownership accessible to millions
of Indians who previously could only afford a more
dangerous motorcycle for their daily travel needs.
Unlike India, however, China has recently become
viewed as souring on foreign investment, making
headlines with actions that ranged from publicly
criticizing the quality of foreign-made goods to
pressuring Google to leave the market by limiting its
business activities.13

Closely Linked for Centuries

The argument for considering Chinas and Indias
prospects in tandem is firmly rooted in both countries
history. Goods and ideas have always flowed easily
between the two nations: Buddhism was originally
introduced to China via India as early as the second
century B.C., and India played a significant role in
Chinas Silk Road, which was important not only for
trade, but also for cultural and technological exchanges
between the two countries merchants, soldiers and
pilgrims for nearly 3,000 years. In July 2006, this
legendary trade route was reopened with considerable
fanfare, pointing to a new era of trade cooperation,
albeit symbolically.
Today the two nations share more than 2,100 miles of
border, although about half still qualifies as disputed
territory. These blurred boundary lines have sometimes
led to heated conflicts, including a war between China
and India in 1962 over a contentious portion near the
Himalayas.
Ongoing diplomatic tensions have also bubbled to the
surface occasionally, such as those stemming from
India granting asylum to the Dalai Lama in 1959 and
China continuing to provide assistance to Pakistani
nuclear-weapons-related projects starting in 1977
and continuing to the present day.14 More recently, in
1993 and 1996, both countries signed the Sino-Indian
11 Sulekha.com, April 2010
12 Trading Economics, 5 April 2010
13 New York Times, Business Day, 26 March, 2010
14 National Security Archive, 2010

fIGURE 3

Indias Trade Deficit With China

(US$billion)
0

Looking at the composition of Indias exports specifically

to China, more than half the demand is for ores and
minerals (particularly iron ore). While exports are lowvalue-added, demand is likely to be boosted as Chinas
purchasing power increases, and the recovery continues.

-5

-10

-15

-20

Indias trade
deficit with
China has
widened 30
times in the last
decade

19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09

-25

Fiscal Year

Source: India Macroscope: Imminent RMB Revaluation: Revisiting ChinaIndia Trade Flows, Citigroup Global Markets, Rohini Malkani and Anushka
Shah, 22 April 2010

Bilateral Peace and Tranquility Accords, focused on

ending conflict along the Line of Actual Control (LoAC),
although neither country has agreed to the exact
location of this key line of demarcation.
Nevertheless, proximate nations naturally tend to
forge trading relationships, if only because of logistical
convenience and the generally lower associated costs
of transporting goods and exchanging services. As of
2010, India has emerged as Chinas seventh largest
export market, principally in the form of iron ore, steel,
plastics and cotton. Over the past five years, India/
China trade has increased by more than 50%. In FY09,
bilateral trade between the two countries reached more
than US $40 billion, and China officially became Indias
largest trading partner, replacing the US, as well as
Chinas 10th-largest export market.15

15 India Macroscope: Imminent RMB Revaluation: Revisiting China-India Trade

Flows, Citigroup Global Markets, Rohini Malkani and Anushka Shah, 22 April
2010
16 India Macroscope: Imminent RMB Revaluation: Revisiting China-India Trade
Flows, Citigroup Global Markets, Rohini Malkani and Anushka Shah, 22 April
2010
17 US Department of Commerce, 5 April 2010 and Reserve Bank of India, 23
April 2010

Today India imports 10% of everything China exports,

and her technology and engineering services-based
export economy is often dependent on what China
manufactures or copies in its thousands of factories
nationwide, adding to her US $84.7 billion deficit.

India imports electronic and engineering goods from

China, as well as key items that include capital goods,
and intermediates, such as chemicals and minerals.
Given that these categories represent key components
of investment growth, demand for such imports may be
on an uptick. However, this could limit gains seen on
the export front, resulting in the deficit remaining high.16
(Figure 3)
The future of both countries seems inextricably linked
going forward, as both have achieved a relatively
high degree of internal stability and global economic
success, despite the daunting odds that often define the
emerging world.

A Study in Divergent Paths

Because China is the worlds largest Communist state,
and India is the worlds largest democracy, the striking
contrasts are also readily apparent.
As Figure 4 indicates, these countries contrast in nearly
every way, down to what seems to be their national
DNA. China is a highly centralized nation with one ruling
party, the Chinese Communist Party, which has been
in power since its civil war victory in 1949. China also
speaks one principal language (Mandarin), while India
is a collection of 28 often-contentious states and seven
union territories, 16 official languages and four major
religions (Hinduism, Buddhism, Jainism, Sikhism) plus
a national centralized parliament with two houses and
more than 70 different ministries.
Moreover, their sources of economic success are also
vastly different. China has built on its solid productmanufacturing legacy to become a largely export-driven
economy, while India focuses primarily on its domestic
market, outsourcing only high-end technology and
business services. One hundred of the worlds Fortune
500 organizations maintain R&D facilities in India, and
more than 250 of the Fortune 500 have IT and backoffice operations.17

While China would seem to be a quantum leap ahead

of India, the European Central Bank concluded the
following in comparing the two economies:
First, considering trade in goods, the overall
degree of Chinas trade intensity is higher than
fundamentals would suggest, whereas the
converse is true for India. Second, Chinese
goods exports seem to compete increasingly
with those of mature economies, while Indian
exports remain more low-tech. Third, exports
of services tend to complement its exports
of goods, while Indias exports are growing
only in deregulated sectors, such as IT-related
services. Last, Chinas and Indias role in the
global financial system is still relatively limited
and often complementary to their roles in
globaltrade.
As a result, China continues to far outpace India in
terms of its sizable foreign exchange reserves (US $2.45
trillion, versus Indias approximately US $280 billion),
and in its essential infrastructure, such as roads, ports
and trains, needed to sell its goods globally.18
Although India is committed to achieving enduring
financial prosperity, it is still working to shed its
reputation for Third-World-style chaos. This includes a
lack of adequate major highways, electrical power, fresh
drinking water and other basic necessities, including
sufficient hospitals and health care for its burgeoning
population. The vast majority of the country still lives on
less than US $2.00 per day and suffers from widespread
poverty, illiteracy, disease and malnutrition, especially in
remote rural areas.
As the worlds largest democratic republic, India places
a high value on business ownership, and many smalland medium-sized enterprises (SMEs) are continuously
evolving into larger businesses. Yet, in this more
individually focused environment, key decisions are
often hampered by official bureaucracy and the legal
requirements involved in gaining consensus. This
can range from obtaining key permits from multiple
governmental ministries to compensating those
who might be adversely affected by key projects or
initiatives, such as those impacted by a new road,
housing development or dam project.
While it could also be argued that the socialist
underpinnings of Communism limit incentives for
individual business ownership and expansion in China, the
day-to-day decisions that can help a business succeed
also tend to be more streamlined due to this highly
efficient, centralized system. The downside, of course, is

fIGURE 4

The China/India Scorecard

China

Governmental efficiency

Free-market economy
Adequate infrastructure

Transparency of public information

Significant urban development

India

Property rights protections

Greater support for rapid entry by

multi-national companies

Greater support for local, private enterprises

More foreign investors
Influential, supportive expatriate community
Resistance to multi-lateral regulations
by other nations

Source: Deutsche Bank, Taimur Baig, Chief Economist, India. March, 2010

that this commitment to moving forward has also led to lax

quality standards and human rights violations in the quest
for economic progress and state unity.
One high-profile example is the Three Gorges Dam on
the Yangtze River, where as many as 2 million rural
inhabitants were relocated to less desirable locations to
create a hydroelectric reservoir, all without their consent
or sufficient compensation.
Other similar problems with Chinese dam and
infrastructure projects have resulted in allegations
of official cover-ups of inadequacies and failures in
resettlement programs; falsification of figures on
their progress; endemic corruption and misuse of
resettlement funds; systematic discrimination against
rural residents in the allocation of resettlement
resources; and a lack of proper efforts to inform, let
alone consult with the populations to be relocated.19
The resulting firestorm of criticism worldwide has only
begun to recently die down, but intensified scrutiny of
China by human rights activists continues. Clearly, China
and India are both defined by a mixture of opportunities
and much-needed improvements.

18 US Department of Commerce, 5 April 2010

19 Human Rights in China/International Rivers Network, 2009

The Quest for Natural Resources

Both countries are further united by their determined
search for raw materials and commodities to meet
future needs, including land, electrical power and water,
but here China is far ahead of India due to central
government foresight. Building on a series of Five Year
Plans that target economic development and using their
sizable capital, China has been steadily buying land in
Latin America and Africa, purchasing industries that could
generate imports or increase consumption over the long
term, and making deals with Russia, Kazakhstan and
Venezuela to secure its future oil supply.
According to a recent China at 2050 report:20
China has one-fifth of the worlds population, but only
about 7% of the globes arable land. Of that, only about
33% is believed to be productive, and the amount of
arable land is declining because of soil erosion and
the demands of a growing population. Farms also face
threats from industrial and agricultural pollution.
Chinas consumption of water already rivals that
of the United States and continues to rise. Its total
energy consumption is second only to the United
States, and China is the second largest emitter of
industrial carbon dioxide pollution.
Given those variables, some analysts believe China
will become much more dependent on food imports.
But that scenario might change, depending on
future technological advances and newly installed
government conservation and environmental
policies.
Even within its own borders, the Chinese government
has developed a number of policies with the aim of
developing its rural areas. These include westward
expansion, with a greater focus on developing inland
cities and communities, as well as offering subsidies
on household appliances and building materials only to
residents living well outside its cities.
Indias relationship to natural resources is considered
more sustainable overall than Chinas, partially because
of the agrarian base of the economy and its strong
internal focus. While air- and water-pollution controls
exist in India, there are still water shortages, soil erosion
and exhaustion, and deforestation occurring due to
increasing consumption needs.

20 CNN 2009
21 Economic Times, 4 April 2010

According to the World Bank, China has also achieved

some significant gains, including increased forest cover
and reduced air and water pollution caused by rampant
over-industrialization. A major stabilization program
enacted in 2008 is helping to expand sewage and waste
treatment facilities throughout the country.
India also appears to be doing more to stabilize agrarian
communities through the National Rural Employment
Guarantee Act Programme. This legislation ensures that
one family member is guaranteed 100 days of wage
employment per year to a rural household whose adult
members volunteer to do unskilled manual work, as well
as direct grants and subsidies for food, fuel and fertilizer.
In this way, the central government hopes to ensure more
long-range sustainability for areas beyond the major
metropolitan centers. Because the subsidies heavily
impact the national budget, the government is trying
to phase them out gradually over time, although this is
extremely unpopular with the electorate.
It remains to be seen how both China and India
will respond to pressure to adopt new, stricter
environmental guidelines, as proposed during the
2009 Copenhagen Climate Conference. The global
environmental summit ended without any legally
binding agreement by the two nations and without any
prospects for further action in 2010-2011.

Opportunities by Asset Class

and Industry
Chinese Equities
The current state of Chinese equities reflects the
central governments recent determination to learn
from the past and prosper based on new insights.
The global financial crisis has now led China to place
more emphasis on internal consumption as a driver
of economic growth, rather than relying as heavily on
exports, as they have in the past.
Nonetheless, Chinas economy remains more
hardware-dominated, with strong manufacturing,
real estate and infrastructure sectors predominating.
While there has been a significant increase in private
companies, the country is defined by its more than
300,000 State Owned Enterprises (SOEs), with the
150 largest employing more than 75 million people.21
Yet, according to a recent trend noted by McKinsey,
government favoritism towards state-owned

companies is fading as officials have attempted to

strengthen domestic businesses and the economy to
prepare them for unfettered global competition.22
The outlook for equities in China continues to be defined
by state-mandated policies, as the government tries
to maintain steady high growth, while avoiding the
bubbles that can form from the economy overheating.
The infamously booming China property market may
well slow down now, as the government has recently
introduced somewhat draconian measures to cool
off the market and drive speculators away. Other
governmental reforms may be implemented slowly, as
senior leadership remains keenly aware of the political
and economic risks of each decision.
For now, the best opportunities for Chinese
equity investors seem to be in consumer goods,
semiconductors, heavy equipment manufacturing
and banking, as they remain largely unaffected by the
downturn in export activity. The automobile industry is
another with relatively attractive prospects, given the
still low penetration of car ownership. For example,
according to the International Road Federations World
Road Statistics 2009, there were only 22 passenger
cars per 1,000 people in China in 2007, compared to
451 for the US.
However, foreign direct investment (FDI) activity and
ownership is still heavily regulated. According to
foreign investment guidelines issued by the National
Development and Reform Commission (NDRC), no
foreign firm can be the majority owner of any entity in
industries such as life insurance, fund management,
printing and publishing, construction, movie theaters
and many other enterprises. This also extends to the
banking industry, and there is a 25% limit on overseas
ownership in Chinese banks.
For certain industries, such as the processing of green
tea using traditional Chinese techniques and ivory
carving, foreign investment is prohibited altogether.
Clearly, the Chinese seem prepared to favor a more
exclusionary long-term approach over short-term
economic gains.
There is some cause for optimism, however, and the
landscape may be liberalizing on an industry-by-industry
basis. In 2009, for example, the government announced
that foreign investments in domestic travel agencies
could now exceed 50%.23

Indian Equities
For all of its challenges, perhaps the biggest surprise in
India is the robust scope of the countrys technologically
advanced, high-speed stock market. As the oldest stock
market in Asia, dating back to 1875 (even older than
Japans), the robust Bombay Stock Exchange (BSE)
numbers 6,600 listed companies only the NYSE has
more and settlement times are now a brisk T + 2. In
fact, the BSE was the second stock exchange in the
world to obtain ISO 9001:2000 certification.
In 2009, the average volume of business conducted on
the BSE was approximately US $40 billion each month,
and the total market capitalization for the companies
traded in the area of US $1.1 trillion.24 Opportunities
abound in India for savvy investors who are ready and
willing to take the long-term view. In 2009 and thus
far in 2010, India has delivered some of the strongest
equity performance of any emerging market. While the
Shanghai composite returned 78% in 2009, 25 Indias
SENSEX returned 80%.26
Long-standing corporate governance laws are also
in place that facilitate transparency. For example,
information about all major companies is readily
available through a Directors Database, as well as the
Indian Corporate Electronic Reporting System (ICERS).
Additionally, Fortune 500 companies continue to
invest in India across a spectrum of sectors: food and
beverages (Coca-Cola, PepsiCo), consumer durables
(Samsung, Philips, LG, Canon, Electrolux), automotives
(General Motors, Ford, Toyota), computers and software
services (IBM, Sun, Honeywell), pharmaceuticals
(GlaxoSmithKline, Pfizer), consumer products (Unilever),
financial services (Citigroup, HSBC), insurance (Allianz,
Prudential), engineering (Siemens, ABB, Alstom,
Bombardier), logistics (FedEx), and petrochemicals and
chemicals (BP, Shell, BASF).
Confidence in Indias equity market has continued to
grow after the Congress Partys decisive win in the most
recent national elections. Immediately afterward, the
legislature began implementing much-needed, muchdelayed financial reforms.
Subsequently, the Congress Party has successfully
moved forward with two IPOs of government-owned
firms, further enhancing their reputation for raising
22 McKinsey Quarterly, July 2008
23 European Chamber of Commerce, 2010
24 CIA World Factbook, 2009
25 MSCI China, 2009
26 Money-zine.com, 2010

money through the equity market. Over the years, the

Indian government has undertaken several ambitious
divestments plans of this type, but success has proven
elusive. This time the outcome may be different, as India
is under constant pressure from the markets and rating
agencies to reduce its chronic budget deficits.
Positive economic data has also supported the partys
cause, delivering strong growth of 7.2% in the first
quarter of 2010.27 It yet remains to be seen how
unpredictable variables such as monsoons, political
uncertainty, further rural development and relations
with Pakistan and China will play out, but Indias equity
market appears to be on a sustained upward trajectory.

Chinese and Indian Fixed Income

CHINA
Chinese and Indian fixed income markets have already
come a long way, but many impediments remain.
In both, foreign investors must obtain licenses and
both place ceilings on foreign holdings and charge
withholding taxes. However, they are both working to
gradually minimize these obstacles to allow increasing
foreign ownership.
In the past, the Chinese bond market was designed to
fund government fiscal deficits, while the corporates
were encouraged to borrow from the banks or tap
equity markets for their financing needs. Over time,
domestic investors have begun searching for alternative
investments and other funding sources than banks and
the equity markets. More recently, the government has
begun gradually easing regulations, leading to faster
development of the overall bond market.
Although China is rich in its potential for bonds, the
market is primarily domestically focused, as foreign
investors can earn only relatively low yields in the
context of emerging markets: CNY-denominated bond
yields may go up to just 4% in the corporate space and
1.5-3.5% in government bonds.28 Abundant liquidity and
traditional reliance on bank lending for corporates are

27 Trading Economics, 5 April 2010

28 JPM Local Currency Guide, October 2008
29 India Macroscope: Imminent RMB Revaluation: Revisiting China-India Trade
Flows, Citigroup Global Markets, Rohini Malkani and Anushka Shah, 22 April
2010
30 Moodys, April 2010
31 Standard & Poors, April 2010

to blame, rather than lack of interest in capital markets.

The Chinese government bond market is the second
largest in Asia, after Japan.
The Chinese currency landscape has also proven
intriguing more from the perspective of politics
and diplomacy than a fundamentally driven valuation
exercise. Many experts argue that the yuan is
significantly undervalued, but some, including the
Chinese government and the sell side, believe it is
priced at fair value.
The currency question in China will remain a
controversial issue that periodically flares up and drives
speculation on potential China-US trade wars, as well
as even gloomier doomsday scenarios. Recently, there
seems to be greater understanding on the currency front
between the two nations, and the stage is now set for
currency reform in China sooner than later, should that
mean gradual appreciation, widening trade bands or a
new currency basket.
In theory, an appreciation in the RMB would lead to
exports from China becoming less competitive, and boost
its purchasing power of imports. Countries that have a
similar export structure to China such as India would
benefit most from an RMB revaluation, given that their
products would be priced more competitively.29
One particularly attractive opportunity for foreign fixed
income investors in China is in China-USD-denominated
corporate bonds. This market is relatively small,
despite Chinas vast size, but it is developing, as many
corporates are looking to diversify their funding sources
beyond bank borrowing, which are normally short-term
and uncommitted.
Chinese high yield Eurobonds are currently dominated
by approximately 10 Chinese property developers, and
their ratings span BB to B-, with yields that range from
8% to 15%.30 Industry sectors of other issuers vary from
domestic consumption plays to natural resources, and
these are currently yielding 4% to 14%,31 depending on
the fundamentals.

INDIA
In contrast, Indias currency continues to float against
the US dollar and offers much broader fixed income
potential. Its bond market has been well-developed
since the mid-1990s, and foreign institutional investors
are permitted, albeit constrained by quotas.

The Indian debt market consists of three main

segments:
1. Sovereign - Government securities, comprising
central and state government securities, and
Treasury bills.
2. Public Sector - Public Sector Undertaking (PSU)
bonds are generally treated as surrogates of
sovereign paper, sometimes due to explicit guarantee
and often due to the comfort of government
ownership of the PSUs.
3. Corporate Sector - Corporate securities comprising
debentures/corporate bonds and commercial paper
This market also has a well-developed term and call
and notice money market. These are non-collateralized
transactions, where players lend and borrow money
among themselves. In addition to ready-forward
transactions, the collateralized borrowing and lending
obligation (CBLO) platform is a unique feature that
offers a secured, guaranteed platform for borrowing and
lending monies in the institutional market.
Pre dominantly a wholesale market, the Indian
debt market is dominated by institutional investor
participation. Major investors in the debt markets are
comprised of banks, financial institutions, mutual funds,
provident funds, insurance companies and corporates.
The smaller number of large players has resulted in the
debt markets being fairly concentrated and evolving into
a wholesale negotiated dealings market.
Corporate debt issues are generally privately placed,
while the government issues are auctioned to the
participants. Secondary-market dealings for government
securities and Treasury bills are done via Negotiated
Dealing Settlement, while corporate bonds are largely
traded over-the-counter (OTC), and negotiated through
brokers.
Major market participants in Indias debt market include:

Indias Central Government

Public-sector Financial Institutions
Reserve Bank of India
Banks
Primary Dealers
Mutual Funds
Indias State Governments
Foreign Institutional Investors
Public Sector Units
Provident Funds
Corporate Treasuries
Charitable Institutions, Trusts and Societies

It is important to note that the average Indian citizen

does not carry significant debt, is risk-averse and
typically has a high savings rate of 32% of disposable
income.32 Most of this money flows into traditional
savings vehicles, such as bank deposits, retirement
funds and insurance, where it is then recirculated into
the economy in the form of loans, further supporting
fixed income activity.
At present, however, the principal drawbacks to Indias
fixed income market are the fairly limited universe of
financial instruments and limited overall access to the
market. The government regulates foreign-investor
participation in Indias fixed income local markets by
imposing strict quotas currently US $5 billion for
investments into India government bonds and US $15
billion into local corporates. Credit default swaps are
non-existent, as are longer-maturity bonds (those with
maturities greater than 10 years).
Corporates that do not make it into the marketplace
typically depend on bank funding, but there is no
secondary market for lower-grade commercial paper.
Secondary markets activity on the corporate side is
primarily for bank certificates of deposit at the short end
of the curve, and bonds of public-sector enterprises.
Activity in non-public-sector companies and commercial
paper is extremely thin.
India also suffers from lacking a single financial
services regulator that can help create a more cohesive
marketplace. For example, mutual funds are overseen
by the Securities and Exchange Board of India (SEBI),
the banks are regulated by the Reserve Bank of India,
and the national pension fund is governed by yet
another regulatory body, the Pension Fund Regulatory
and Development Authority (PFRDA). This lack of a single
overarching structure and more bureaucracy contributes
to fewer market participants.
Today a 10-year Indian government bond offers
very attractive returns 400 basis points over a US
government bond33 especially given that incremental
risks are not increasing. Despite the Asian economic
crisis of 1997-1998, the Indian government has never
defaulted on any of its obligations.34 Bonds issued
by public-sector enterprises (those in which the
Government of India owns a majority stake) tend to
grade at around 80-100 basis points over comparable

32 Confederation of Indian Industry, 2008

33 Seeking Alpha, December 2009
34 Goldman Sachs, Fair Value of BRIC Currencies, BRICs Monthly, 16 March 2010

government bonds. These issuers enjoy the highest

credit-quality ratings from domestic rating agencies due
to their ownership; i.e., their default risk is perceived to
be the same as that of the Government of India.
In Indias USD-denominated corporate bond market, the
opportunities are quite limited. The market itself is very
small with literally only a few issues; primarily banks that
are priced quite expensively and return yields ranging from
4% to 7%. Because the countrys bond market is deep
and liquid, Indian corporations have traditionally relied
on raising funds at home to avoid currency risk. Most US
dollar bonds were issued in 2006-2007, as the issuers
clients wanted access to dollar funding at the time.
As for its stature among rating agencies, Standard &
Poors rates India as investment grade, while Moodys
considers it one notch below investment grade due to
its high fiscal deficit and ongoing infrastructure issues.
As a way of closing the budget gap, the government is
trying to develop a unified tax rate for all types of assets
and services so that there is more uniformity, fairness
and potential revenue generation inherent in the tax
code, but that proposal has recently been postponed
until 2011.35

Weighing Political and Economic Risks

As with all emerging markets, China and India also
carry inherent economic, social and political risks for
investors. Despite having joined the modern age in
many respects, both countries determination to keep
foreigners at arms length and the potential for currency
and market fluctuations, together with their relentless
appetite for raw materials to accommodate population
expansion, may well lead to higher inflation, as well as
boom and bust cycles.
At present, the chief risk in China is a potential property
bubble, but inflation, excessive monetary tightening and
the administrative measures needed to regulate the
economy also represent concerns. If the government
is too harsh in containing property price increases,
for example, it may have a negative impact on raw
materials, employment and housing-related industries.
Excessive monetary tightening could also squeeze
growth in corporate earnings, and a further rally in
commodity prices would increase Chinas imports.

35 Seeking Alpha, December 2009

10

Additionally, there are many unknowns related to full and

accurate financial reporting in Chinas economy. It is well
known that local government entities engage in heavy
borrowing that does not appear in any official statistics.
Instead, these expenditures are being funded through
the use of off-balance-sheet special purpose vehicles.
In India, inflation is the key risk, as it has reached
almost 10% year-over-year in March 2010 and may
well increase. The central bank only became serious
about tackling this issue recently through a series of
emergency rate hikes. Investments are also a high
priority on the governments agenda and prominent
on investor radar screens, so any further delays and
setbacks would clearly have a negative ripple effect.
Although steady, sustained measures have been
taken to integrate Indias economy into a globalized
environment, her future growth will also depend on
successfully establishing a world-class infrastructure,
and still more needs to be done to reduce the fiscal
deficit. For India to sustain strong GDP growth,
investment in infrastructure needs to be enhanced
significantly. Without more roads, the number of
cars cannot increase; without more power, industrial
production cannot grow; without more ports, trade will
be unable to expand. It is therefore imperative for this
sector to keep delivering above GDP growth rates in
order for India to flourish.

Envisioning the Future

Due to the difference in the immediate focus of the
two economies, including both countries in a portfolio
would allow an investor to maximize a broader spectrum
of opportunities, while at the same time diversifying
underlying political and socioeconomic risks.
It is obviously essential to be able to wield the local
knowledge, cultural insight and in-depth experience to
identify and capture the right opportunities at the right
time in order to avoid the pitfalls before they make an
impact.
The picture of Chinas and Indias immediate future is
still coming into sharper focus, but the well-learned
lessons of the past indicate there is still much more to
be gained in the months and years ahead.

biographies

Peter Soo, Managing Director, Head of Asia ex-Japan Equities

PineBridge Investments, Hong Kong
Mr. Soo joined the firm in 1989 and is responsible for Asia ex-Japan equities. Mr. Soo also oversees
regional portfolio management and strategic asset allocation. His investment industry experience started
in 1985 when he was a Portfolio Manager for New Zealand Equities. Mr. Soo graduated from Auckland
Technical Institute specializing in Accounting and Finance. He is a Chartered Accountant and a member of
the Chartered Institute of Corporate Secretaries and Administrators.

Elizabeth Soon, CFA, Managing Director, Portfolio Manager, Asia ex-Japan Equities
PineBridge Investments, Hong Kong
Ms. Soon joined the firm in 2008, having extensive experience in managing investment teams and
running Asia equity portfolios. She was Director and Head of the Pacific Basin for Standard Life
Investments (Asia) Ltd., where she was responsible for the management of the Groups Asian funds and
amember of the Global Stock and Sector Insights Committee (UK). Ms. Soon also spent 10 years at
Schroder Investment Management (HK), where she was Director and Head of Asia ex-Japan,
responsible for asset allocation and stock selection in Asia, and managing retail unit trusts and large
institutional portfolios. She is also a CFA charter holder and a board director of the Hong Kong Society
of Financial Analysts.

Kheng-Lai Tan, Managing Director, Portfolio Manager, Asia ex-Japan Equities

PineBridge Investments, Singapore
Mr. Tan joined the firm in 1999 and is responsible for managing Asia ex-Japan equity client portfolios. He
is also responsible for managing the balance sheet and product portfolios related to Indonesian equities
for AIGs insurance operations (AIA Financial). Prior to joining our firm, Mr. Tan worked as a Portfolio
Manager with AGF of Canada and John Govett from the United Kingdom. He was also involved in the
establishment and running of Pheim Asset Management, a boutique investment firm in Singapore. Mr. Tan
began his career in investments as an Analyst with DG-GZB (Asia) in 1988. He received a Bachelor of
Business Administration from the National University of Singapore. He also obtained his Certified
Financial Planner designation.

Natasha Smirnova, Senior Analyst, Emerging Markets Fixed Income

PineBridge Investments, London
Ms. Smirnova is a research analyst working in the Emerging Markets Fixed Income Team. She joined the
firm in 2004 as a Management Associate in the Emerging Markets Fixed Income Team. Prior to this, Ms.
Smirnova was a Junior Macro economist with the Emerging Markets Research team at Credit Suisse
First Boston, covering Russia and Ukraine. Before that, she worked for the Moscow-based AIG
Investment Bank. Ms. Smirnova received a first class honors degree in BA Foreign Languages from the
Moscow State Linguistic University, a first class honors postgraduate degree in Financial Management
from Finance Academy at the Government of the Russian Federation in Moscow and an MSc in Money,
Banking and Finance (Merit) from the Middlesex University in London. Ms. Smirnova passed Level I of
the CFA program.

Andressa Tezine, Vice President, Senior Research Analyst, Emerging Markets Fixed Income
PineBridge Investments, London
Ms. Tezine joined the firm in 2005 as a Senior Analyst for Latin America. She is responsible for the
coverage of Latin American sovereign credits and market analysis. In 2008 she became Head of
Research for the Emerging Markets team. Prior to joining PineBridge Investments, she was a Senior
Analyst at ABN Amro Bank Brazil and also Dresdner Bank Lateinamerika. Ms Tezine began her investment
career in 1993 at Unibanco. She received a degree in Economics from the University of Sao Paulo and an
MSc in Economics from the Universitat Pompeu Fabra, Barcelona.

Huzaifa Husain, Head of Equities-India, Portfolio Manager, Mumbai*

Mr. Husain joined the firm in 2004 and is now the Head of Equities in India. He has more than 12 years
of experience in fund management in India. At the firm, Mr. Husain has been a key member of the
team advising AIG India Equity Fund (a Dublin domiciled India offshore fund). He is also responsible for
managing the India domestic funds. Prior to joining the firm, Mr. Husain was an Equity Analyst at Principal
Mutual Fund and SBI Mutual Fund. Mr. Husain received a Post Graduate Diploma in Management (PGDM)
from Indian Institute of Management (IIM) Bangalore and a B.Tech from the Institute of Technology
(Banaras Hindu University).

Ruchir N. Parekh, Portfolio Manager, Fixed Income, Mumbai*

Mr. Parekh joined AIG Investments in 2007 as Assistant Vice President, Fixed Income. Mr. Parekh is
responsible for driving fixed income investment strategy and managing fixed income portfolios of the
domestic mutual fund schemes. He has over 11 years of experience in the Fixed Income markets in India
and the US. Prior to joining AIG Investments, he was working as a fixed income analyst at HDFC Asset
Management Company, where he was responsible for analyzing a variety of credits across several
industries and asset-backed securities. Prior to that, Mr. Parekh worked with Bear Stearns and Moodys
Investor Services in New York, covering investment grade and high yield credits. Mr. Parekh completed his
MBA from the University of Hartford and is a Graduate in Commerce from the University of Mumbai.

Siddhartha Singh, Head of Product Development-India/Product Specialist, Mumbai*

Mr. Singh joined AIG Investments in 2006 as Head of Product Development based in Mumbai. Prior to
joining AIG Investments, he was head of the Product Development and New Initiatives function at Indias
largest AMC - Reliance Capital Asset Management Company. Before that, Mr. Singh was with ABN AMRO
Bank responsible for branch banking operations and third-party product distribution. Mr. Singh has a
Masters degree in Management Science (MMS) from DAVV, Indore and a Bachelors degree in Physics from
Delhi University.

*The team members located in India are currently part of AIG India Asset Management Company and
are scheduled to transition to PineBridge Investments shortly.

PineBridge Investments is a group of international companies acquired by Pacific Century Group from American International Group, Inc. in March 2010. PineBridge companies
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value of portfolios we manage may fall as well as rise, and the investor may not get back the full amount originally invested. The investment risks vary between different types of
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