Emerging Market Contrasts: China and India

China's stock market is the best performing in the world so far for the second quarter. The performance of the MSCI China Index has risen above that of the S&P 500 Index in 2024, after having taken a very different path since the start of the year. India's stocks have now lagged a bit, slumping since April, after previously tracking U.S. stocks.

China's stocks did not sustainably climb above its flattish performance for this year until late April. What changed for China in April and May? Very little.

• Domestically, the property market remains the primary source of trouble with home prices continuing to fall. This has prompted consumers to pull back on their spending with retail sales remaining weak and consumer confidence near all-time lows.
• On the international front, the Biden Administration revoked Huawei's U.S. chip license, passed legislation banning TikTok or forcing its parent, ByteDance, to divest, and unveiled new tariffs on China. Although China's President Xi visited Europe for the first time in five years in early May, he didn't come away with trade deals or policy agreements. Instead, French President Macron and European Commission President von der Leyen pressed the Chinese leader to address China's trade imbalances with the European Union and to use his influence on Russian President Putin to end the war in Ukraine.

China's woes mark a sharp contrast to how well things are going in India. We profiled India's rise last June (India on the Rise?), but here is an update:

• Domestically, the International Monetary Fund estimates that India's economy grew a robust 7.8% in the fiscal year that ended March 31—the fastest pace of any country in the world. India's manufacturing Purchasing Managers' Index (PMI) came in around a booming 59 in March and April. India was also a standout in Apple's earnings report from early May; the country delivered strong double-digit sales and production growth that helped the iPhone maker beat expectations globally, even as sales slumped in other regions.
• Internationally, demonstrating the desire to work with India on their shared goals, President Biden threw a formal banquet for Modi at the White House last summer and the leaders of Congress invited him to address a joint session—highlighting the difference in U.S. relations between India and China. President Xi asked to address Congress in 2015, but the request was denied. More recently, the U.S. Department of Agriculture's April trade mission to India was successful in expanding trade relations, according to the U.S. agency.

Why is the performance of the stock markets in China and India seemingly contrary to the fundamental environment detailed above? While valuations for China's stocks have fallen to the low end of their range over the past 20 years, the opposite is true in India, where stocks are near the high end of their historic range. When stocks are valued near their all-time lows, it may only take a lack of bad news to get them to bounce. When stocks are valued near all-time highs it may take ever better news to avoid a pullback. This may explain the relative performance of these markets recently.

What justifies the widening gap in valuations between these two emerging market countries? Higher valuations generally reflect a stronger growth outlook. In a stark contrast to China, India has the world's largest democracy with the world's most popular leader (according to the Morning Consult survey), favorable demographics, and debt on a sustainable path, all supporting the world's fastest economic growth.

• Growth - China's economic growth remains muted due to the weight of the property-market slowdown on consumers, frictions with major trading partners, and years of abrupt domestic policy changes with tough regulations imposed on educational tutoring, video game developers, businesses consultants, and mobile app creators, among others. These factors may have led to an unsupportive environment for both established businesses and entrepreneurs. In contrast, India is the world's fastest-growing major economy and remains on track to overtake Japan and Germany to become the world's third largest economy by 2027, having now recorded three consecutive quarters of growth over 8%. It has managed this despite a relatively tight monetary policy at home and weak demand abroad, with a trade hit caused by shipping delays in the Red Sea. Economic growth is underpinned by widely touted policies that offer incentives for production in India, ease in regulatory burdens, and investments summing to over a trillion dollars in improving the country's infrastructure, according to India's Department of Economic Affairs. India's 2024 elections are taking place with the popularity of Prime Minster Modi (with a May approval rating of 74% compared with 39% or less for every leader of the Group of Seven countries) and his ruling Bharatiya Janata Party likely to see a strong showing, ensuring continuity in these pro-growth policies.

• Demographics - India's population exceeded that of China for the first time last year to become the most populous country. United Nations projections indicate that India's population is expected to continue expanding and reach a peak of almost 1.7 billion in 2064. China's population is expected to continue to decline after beginning to shrink for the first time in six decades in 2022, following the record-high population of slightly over 1.4 billion in 2021. More importantly, people under the age of 25 account for 43% of India's population. In fact, there are so many Indians in this age group that roughly one-in-five people globally who are under the age of 25 live in India, according to research produced by the United Nations. There are more than six people under the age of 25 for every person over 65 in India, while that number is just above two in China. The combination of overall population growth and a younger workforce in India, rather than a shrinking and rapidly aging population in China, offers a runway for faster growth.

• Debt sustainability - According to estimates presented in the latest IMF Fiscal Monitor report, China is anticipated to rapidly grow its debt-to-GDP ratio from 83.6 in 2023 to 110.1 by the end of the decade. At the same time, India is seen lowering its debt-to-GDP ratio from 82.7 to 78.8. India's more sustainable debt path indicates less vulnerability to a debt crisis that could undermine growth.

Of course, India also faces risks, including lower worker productivity, inconsistent manufacturing quality, and a complicated bureaucracy. However, investors may be seeing these from glass-half-full perspective, with lower productivity offering the potential for growth-boosting productivity gains, nascent manufacturing efforts offering new growth for what has been a largely service-based economy, and the great strides taken in recent years improving infrastructure despite myriad levels of bureaucratic control.

The extreme contrast is not lost on the stock market with investors valuing stocks in India at more than double the valuations of those in China. Recent stock market performance might suggest that the gap in the optimism on India and the pessimism on China are stretched to the maximum. But that is hard to know. The high valuations of India's stocks don't necessarily mean they are set to slide, after all they have hit new highs again this year despite trading at a high valuation premium for nearly four years. At the same time, China's stocks could continue to suffer and push down to new lows in valuation on deepening retrenchment by consumers, trade wars, and rising concerns over debt and demographic trends.

For investors considering investing in emerging markets, as India's growth, optimism and high valuations increasingly balance China's weakness, pessimism, and low valuations, it creates a unique environment of diversification within the overall emerging market index. It was once true that "as goes China, so goes the MSCI Emerging Market Index (EM)" and all the funds tied to it. But times have changed. In October 2020, Chinese stocks made up nearly half (43%) of the EM index while India comprised only 8%, a gap of 35 percentage points. But over the past three and a half years, that gap has closed to just seven percentage points—with China and India approaching near-equal weights in the index.

The convergence in weightings means investors can own EM stocks in their portfolios and get the built in diversification. Holding a broad mix of exposure to emerging markets includes meaningful exposure to India's growth and China's value, but also diversification to help insulate from their divergent risks.