Share |

Investing in opportunity

John Adams is a freelance journalist based in the UK.

With India and China competing to become the world's next major superpower – both economically and politically – it remains to be seen who will benefit the most from globalisation. John Adams asks which destination will reap bigger rewards for investors

As India and China emerge as economic superpowers, it tends to be the threats to such countries as the UK – struggling to compete with Asia's lower cost base – rather than the opportunities that have made the headlines. But there are plenty of opportunities in these quickly growing markets; a fact not lost on private equity firms. In India, for example, the value of deals involving foreign and local funds stood at $2.2 billion in 2005 and, in September 2006, consultant Bain & Co forecast that the annual value of private equity deals would roughly triple by 2010 to around $7 billion.

Meanwhile, in China, cheap labour and foreign investment have turned the country from communist monolith into a manufacturing giant that has embraced western capitalism and which boasts about $60 billion of foreign direct investment – dwarfing, for now at least, the money invested in India. Against that background of phenomenal growth, investors will inevitably ask themselves which country is the best destination for their capital.

Chasing trade
On the face of it, dirty water, pitted roads and widespread poverty leave Indian prime minister Manmohan Singh's call to make the 21st century the "Indian century", looking like a distant prospect. Yet India boasts a relatively decent education system, the widespread use of English, a free press and, of course, a democratic government. Indeed, democracy is potentially a significant bull point for stability. China may have embraced capitalism, but it's unclear whether China's government can indefinitely suppress political freedom and expect to remain economically successful. That raises the prospect of longer-term political instability in China.
The demographics in the two countries, key to developing internal consumer markets, are also important. India already boasts a steady supply of young aspirational consumers, boosting demand in sectors such as hospitality retail and healthcare, and India may be better placed than China with regard to their demographics. China's one-child policy means that, by the middle of the century, the most populous age group there will be the 55–65-year-olds, leaving too many retirees being supported by a shrinking workforce. But in India, the most populous age group by mid-century will be the 40–50-year-olds.

That said, neither country has a completely open-door policy towards foreign investment. In India especially there is a myriad of issues to overcome before becoming the truly business-friendly environment the country tried to present itself as being at January 2006's Davos World Economic Forum. India is still a tiny player in terms of world trade: goods exports account for a mere 0.8% of the global total, compared with 6.4% for China. And Indian regulatory limitations on foreign investment don't help. Although, to coincide with the Davos summit, the government did liberalise foreign investment rules in the retail sector, allowing foreigners to take majority stakes in single-brand retail operations.
But China's high streets were thrown open to foreign investors long ago and there are few signs yet of the deregulation of India's banking sector – perceived as a key element in attracting the wall of private equity cash thought to be interested in India. That limited progress has led some economists to think that India's economy, already growing at a heady 8% a year,  could achieve 10% growth if only the government would stand aside.

Family ties
The family-controlled nature of many Indian businesses also raises issues. An understandable reluctance on the behalf of owner-managers to cede control leaves private equity investors holding minority stakes, with few options for influencing the development of these businesses. There is, however, scope for optimism. "We've observed early signs that the traditionally strong opposition to change in control issues may be starting to diminish," says Sri Rajan, head of Bain & Company's Private Equity Practice in India. "Removal of this roadblock could pave the way for the emergence of a private equity buyouts market in India."

The relative merits of the two countries' legal systems deserve consideration, too. Technically, India's legal system offers more property rights than the Chinese system, but pursuing a claim in the Indian courts can be slow. Cases are capable of taking up to 10 years and bankruptcies can take three to four years. Not that China boasts an ideal legal system. China has a reputation as a haven for intellectual property piracy, and the often opaque way in which business gets done in China raises questions over how level the business playing field actually is. That reflects the Chinese system of "guanxi" in which business is often conducted through an elaborate network of relationships rather than on merit.
Yet, overall, China's consumer economy does look more advanced than India's and, ultimately, it's consumer markets that will drive growth in both countries. China will also play host to a number of major international events in the years to come – the 2008 Olympics and the 2010 World Expo in Shanghai – which may act as unique investment catalysts. While the size of the average investment deal-size in India, at $21 million, bears witness to China's relative advantage to date (the average deal size is $66 million in China) in attracting investment.

In practice, the considerable differences between the two countries can leave the question of which is the best investment destination look like something of a false debate. Chinese investment deals, for instance, tend to flow across a multitude of manufacturing, technology and financial services sectors. Whereas India, helped by a large pool of Indian business mangers with extensive experience of working overseas, looks better placed for service-based sectors, especially information technology, healthcare and  pharmaceuticals.

Factors beyond the pros and cons of the business
environment on the ground also need consideration, such as the ability to take profits by exiting an investment – key for private equity players. A clear winner is difficult to spot. More Indian companies than Chinese ones are co-based in the US, leaving exits for private equity through a US sale or an IPO potentially easier than with Chinese companies. And when private equity firm Warburg Pincus successfully sold a $560 million stake in India's largest publicly traded mobile telephone company, Bharti Tele-Ventures, in 2005, the Indian stock market demonstrated an unexpected degree of liquidity. It's also worth noting that Indian asset valuations look stretched when compared with China, making investing pricier to begin with. For instance, stocks on Hong Kong's exchange trade on roughly 14 times earnings, while in India that ratio is nearer 20 times.

Ultimately, both China and India have unique markets and unique risks, but both will continue to benefit from globalisation – essentially, people will work harder for less in both countries and, increasingly, services and manufacturing will move to these countries. On that basis, considering how the relative strengths and weaknesses in each nation affect specific investments in particular markets looks like a wiser way to proceed than forming judgements about which is the better destination overall. Bain & Co's recommendations look like a good place to start. "Target the beneficiaries of a growing consumer class, forge key local relationships, leverage global networks and plot a flexible course to exits," says Mr Ragan. He made those points with India in mind, but there's no obvious reason why they shouldn't hold good in China or, for that matter, elsewhere in Asia.

Click here >>