China has made more economic progress and is moving into the core-plus space, yet India offers greater transparency - and better prospects for opportunistic investors, as Megan Walters and Nick Crockett report
China is increasingly becoming a core-plus play, while India remains opportunistic. However, Jones Lang LaSalle's recently released 2010 Transparency Index reveals that India ranks slightly ahead of China at all city levels - Tier 1, Tier 2 and Tier 3 - in market transparency.
India represents a good opportunity for future growth, based on continuing regulatory reforms that should boost fixed investment and, more importantly, a falling dependency ratio that will boost productivity and economic growth. The combination of an increased share of GDP being spent on fixed capital expenditure over the next five years together with the dependency ratio shift, presents a one-off chance for investors looking at the opportunistic end of the risk-return spectrum.
China and India present challenges to foreign investors both in deploying capital and repatriating capital and returns. They also both restrict the type of investments that foreigners can participate in. Currently the most popular asset sector for China investment is retail and in India the most popular sector is residential development.
The corporate finance group at Jones Lang LaSalle, which manages the firm's fund-raising, debt advisory and M&A mandates, has been involved in equity raising for both China-based and India-based funds over the past 12 months. Recently we have seen a shift of focus in the market, with opportunistic investors moving away from China-based funds to other emerging markets such as India. China's recent currency announcement has yet to play out in the real estate markets. The immediate impact is likely to be limited, with new regulations having an adverse effect on real estate investment rather than currency risk.
Jones Lang LaSalle's 2010 Global Real Estate Transparency Index shows that at each level, India ranks as a more transparent market than China. But the reality is that expectations of returns in China have remained at opportunistic or near opportunistic levels, where managers have found it increasingly difficult to attain anything more than core-plus returns without taking risks or investing into countries foreign investors are uncomfortable with.
Investors who had been focused on China are now concerned about the possibility of an overheated property market. Yields may not currently reflect the risk that investors perceive to be unfolding; they appear to prefer to wait until the effects of government tightening are seen in the market. However, it may be that foreign investors are missing the point. In China the market is maturing rapidly into a stable economy, with GDP per capita income levels expected to greatly exceed India's over the next five years. At this point there is an imbalance between economic progression, growth and the transparency of the market, with economic growth running ahead of market transparency.
Interest in India has been limited in the past two years due to the market downturn and failure or bad investing executed by a number of general partners. While the failure of some general partners has created issues for some foreign investors, the flipside is that the market cycle has highlighted which managers are of ‘institutional quality' - allowing for a more transparent fund selection process in the future. It has also shown the best investment strategy for foreign investor funds in the market. Clearly, a reliance by some general partners on investing in new Special Economic Zones (SEZ) led to some of the problems. However, strategies by some funds to provide capital to economically viable and scalable residential developments has largely been successful.
Market transparency index
Many of the aspects that investors are interested in are reviewed within the recently released Jones Lang LaSalle Transparency Index. The Transparency Index ranks 81 countries based on the transparency of their real estate investment markets. For India and China, the index is calculated at the Tier 1, 2 and 3 city levels, and reflects the large and diverse nature of these two countries on a variety of issues including political structure, regulations and property rights.
The Transparency Index ranks cities in India just above China's in all tiers. However, there have been improvements in both markets since the last survey. This is mainly due to increased data availability as well as ongoing regulatory changes.
In both countries the booming real estate markets in recent years have greatly contributed to the improvements, as both public and private sector players have taken important steps forward to promoting greater levels of transparency. Government agencies and market regulators have also made slow but steady progress on the regulatory and legal front.
India's GDP per capita is estimated at $1,266 for 2010. By comparison China's GDP per capita is over three times that at $4,393. By 2015 the estimates are for India's GDP per capita income to reach $2,327 and China's to reach $9,433.
From 1870 to about 1914 China and India's per capita incomes were roughly matched. However, by 1950 India's was about 40% higher and it took China until about 1980 to catch up. China began its market reforms around 1979, whereas India's market reforms only really began in 1991.
On the bases of a longer period of market reform and higher GDP per capita income, one could argue that China represents a stronger market with greater potential. This is the case in terms of external assessment of the overall market development at the sovereign risk level: Standard and Poor's China A+ rating compared with its BBB rating for India.
India usually records a GDP growth rate similar to or slightly lower than China's. The structures of the economies are broadly similar, with a similar proportion of GDP growth coming from services, manufacturing and agriculture. However, the percentage of people employed within these sectors starts to differ, as does output per person in terms of raw productivity.
Some of the differences in productivity come from the disparity in the dependency ratio between the two populations (people with dependants have less time to be productive), but this is also partly due to the superior infrastructure investment that China makes as compared with India.
Benefits from shifting dependency ratios
One difference between the two countries is the change in the dependency ratios in the populations. The dependency ratio is the proportion within a population of children and old people not working. Broadly, India's children are growing up and becoming productive, but the elderly are not greatly increasing in number. By contrast China has an increasing elderly dependency ratio.
To give a comparison, the US has roughly a 50% dependency ratio, 20% children and 30% percent elderly. China will start to have a greater proportion of its dependants as seniors whereas India will simply have more workers per head of population. This process will give a lift to growth in India.
Changing levels of fixed asset investment
In manufacturing, greater GDP per capita reflects higher levels of productivity - in China much of this has come about from higher levels of investment in fixed capital, roads, buildings, plant and machinery. For India to reach the same levels of productivity in the future it will require a similar level of fixed asset investment.
China invests nearly half of its GDP in percentage terms, with 45% accounted for as gross fixed capital expenditure. Much of this investment is made by what were state-owned enterprises. State-owned enterprises had little requirement to pay out dividends to owners. Consequently, reinvestment of surpluses back into fixed investment became the norm. This practice appears to have largely continued despite becoming capitalist enterprises with profit motives, as spending on fixed investment to build future capacity is in the genes of these organisations.
The practice of saving and spending on fixed investment from corporations rather than consumption means that when combined with government-led investment, China has an incredibly high proportion of fixed investment that will continue to boost incomes.
India is expected to experience an upward shift in its level of fixed asset investment, rising from around 34% to 42% in 2015. That lift in investment over the next five years is a key argument for investors to look at the opportunities available in India now.
Which has the better outlook?
The outlook for the two countries is positive, with solid domestic demand evident in both. The global financial crisis has highlighted that countries with local consumer bases and low levels of debt are likely to continue to out-perform economies with ageing populations and higher debt levels for the medium term.
The risks in Asia emanate from outside the region, with volatility possible through unstable currency conditions. Currency is an issue for all cross-border investors when choosing between China and India. The yuan is widely expected to appreciate against a basket of currencies and lift Asian currencies in its wake, while the consensus outlook for the rupee is currently steady appreciation, but dependent on inflationary pressures.
In the long term, both China and India have excellent merits for investment, but in the short term, returns from India might be slightly better priced as opportunistic compared with the risks incurred.
Further information on Jones Lang LaSalle's Transparency Index can be found at www.joneslanglasalle.com/transparency
Nick Crockett is head of corporate finance Asia, and Megan Walters is head of research, Asia Pacific capital markets, at Jones Lang LaSalle