India’s Demographic Dividends

Thursday, May 31st, 2012

India’s Demographic Dividends

Week of May 25, 2012

by Sunil Asnani, Matthews International Capital Management, LLC

The wine of youth does not always clear with advancing years; sometimes it grows turbid.—Carl Gustav Jung

Fortunately, India’s vast population of 1.21 billion, considered a “time bomb” not long ago, is increasingly being viewed as a positive. While its population has grown by roughly 18% over the past decade, the percentage of its children has actually fallen during this same period. This demographic shift could help India enjoy increasing national prosperity. The country appears to be at an early stage of declining fertility, leading to fewer young mouths to feed at the same time that it has a greater number of wage earners. This may result in a rise in income per person and the freeing up of resources for investment in economic development and family welfare. Popularly called “demographic dividends,” this phenomenon is expected to bridge regional economic inequalities as the poorer states in northern India catch up to their southern peers, which were early beneficiaries of this trend. Gender equality may also get a boost as women may have more freedom to work outside the home as their domestic responsibilities decrease.

This shift is worth a closer look. First of all, nations that have benefited from both declining fertility and advances in health care have eventually seen a resurgence in dependency ratios (a measure that expresses the number of a nation’s unemployed dependents—children under 15 and seniors over 65—to the total working age population) as their elderly populations rise in proportion. This means that today’s “dividends” will eventually have to be paid back. Granted, in India’s case, any reversal in fortunes is still a few decades away. But sooner or later, the country needs to develop a stronger culture of productivity and sustainable family planning. Secondly, India needs reforms that enable investments in social infrastructure and mobility within the labor pool while ensuring an adequate social safety net for all.

Cultivating the quality and skills of India’s young workforce is probably more important than the sheer increase in its employable population. Currently, at least a quarter of India’s population is illiterate. Having a workforce that has recently seen double-digit wage growth alongside a vastly unemployed and malnourished young population (the prevalence of underweight children in India is among the highest in the world) does not bode well. In addition to devoting further investment to improve nutrition, education and skill development for its citizens, the country must also reform its labor laws in order to attract more investment in the manufacturing sector. This segment has had a better track record of creating jobs than, for example, India’s “knowledge-outsourcing” industries. The timing arguably could not be better: China’s low-cost labor advantage is dwindling, and many companies with a presence in China are looking to base manufacturing operations in other countries.

India would do well to realize that this period of demographic shift is not merely a stroke of luck, but a window of opportunity. For growth to be sustainable requires some reforms in the way people live and work.

Sunil Asnani
Portfolio Manager
Matthews International Capital Management, LLC
The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.

Copyright © Matthews International Capital Management

Tags: Age Population, Capital Management, Carl Gustav Jung, Demographic Shift, Dependency Ratios, Dependents, Dividends, Domestic Responsibilities, Economic Inequalities, Elderly Populations, Family Welfare, Gender Equality, Income Per Person, India, Management Llc, Matthews International, National Prosperity, Northern India, Resurgence, Time Bomb, Wage Earners
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A Bad Year for Common Sense

Thursday, December 22nd, 2011

A Bad Year for Common Sense

by Gerald Hwang, CFA, Portfolio Manager, Matthews International Capital Management, LLC

The phrase “common sense” can be a paradoxical concept in investment conversations. Seemingly imbued with a perverse, reverse meritocracy, the catchphrase appeals to investors as an intellectual leveler. It suggests, “Let us think things through logically.” Not only does this sound good, but what could be more egalitarian and humble? But when investment managers consider something to be “common sense,” be wary.

Let’s take a look at how common sense failed bond investors this year.

Risky or Risk-free: Which Is It?

From the start of the year until the end of November, long-dated U.S. Treasuries generated 26% in returns. Few market participants were predicting such a rally. Sober analysts with common sense made note of the low yields early in the year and an economy that was two years past the peak of the financial crisis. The probability of further rate declines appeared low with the Federal Reserve at ZIRP (zero interest rate policy). Some bond investors even shorted Treasuries outright, assuming that some combination of factors (such as better economic growth prospects or a pickup in inflation) might drive rates higher.

Regarding any potential flight to Treasuries caused by stress in Europe, common sense dictated that this was already priced into the market: yields were already extremely low. But they headed lower. This is bad news indeed for those holding Treasury shorts and who are benchmarked versus indices with a heavy government component.

Euro Stability Amid Political Chaos

The euro is up about 0.5% versus the U.S. dollar from the start of the year through November 30. The European Monetary Union itself is a magnified example of the “tragedy of the commons.” Just as individual sheepherders acting rationally will plunder a commonly held pasture, so too have individual countries acting rationally plundered the common currency. The relatively tight trading range of euro versus U.S. dollar, and the relatively flat year-over-year performance of the euro has confounded many investor expectations. This has been particularly baffling given the severity of the underlying crisis and the market’s consensus view of its intractability.

Japanese Government Bond Outperformance

Investors have a number of good reasons to dislike Japanese Government Bonds (JGBs). U.S. holders of JGBs enjoyed a 6% year-to-date total return—which is surprising given the low yields across the entire Japanese curve. At the start of the year, the 10-year JGB yielded 1% (and you thought the U.S. 10-year bond was low at 2%!). Two surprises are attached to JGB outperformance. First, Japanese yields declined slightly from those already-low levels, creating a capital gain. Second, a 4.5% appreciation in the yen versus the U.S. dollar augmented JGB returns to U.S. dollar-based investors. (And the yen appreciated 3.9% versus the euro.)

It is unlikely that many bond investors outside Japan overweighted JGBs in anticipation that the minimal carry would be so strongly augmented by positive yen returns. Japan has the developed world’s highest debt/GDP ratio. Recovery efforts from the earthquake and nuclear disaster would suggest that this ratio would rise. Japanese demographics suggest that the growing ranks of the elderly will cease being net providers of capital to the Japanese government. At least this year, none of these factors mattered.

Given the extraordinary macroeconomic conditions in which we find ourselves, perhaps some of these performances are not out of keeping with the environment. High levels of unemployment in the West have been paired with tight fiscal policy and less-than-accommodative monetary policy, which itself seems absurd. In Asia, India and China have been stepping on the brakes for most of the year.

Perhaps next year, counter-intuitive investment theses will continue to prevail over false “common sense.”

Gerald Hwang, CFA
Portfolio Manager
Matthews International Capital Management, LLC
The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.

Tags: Bond Investors, Capital Management, Cfa, European Monetary Union, Growth Prospects, Hwang, Interest Rate Policy, Investment Managers, Leveler, Management Llc, Market Participants, Market Yields, Matthews International, Political Chaos, Portfolio Manager, Rate Declines, Sheepherders, Tragedy Of The Commons, Treasuries, Zero Interest
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Searching for Growth in Asia (Matthews)

Thursday, March 24th, 2011

Searching for Growth in Asia

by Taizo Ishida, Portfolio Manager, Matthews International Capital Management, LLC

March 2011

Date of publication: March 8, 2011. This piece was written prior to the earthquake and tsunami that took place in Japan on March 11, 2011.

There are many ways one might define “growth” and go about uncovering it. In my experience, I have found that there is an abundance of growth available if you know where to look and how to find it. There are a few key elements I look for: main drivers of growth, sustainability and scope of growth, and market expectations (in terms of valuation).

Many global investors today are seduced by the last several years of strong stock performance in China and India, fueled by robust economic growth. However, economic growth alone does not guarantee good stock performance—as evidenced in the chart below, comparing India’s stock market returns to the country’s GDP growth. In fact, many studies argue that, historically, there has been little correlation between stock market performance and economic growth.

Regardless of whether these empirical studies are still valid, my interest as an equity portfolio manager, revolves around one main concern: how does a company grow? How does it grow from US$100 million market capitalization to US$1 billion market cap, from US$1 billion to US$10 billion and so on.

Asia’s “Obvious Growth” Areas

“Growth” is often associated with something new and exciting, such as new technologies, new industries and new territories. It may seem obvious that as incomes grow, the average basic needs of households (housing, food and clothing) should also rise. With about 3 billion people in Asia waking up to the idea of increasing personal consumption, the region can certainly be considered to be growing and exciting.

Let us first consider a few examples of perhaps more apparent areas of growth in Asia. Prior to 2000, annual automobile sales in China had barely reached 2 million vehicles, while U.S. auto sales were approximately 17 million a year. In 2010, China’s auto sales reached about 18 million vehicles, surpassing U.S. car sales at 11 million. Autos have certainly been a growth sector, but will this continue to be the case going forward? There are many questions one should ask before making a quick investment decision in this sector. Is this growth secular or cyclical (like many other markets in history)? Which segments of automobiles—sedans, SUVs or trucks, for example—should see the fastest growth? What about electric cars? Should more investment go toward local companies or multinational joint ventures? We believe that growth in this sector will be less obvious over the next 10 years than it was over the past decade, and that identifying primary drivers of future growth is essential.

Another example of an “obvious growth” area is the wireless telecommunications sector in Asia’s emerging markets. India’s cell phone market grew from 2 million handsets sold in 2000 to about 545 million in 2010. The industry is still growing with approximately 18 million new subscribers a month. However, the stock performance of Indian telecom firms over the last five years tells a different story: Stock prices for this sector fell, most likely as a result of overvaluation just prior to this period. The sustainability and scope of growth for a business, therefore, are key elements to consider.

Emerging Growth

Growth is emerging in less obvious areas or, in what some might consider, the most unlikely of places. Much recent press on Japan has emphasized “how cheap” it is for investors, but we also see compelling growth as a reason to be interested. The trick here is to select companies on a bottom-up basis, rather than considering the sector overall. Retail industries in developed countries tend to be quite mature and, as such, investors don’t tend to get very excited about the prospects. But there are, in fact, a few Japanese retail companies doing very well domestically. One is a retail bicycle chain, and another is a retail electronics chain. Both generate revenues almost entirely from the domestic market, yet their revenues have grown each year for the last 10 years, a notable achievement for any part of the world. There is also another type of emerging Japanese retailer—the type that is seeking new territories within Asia. A few are even targeting select major U.S. and European cities. While the bulk of their operations are in Japan, in the coming years, a primary driver for this type of firm is faster overseas growth. None of these retail companies is an obvious investment candidate. However, they show attractive potential in their fundamentals.

There really is no easy slam dunk or truly “obvious growth” in the world of investing as so much changes so quickly (even as I write this). Particularly in Asia, the pace of change seems faster than in other regions simply due to the region’s rapid economic growth. As these changes continue, one of the more encouraging developments is the improvement of living standards in certain pockets of Asia—though not necessarily for a country as a whole. GDP per capita alone would not lead to good investment decisions because big cities are often completely different from the rest of the country. The needs and lifestyles of those living in some big Asian cities, such as Shanghai and Mumbai, are becoming quite similar to those in New York or Tokyo. This is good news for global companies that see the potential for an expanding customer base, but it may indeed be even better news for Japanese consumer companies due to their proximity and cultural similarities. Chinese tourists with spending power, for example, are quickly becoming a permanent fixture in Tokyo’s high fashion area of Ginza. Who knows? Perhaps my next investment idea may come from Ginza!

Also stemming from Japan, one “new” and less-hyped industry—unlike today’s social networking companies—is the robotics industry. Robotics firms are generally off the radar screen of many global investors simply because few of these companies are listed anywhere, except in Japan. It is no secret that Japan loves robots and more than 30% of the world’s robots are estimated to “live” in Japan. Most of these industrial robots can be found in factories as essential partners to human laborers, and the cost of replacing people with industrial robots has decreased dramatically over the last 20 years. As a result, factories in China are increasingly installing these robots at a faster-than-expected pace. Rising Chinese labor costs are encouraging more Japanese-led automation in China, and many robotic component companies are also benefiting. It would not be difficult to imagine the continuation of this trend as long as China maintains its status as the “factory of the world.”

Japan’s Growth Curve

The fact that Japan once dominated the mobile Internet space (prior to 2000) escapes most people. That was almost a decade before the average American began busily engaging in social media and games on mobile devices as they do now during their daily commute. “I-Mode,” launched in Japan in 1999, was a pioneering technology used to connect mobile phones with various Internet-related services, including e-mail and games. It was an instant hit and became a de-facto standard in Japan, though it was used only domestically.

The emergence of smartphones and third-generation (3G) and fourth-generation (4G) networks changed all this as standards became more universal, and began enabling many Japanese companies to participate in markets overseas. Some of Japan’s up-and-coming companies offering interactive mobile Internet game platforms are already attracting much interest from around the world, including the U.S. and China.

Why have I focused so much on growth related to Japan? As I mentioned earlier, I look for companies that possess certain elements, and many Japanese companies I am finding fit the bill very nicely. For me, they offer attractive company valuations and robust compliance levels that meet the standards of the developed world. Meanwhile, many actual operations of Japanese firms are increasingly taking place in more emerging nations in the region.

An Analogy for Japan

For those who have concerns over investing in Japanese companies, I would suggest considering Japanese stocks as if you were considering Swiss stocks. This is less farfetched than it may sound: both Japan and Switzerland are older, smaller countries with few natural resources. Moreover, both countries are established tourist destinations within their regions, with the added attraction of clean air and water. If you are beginning to see my analogy, I would pose this question: Would you think about the overall Swiss economy or demographics in considering whether or not to invest in some of Switzerland’s strong, global companies? If your answer is negative, you may see my point about investing in Japan from the bottom up.

Ultimately, the growth we encounter as investors is the growth of businesses and the value they create for shareholders. Finding these opportunities is never the result of simplistic processes—whether they be top-down, macroeconomic, theme-based or driven by historical data. It is a constantly surprising search to challenge conventional wisdom.

Taizo Ishida
Portfolio Manager
Matthews International Capital Management, LLC

Tags: Automobile Sales, Capital Management Llc, China, Emerging Markets, Empirical Studies, GDP Growth, Global Investors, Good Stock, Growth Areas, India, Ishida, Last Several Years, Market Capitalization, Market Expectations, Matthews International, New Territories, Personal Consumption, Portfolio Manager, Publication March, Robust Economic Growth, Stock Market Performance, Stock Market Returns, Stock Performance
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Postcard from Japan

Sunday, October 24th, 2010

Postcard from Japan

by Kenichi Amaki, Portfolio Manager, Matthews International Capital Management, LLC

October 22, 2010

Tags: Birth Rates, Capital Efficiency, Capital Management Llc, Capital Returns, Child Care Facilities, Child Care Provider, Child Care Providers, Declining Population, Deflationary Pressures, Government Plans, Growth Areas, Growth Business, Japanese Companies, Matthews International, Overseas Investors, Portfolio Manager, Proactively, Profit Margins, Research Trip, Service Sector Companies
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Postcard from India (Matthews)

Monday, July 12th, 2010

This article is a guest contribution by Sharat Shroff, CFA, Portfolio Manager, Matthews International Capital Management, LLC.

There seems to be a quiet sense of confidence among Indian management teams recently—much in contrast to the display of hubris that I encountered in the days before the onset of the global economic crisis. In recent meetings with companies in India, I got the distinct feeling that managers are focused on building the right strategies and platforms to address growth opportunities that should arise in the coming decade. This is also a far cry from the prevalent short-term steps some management teams took about five years ago to create market capitalization. The recent crisis has perhaps forced a more honest and realistic assessment of strengths and weaknesses. Some entrepreneurs have even decided to exit parts of their business. As such, there has been a pick-up in corporate mergers & acquisitions in India. In some cases, multinational firms have been the acquirers—a reflection of India’s importance as an emerging growth destination.

A key theme that seemed to resonate in many meetings during my last trip to India was the gradual resurgence of rural areas and smaller Indian cities, and hence the need for innovative products and solutions that can cater to demand from these parts. Car companies pointed to a near doubling in sales last year, and consumer companies were quick to highlight their pricing strategies and plans for distribution reach into the country’s hinterlands. Even as some of the metropolitan areas suffered a slowdown last year, company performance in second- and third-tier cities seems to have escaped these pressures. Often criticized for being a drag on India’s economic growth, the rural consumer is growing in importance in the marketing campaigns of companies eager to establish a foothold in some of India’s emerging consumption centers.

It is easy to get carried away with the potential of a full economic revival of rural (and consequently, agricultural sectors) within India. Some of the recent strength can be attributed to new policies by the central government, including guaranteeing employment for 100 days (under the National Rural Employment Guarantee Act). The early results of these policies are encouraging, but the impetus needs to be sustained in the form of more forward-thinking investment in some parts of the social infrastructure, such as health and education. Nonetheless, it is hard for any long-term strategy focused on India to ignore the potential of these smaller markets.

Sharat Shroff, CFA
Portfolio Manager
Matthews International Capital Management, LLC

(c) Matthews Asia

www.matthewsasia.com

Tags: Acquirers, Companies In India, Company Performance, Corporate Mergers, Emerging Growth, Global Economic Crisis, Hinterlands, India, Indian Cities, Management Teams, Many Meetings, Market Capitalization, Marketing Campaigns, Matthews International, Multinational Firms, Pricing Strategies, Quiet Sense, Realistic Assessment, Revi, Shroff, Strategies And Plans
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Contemplating Capital Controls

Wednesday, July 7th, 2010

A guard stands before a Thai bank

This article is a guest contribution from Dr. Robert Horrocks, Matthews International Capital Management LLC.

It seems that every week we hear that the world’s economy is unbalanced—European and American economies face, among other things, fiscal austerity, weak housing markets and the threat of deflation. In contrast, China and India are booming. Western central banks are trying to stimulate demand through low interest rates while central banks in Asia are trying to cool demand amid private capital inflows.

While the West pushes for more growth from the East, Asia’s governments fear that speculative inflows of “hot money” could cause economic overheating and price volatility. Recently, China raised reserve requirements and India raised interest rates. China also implemented a series of administrative controls to sharply decrease property speculation by making it harder and more expensive to buy a second or third home. One tool policymakers might use to quell speculative investors is currency appreciation—but many countries in Asia have preferred to peg their currencies to provide a predictable value for the exchange of goods in their most important overseas markets.

Another tool for policymakers in discouraging asset bubbles is capital controls. However, capital controls are a double-edged sword. They help governments retain control over their exchange rate and domestic monetary policies but they are also coercive measures that bring into question a country’s commitment to free markets. Asia has had a checkered history with capital controls. Most notably, Malaysia imposed harsh controls to prevent capital from fleeing the country during the Asian financial crisis of 1997–1998. Malaysia had a difficult choice to make: it imposed its controls at the height of the crisis in order to stop a panic and buy time for the economy to recover. Nevertheless, it left foreign investors feeling bitter for years afterward.

The situation is different now. Asia’s economies are not in crisis. They seek to dampen the influx of capital for fear that it will be suddenly withdrawn at the first sign of volatility. Capital controls are perhaps both a blunt tool (determined investors can circumvent them) and a controversial one. So, recent moves to impose controls have been modest compared to Malaysia’s experience: Korea has imposed limits on its banks’ positions in currency derivatives; Taiwan banned foreigners from holding time deposits as a way to speculate on its currency; and Indonesia announced controls on sales of central bank paper. All countries have downplayed the idea that they would impose stricter capital controls. In addition, inflows of portfolio equity investments are probably less concerning to policymakers than inflows of credit, particularly bank loans. The withdrawal of equity investments, while damaging to sentiment, should not cause a credit crunch. Harsh controls on equity investments at this stage would appear unlikely.

Policymakers are clearly wary of imposing further controls on capital. However, they cannot prevent the bubbles they fear by using monetary policy alone—until they allow their currencies to appreciate. Otherwise, they are simply allowing international investors to enjoy the high interest rates that tighter policy brings at the existing cheap exchange rate and capital will flow in. Investors should keep this in the back of their minds. As enticing as the current economic climate is for Asian investment, any “rebalancing” in the world economy will be managed at a pace with which Asia feels comfortable. Controlling the pace will require Asian economies to follow a pro-active monetary policy, allow currencies to appreciate—or, yes, even consider capital controls. Even more reason for investors to maintain a long-term time horizon when considering investment in Asia.

Robert Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC

Copyright (c) Matthews Asia

Tags: Administrative Controls, Asian Financial Crisis, Capital Inflows, Central Banks, Checkered History, China, Coercive Measures, Countries In Asia, Double Edged Sword, Fiscal Austerity, Foreign Investors, Horrocks, Hot Money, India, Low Interest Rates, Matthews International, Monetary Policies, Overseas Markets, Price Volatility, Private Capital, Property Speculation, Thai Bank
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Another Step Toward Gender Equality in India

Sunday, March 28th, 2010

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Women in New Delhi rally for rights

By Sunil Asnani, Research Analyst, Matthews International Capital Management, LLC

Week Ended: March 26, 2010

India’s upper house of parliament recently supported a historic bill that would reserve one-third of its legislative seats for women. The passing of this contentious bill is an early step in the process of amending the country’s constitution.

The bill, which had been stalled for over a decade by political opponents on various grounds, now requires lower house (Lok Sabha) and state legislature approval before it can become law. Its passage in the upper house marks a historic event in the political sphere as it seeks to empower women to actively take part in India’s most critical decisions by reserving national and state governmental seats on a rotational basis for 15 years. Once passed, India’s top legislative bodies would have participation by more women than even the United States, which claims 17% participation by women in Congress.

Though India’s Constitution is quite progressive when it comes to gender issues, Indian women still face inequality in many areas. Fewer women than men receive proper schooling and nutrition, and women suffer from the ills of fetal homicide and infanticide. They are also subjected to violence, and even homicide, related to dowry disputes.

While there is some correlation between gender equality and economic development, it is interesting to compare the gender issues prevalent in India and China, which have adopted different paths to prosperity. China seems to have engaged more women, who make up nearly half its workforce, compared to India, where women make up about a quarter of the workforce. However, China also requires women to retire five years earlier than men, unlike India, which does not impose gender discrimination on a policy level (with the exception of the armed forces). On the political front, about one-fifth of China’s parliament is comprised of women, compared to about
one-tenth in India’s case, but the real seat of power in China lies within the Communist party, whose top leadership consists of an all-male ruling body. China’s one-child policy—designed to rein in population growth—freed up many women from having to care for a large family, but the policy has had the effect of distorting the ratio of male-to-female births as there appears to be pressure to produce male heirs. No wonder more than 118 Chinese boys are born for every 100 Chinese girls. The average for most industrialized economies is 107 boys for every 100 girls. India’s gender ratio at birth is slightly less tilted than China’s, but certainly not a cause of pride. The male child continues to bring more celebration than do little girls.

India has a long way to go before it can claim gender equality success, but placing more women at the top of the political chain should be instrumental in furthering equality in other aspects of Indian society.

Sunil Asnani
Research Analyst
Matthews International Capital Management, LLC

Tags: Capital Management Llc, Contentious Bill, Critical Decisions, Different Paths, Dowry, Gender Discrimination, Gender Equality, House Of Parliament, India, India Women, Indian Women, Legislative Bodies, Legislative Seats, Lok Sabha, Matthews International, One Fifth, Political Opponents, Political Sphere, Research Analyst, Rotational Basis, Upper House Of Parliament, Week Ended March
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Postcard from China – Labour Shortfall

Tuesday, March 23rd, 2010

by Richard Gao, Portfolio Manager, Matthews International Capital Management, LLC.

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I recently spent two weeks visiting companies in various cities in China, including Shanghai, Chongqing, Xiamen, Beijing, Xi’an as well as in Hong Kong and Macau. In general, most companies have seen a substantial increase in momentum to their business growth so far this year. Companies in a wide range of industries—tourism, machinery, infrastructure, retail, health care, telecommunications and software—all indicated strong growth, not only compared to the same period last year (which was at a low level), but also compared to the high levels of the fourth quarter of 2009. Meanwhile, banks are more cautious about lending this year, especially with regard to property developers. Contrary to last year when the central government initiated a massive stimulus program to boost the economy, the challenge for China this year is to maintain economic growth yet avoid overheating.

During my visit to the western city of Chongqing, I was amazed to find an article in a local newspaper about a factory owner who had just hired three new employees from an employment center. In the accompanying photo, the owner was happy and smiling, having driven his luxury car to recruit workers. Managers themselves need to go out and find labor in China these days! Indeed that was news.

This apparent phenomenon of a labor shortage in China is becoming severe. Not only is this shortfall in traditionally labor-intensive export areas such as the Pearl River delta in the south and the Yangtze River delta in the east, but also in the country’s western and northern regions. Managers from several export-oriented industrial companies with factories in Guangdong told me that despite 15% to 20% wage hikes for factory workers, firms are still experiencing difficulty recruiting workers.

One of the main reasons behind the labor shortage is that there are increasingly more job opportunities inland. Factories in the coastal regions rely heavily on migrant workers coming from the country’s mostly rural inland areas. As these areas become more prosperous, migrant workers who might have previously relocated in search of work are staying closer to home. In addition, it is also becoming harder to find young Chinese who want to work in factories as China’s younger generation is generally more optimistic about their career options.

After years of being the world’s low-cost producer, China no longer seems to have a cheap labor pool as its heartland catches up with its more modern coastal regions. Better living standards throughout the country will surely lift China’s domestic consumption over the long term. However, for the time being, factories that rely on cheap labor should likely see their already thinning profit margins come under further pressure. This will likely force them to either exit the industry or try to move up the value chain and increase productivity.

Richard Gao
Portfolio Manager
Matthews International Capital Management, LLC

Tags: Business Growth, Capital Management, Capital Management Llc, China, Chongqing, Cities In China, Emerging Markets, Employment Center, Export Areas, Guangdong, Labor Shortage, Luxury Car, Matthews International, Northern Regions, Pearl River, Pearl River Delta, Portfolio Manager, Property Developers, Richard Gao, Substantial Increase, Xiamen, Yangtze River, Yangtze River Delta
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Assessing India and China

Thursday, March 18th, 2010

Sunil Asnani
Research Analyst
Matthews International Capital Management, LLC

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Investors often compare India and China, debating the two in their assessments, though China has historically enjoyed better luck with foreign investments. However, as portfolio managers, we find the contrasts between the two to be advantageous. Unlike policymakers who must deal with the cards they have been dealt, we can enjoy the benefits of investing in each country. In assessing the two, we find that China promises higher but arguably more volatile growth, while its Indian counterpart seems to be on a relatively more moderate and sustainable growth path. Ideally, each camp should gather a sufficient following. But the reality is that the typical U.S. investor looking at Asia is probably growth starved, which tilts the argument in favor of China. Because the case for investing in China is probably better known, I sought to emphasize the case for India.

The stability of the Indian economy has often been underappreciated, though the recent global slowdown was an eye opener. Both China and India bottomed out at about 6% GDP growth during the second quarter of 2009. However, while China plunged to less than half of its peak of 13% from two years ago, India fell by only about a third of its peak of roughly 9% over the same period. India’s ability to not only achieve respectable economic growth in a turbulent environment but to do so without injecting mammoth stimulus demonstrates its inherent resilience. The Indian government did take fiscal measures during the peak of the crisis, but the stimulus measures amounted to about US$80 billion, or just 7% of its GDP, and were limited mostly to tax cuts. China, on the other hand, was much more aggressive, infusing its economy with about US$600 billion of investment-led stimulus, almost 15% of its total national income.

One factor that helped India during the crisis was its high dependence on domestically oriented demand, notwithstanding its reputation as a major exporter of outsourced services. In fact, India is a net importer, whereas, China enjoys a trade surplus, which has been as high as one-tenth of its GDP. Exports contribute to national income in good times, though excessive reliance on external trade also brings uncertainty during global slowdowns. Another savior for India’s economy was its reliance on consumption, which contributes as much as two-thirds of its national income, compared to less than half in China’s case. Consumption-driven economies tend to be resilient, even though they may grow moderately.

Savings and Investments

I believe that by drawing on lessons from China, India can also achieve similar growth rates for years to come, provided it is able to sustain its recent uptick in savings and investments. China’s journey of growth has been accompanied by a high savings rate, which exceeded 35% of GDP for almost two decades. This has helped the country achieve an average investment rate of about 40% of GDP during this period, amid a low cost of capital. The situation was further helped by external trade surpluses and high rates of foreign direct investment, which were in the range 3% to 5% of GDP in the last decade. India, on the other hand, had much lower savings and investment rates, in the low 20% range during the 1980s, and rising to about 30% only in the last decade. Not surprisingly, the cost of capital has been high and is still in the double digits, setting a high hurdle for many businesses to clear in order to flourish. The good news for India is that in the last few years, the country’s savings and investments have achieved a rate of more than 35%, putting the country on a growth track similar to that of China. India’s foreign direct investments, which had averaged less than 1% of GDP for the last decade, crept up to 2% even in the middle of the global crisis, suggesting increased investor confidence in its growth potential. Given that India’s capital efficiency is on par with or even better than that of China, it would not be surprising for India to replicate China’s growth under a similar savings and investment environment.

Feeding India

The area that has probably been most “starved” of investment is India’s agriculture sector. In my view, excessive regulation and lack of infrastructure have held back this sector’s growth, and left it to the mercy of India’s unpredictable monsoons. Indian agriculture contributes about one-fifth of the country’s total income, even though it employs more than two-thirds of the population. The low productivity is also reflected in India’s farm output, which for food grains is about one-third of China’s and one-fifth that of the U.S. It is not difficult to see why this is the case. India’s investment in agriculture has averaged about 3% of the income generated from the sector, compared to about 6% in China’s case. Consequently, over the past three decades, India’s agricultural output has increased by an average of less than 3%, compared to more than 6% for China. Given India’s political inertia, liberalizing agriculture, executing land reforms and shifting subsidies from consumption toward investments might not be easy, but the value that could be unlocked from the sector could be enormous. A healthy doubling of farm productivity in the sector over the next decade is achievable, and in my view, could add another percent or more of growth on a continuous basis. As an offshoot, higher agricultural productivity would enable greater food security and domestic price stability, paving the way for a long-term lower interest rate regime that would benefit the entire country.

Containing India’s Fiscal Deficit

Another major hurdle toward lower funding costs has been the government’s inability to self-finance its expenses, which stems mostly from consumption subsidies and wage hikes. Years of deficit have caused the government to borrow heavily, resulting in a public debt as high as two-thirds of GDP. In fact, about a quarter of the deposits collected by banks in India are used to fund government borrowings. The argument that the private sector’s inability to invest in social infrastructure justifies the government’s inefficient usage of capital doesn’t hold water when you consider that the government has borrowed primarily to fund consumption expenditure over the years. China, on the other hand, has been almost debt-free, and deficits, if any, have resulted from increased investments in fixed assets. At the same time, China has been able to contain deficits via good tax collection. India’s government expenditure as a proportion of its GDP is actually lower than China’s, but its poor tax collection has led to huge deficits. The current government has initiated tax reforms, which over time could bridge the fiscal deficit. Meanwhile, the least India could do is to use deficit financing, if only to fund investments rather than give them away as subsidies.

Accessing Growth

While both countries are on a growth path, investors may wonder which offers better investment opportunities to access the growth in its economy. Both countries have liberalized their economies for quite some time, and the entrepreneurial private sector likely seems big enough (and could actually be the best way) to ride these waves of growth. The private sector contributes more than three-quarters of India’s GDP, and about two-thirds of China’s GDP. But a look at the MSCI indices of the two countries would suggest that privately owned companies constitute about 75% of market capitalization in India, compared to only about 18% in China. I would surmise that the majority of private sector companies in China are either not listed or not available for investment to foreigners. Not surprisingly, the listed companies (that constituted respective MSCI country indices) in both the countries grew their earnings by almost the same rate over the last decade, even though China outpaced India in economic growth.

It would be fair to say that despite their relative strengths and vulnerabilities, both India and China can learn a lot from each other. Each country offers a spectrum of unique investment opportunities for long-term investors.

Assessing India and China Roundtable

This month Asia Insight focuses on Assessing India and China, and features a conversation with the following Matthews Asia Funds Investment Team members:

• Robert Horrocks, PhD, Chief Investment Officer
• Sharat Shroff, CFA, Matthews Asia Pacific, Matthews Pacific Tiger and Matthews India Funds
• Lydia So, Portfolio Manager, Matthews Asia Small Companies and Matthews Asian Technology Funds
• Winnie Phua, Research Analyst, Matthews Asia Pacific and Matthews China Funds

Q: What do you see as the most compelling factors for investing in India, and how does this compare to China?

A: Sharat Shroff
I would say one of the more underappreciated facts about the Indian economy, is that it has been driven by the private sector. In our research, we found that, surprisingly, the government accounts for less than 20% of India’s GDP. This means that the private sector is the sharpest driver of growth in the Indian economy.

We have high quality companies in which to invest, and hence participate in this growth. That may not always be the case in other markets, especially at this stage of development. I think that’s something that’s not well appreciated by the market. If you look at the market capitalization composition in India, a large bulk of it is driven by entrepreneurial private sector companies.

Q: Are there any surprising distinctions you have found in your assessment of the two countries?

A: Lydia So
Consumption power in China is higher and the critical mass is also bigger than that of India. So you can probably find a broader consumption plate in China. On the other hand, India’s history of entrepreneurship is much deeper and longer. You can easily find proven Indian brands with a 60-year history. So even though you have the “critical mass,” of a larger middle class in China, you also have brands that are less proven and have only been around maybe five or six years.

A: Robert Horrocks
When it comes to India and China, they are mirror images of each other in so many ways. You have a sophisticated market structure in India, and a less sophisticated one in China; better physical infrastructure in China, and less of that in India; and stable politics in China versus a fragmented political structure in India, where they are living with terrorism. From a portfolio manager’s point of view, this means we can use both China and India in a portfolio and try to get the optimal mix. It’s not an either/or decision and the differences between the two makes holding both more attractive.

Sharat Shroff
It’s hard to paint India in a single brush stroke. Once you state something, you’re bound to find contradiction to that statement. For example, people say that India’s manufacturing sector is not developed, and you should look instead to China. But telecommunications firm Nokia’s largest plant globally is in India, which I think people would be surprised to know. India is also strong in pharmaceutical manufacturing. Even though India’s capital markets have the longest history in Asia—even two years earlier than Tokyo— trading volumes and liquidity in these markets leave a lot to be desired, which is why India has one of the most volatile markets in the region.

Q: There is a lot of recent discussion about real estate in China? How does this compare to India?

A: Winnie Phua
If you look at the urbanization rate in both countries, I think India is at about half that of China’s speed right now. Urbanization is a key factor in economic network growth and income growth, which in turn encourages infrastructure build out. With a faster pace of urbanization, and hence the more rapid infrastructure progression you see in China, one sector that has developed more quickly there is real estate. China has rolled out its land reform since the mid-1990s, allowing land sales and individuals the right to own properties. In comparison, this development is slower in India where there is less clarity in land titles. Further, the real estate industry is a very capital intensive industry so with easier access to capital markets, China has a broader selection of real estate developers.

Q: In what areas do you see China and India drawing lessons from each other?

A: Sharat Shroff
Nearly two decades ago, China embarked on the special economic zone concept, giving tax-related incentives for business to set up operations within land earmarked for business development. That’s been an inspiration for the Indian government and they’ve been trying to kick-start that process. On the flip side, if you look at China, they’ve really gone after developing information technology (IT) service businesses within their country. To that extent they’ve encouraged Indian companies to set up operations in China and hire from their universities, and they’ve given tax benefits. There’s a real desire for them to boost their presence in the services segment.

A: Lydia So
From my experience in speaking with management teams in China and India, I get the general sense that Indian entrepreneurs tend to be more cautious about employment and returns of capital given that capital is more scarce. They seem very oriented toward profit and returns. In the case of China, where capital is more abundant, some Chinese entrepreneurs tend go for market share growth and might place profitability as a secondary consideration. Growth and profitability are both important factors contributing to the success of a company, I suppose both China and India can draw some lessons from each other as to how to balance those two things in the longer run.

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WealthTrack’s Great Investors: A Conversation with Mark Headley

Tuesday, August 18th, 2009

This week in WealthTrack’s series on Great Investors, Consuelo Mack features Mark Headley, chairman of the board of Matthews International Capital Management, which runs a family of Asia-focused mutual funds.

Headley discusses the impact of the financial crisis in Asia as well as potential opportunities in the region. (If there is no sound, click on “unmute” by scrolling over the bottom of the image.)

Note: The transcript of this interview is not available yet, but will be posted here as soon as it arrives.

Source: WealthTrack, August 14, 2009.

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