The news coming out of China is grim. According to Financial Times, foreign investors have pulled out over $12 billion out of mainland China equities since the beginning of June 2024. The Chinese government, in a knee-jerk reaction, has stopped publishing daily data of inward foreign portfolio investments into the country, to douse the rising panic among domestic and foreign investors.

Foreign investment outflow is the natural fallout of the consistent underperformance of Chinese stocks in the last three years. The underperformance has resulted in the country’s weight in important global equity indices moving lower. According to Reuters, China’s weight in MSCI Emerging market index has declined from 39.1 per cent in December 2020 to 24.2 per cent in August 2024.

China’s loss has been India’s gain as far as wooing foreign portfolio investors go. While China’s weight in the MSCI EM index slipped, India increased its weight from 9.2 per cent to 19.8 per cent in the last three-and-a-half years. According to Morgan Stanley, India has surpassed China’s weight in another index, the MSCI EM Investable Market Index in September 2024, with Indian stocks’ weight at 22.27 per cent compared with weight of Chinese stocks at 21.58.

These higher weights are already translating into higher inflows into India. FPIs net purchased Indian equity worth over ₹2 lakh crore in FY24 and almost ₹60,000 crore in FY25.

India outperforms

It is not without reason that foreign investors are turning to Indian stocks markets. While other markets including the Chinese markets were hit by the Russia-Ukraine conflict and global central bank tightening 2021 and 2022, India stocks have stayed resilient thanks to domestic money pouring into stock markets.

The pricier valuation of Indian stocks could be making some of the foreign investors cautious. At 27.8 times price earning multiple, the Nifty50 is trading at a premium to its long-term average. But sustained growth in many of the larger companies, improving margins thanks to lower finance and input costs and sustained demand from the affluent section seem to be keeping the large companies on a stable footing. Of greater importance is the sustained demand for Indian equities from the growing tribe of domestic investors who are investing through the mutual fund route.

This is reflected in the out-performance of MSCI India compared with MSCI China (see table).

While India stocks have delivered a whopping 40 per cent return in dollar terms over a one-year period, MSCI China gave negative return of 2.57 per cent in this period. Returns from MSCI India were in double-digits over three- and five-year periods too while the Chinese equity made losses.

But this was not always so. A look at the annual performance of MSCI India and China since 2010 shows that the returns from Chinese equity were superior to India equities until 2020. The domestic consumption led growth in China, massive investments in infrastructure and capacity building for producing goods across the spectrum from commodities to new-age semiconductors and EVs, had foreign investors rooting for the country prior to 2020.

What ails Chinese stocks?

The underperformance of Chinese equities began in 2021. A combination of factors such as the suppression of the Covid 19 infection in the first wave which led to an intense outbreak in 2021 and the regulatory clampdown on corporates in edtech, e-commerce and other tech-driven sectors made the stocks lose momentum in 2021. This was the period when other markets, including India’s, were racing higher as post-Covid recovery gained momentum. The disruption caused by the Russia-Ukraine war on commodity prices delivered a big setback to China in 2022.

Besides this, there are intrinsic factors weighing on Chinese equities. The real-estate crisis, currently in its third year, has taken a toll on consumer and investor confidence. With large inventory build-up, developers not having funds to complete projects, and homebuyers not getting delivery of homes they have already paid for, the crisis is spilling into the larger economy as well.

The other challenge facing China is slowing exports. While part of the slowdown is cyclical due to slowing demand from developed economies, the structural challenge facing China, in terms of other economies wanting to reduce their dependence on Chinese imports and seeking to build domestic capacities or diversify to other countries, can have longer lasting repercussions.

In terms of market fundamentals, Chinese stocks are much cheaper compared with Indian equity. The MSCI China index trades at a price-earnings multiple of 11.3 times on trailing basis and 8.9 times based on forward earnings. The price to book value is also quite low at 1.22 and dividend yield is quite robust. Yet, foreign investors are worried that the earnings growth priced into the valuations may be too optimistic.

Going ahead

The worst seems far from over for Chinese equities. The real-estate crisis seems set to prolong. With demand yet to pick up, home prices are not expected to revive until next calendar and most experts are saying that the government’s fiscal and monetary support has fallen short in supporting the sector. The upcoming US elections poses the threat of resumption of trade war, which can hurt the economy greatly. All countries are now increasingly resentful of the large capacities created by China. Diversification away from China is going to hurt businesses which have created the large capacities.

China’s loss is already turning into India’s gain as far as foreign investments go. Morningstar’s offshore fund spy report notes that, “The India-focused offshore fund and ETF category has been witnessing net inflows for eight consecutive quarters since the quarter ended September 2022. This year so far till June 2024, the category has received net inflows of $18.4 billion…it received the highest ever quarterly net inflows of $9.4 billion during the quarter ended June 2024.”

The reducing weight of China and increasing weight for India in global equity indices translates into strong investment flows into Indian stocks. With appetite of domestic investors for Indian equity remaining insatiable, additional foreign inflows will help to keep stock prices at elevated levels, truncating corrections.

While China’s weight in the MSCI EM index slipped, India increased its weight from 9.2 per cent to 19.8 per cent in the last three-and-a-half years