MSCI India is moving towards a third straight year of outperformance of MSCI China in 2023. India is currently our top pick in Asia ex-Japan / emerging markets (EM) equities, and we think a fourth straight year of outperformance of EM and China is likely in 2024. Central to our bullish view on India versus China's performance is the trend in earnings.
Starting in early 2021, MSCI India US dollar earnings per share (EPS) has grown this cycle by 61 percent versus a decline of 18 percent for MSCI China. As a result, Indian earnings have powered ahead on a relative basis. This has been the best period for India's earnings relative to China in the modern history of the two equity markets.
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There are two fundamental factors underpinning this trend in India's favour, both of which we expect to continue to be present in 2024. The first is India's relative economic growth, particularly in nominal gross domestic product (GDP) terms, which exceeded 12 percent in 2023 and is likely to equal or beat that growth rate in 2024. We, at Morgan Stanley Research, have written frequently in recent months on China's persistent 3D challenges — its battle with debt, deflation, and demographics — and are forecasting another subdued year of around 5 percent nominal GDP growth in 2024.
In contrast, our thesis on “India's decade” suggests growth is underpinned by the formation of a large urban middle class and a surge in manufacturing investment — including by foreign multinationals — as well as infrastructure delivery in areas like power, transportation, and logistics. This combination is ensuring that supply is moving ahead alongside growth in demand without driving a breakout in inflation, which has traditionally halted economic cycles in India. Nominal GDP growth will be well into double digits as both aggregate demand and crucial supply move ahead on multiple fronts.
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The second factor is India's improvement relative to China in currency stability. Our FX team anticipates that prudent macro-management (particularly on the fiscal deficit), geopolitical dynamics, and in particular foreign direct investment (FDI) and portfolio equity investment into India will lead to continued Indian rupee stability in Real Effective Exchange Rate (REER) terms, in sharp contrast to the volatility of previous cycles. This has been a remarkable feature of India's performance in the last 18 months, when the US Federal Reserve executed the most dramatic tightening in monetary policy in 50 years.
In sharp contrast, the Chinese yuan (CNY) in REER terms has begun to slide lower as FDI flows have turned negative for the first time in recent history and domestic capital flight begins to pick up. For year-end 2024, our FX team forecasts the Indian rupee to appreciate to 82.5 versus the current spot level of 83.3, while we expect the CNY to depreciate to 7.45 versus the current spot level of 7.15.
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The pushback we get from continuing to prefer India to China in 2024 includes the potential volatility of the Indian market in an election year. However, the main concern is relative valuations. As always, we feel it is important to contextualise versus Return on Equity (ROE).
Currently, India is trading on a little over 3.7x price to book ratio (P/B) for around 15 percent ROE. This makes it the most expensive market in Asia ex-Japan / EM and second only to the US. China is trading on 1.3x P/B for around 10 percent ROE. Importantly, we forecast ROE to remain high in India even as earnings compound going forward, as margins and asset turnovers remain strong in a buoyant macro environment.
Meanwhile, corporate leverage can build from current levels as nominal and real interest rates remain low to history. However, for China, the outlook is very different. In a recent detailed piece, drawing on sector inputs from our bottom-up colleagues, we concluded that while the base case is for ROE stabilisation if reflation is successful, there is also a bear case for ROE to fall further to around 7 percent over the medium term, which would be less than half the level of India.
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Finally, within the two markets, we are overweight India Financials, Consumer Discretionary, and Industrials. These are sectors that typically do best in a strong underlying growth environment. They are the same sectors on which we are cautious in China. There, our focus is on A shares rather than large-cap index names. We like niche technology hardware and clean energy plays, which benefit from China's policy objectives.
(Jonathan Garner is Chief Asia EM Equity Strategist at Morgan Stanley)
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