Some financial commentators are advising that investors forget about China this year and put their money into India. But while it is true that both countries demonstrate some considerable similarities in the way their economies are being (successfully) run, there remain a number of key differences that set them apart; and indeed further research suggests that China will continue to outpace its major rival for the time being – albeit perhaps not for long.

CHINA TODAY

As a result of decades of deft economic reform and management, China has emerged as an economic and political powerhouse. No longer insular, and with a burgeoning manufacturing capacity, it is currently the world’s largest exporter. Not even the United States can ignore China, which now owns around $800bn worth of US Treasury bonds and is the US’ second-biggest trading partner. Both countries are inextricably linked, and although they have their disagreements, such as over US President Barack Obama’s planned forthcoming visit to the Dalai Lama, it is not in their mutual interest to rock the boat too much.

Since coming into effect at the end of 2008, the Chinese government’s two-year stimulus package appears to have helped shore up the domestic economy against global recession. The News reports that China’s exports rose by 17.7 per cent in December 2009, whereas in previous months they had been very much in decline. At the same time, however, the government has had to take preventative action to stabilise growth: in January this year China’s central bank raised the proportion of reserves that the country’s commercial banks are required to set aside, in an attempt to curtail aggressive lending practices that risk creating asset bubbles; similarly, some banks were ordered to rein in lending after they failed to meet certain capital requirements.

This tightening of money supply has had a direct and negative impact on China’s commodity markets. Chinese stocks have dropped to a four-month low, reflecting fears that the government will take further action to slow down the pace of economic growth. (This would stem the tide of overcapacity in industries such as steel.) As the Chinese government is unlikely to want to devalue the yuan, an interest rate increase could be on the horizon. But financial markets worry whether this would be a step too far, reversing rather than stabilising China’s economy. The Chinese government, therefore, has to achieve a fine balance.

ENTER THE TIGER

‘China’s proposition is vastly different from India’s own one,’ says Vikas Pota, author of India Inc: How India’s Top Ten Entrepreneurs are Winning Globally. India, he explains, has a completely different appeal to investors, offering more of a long-term approach that doesn’t rely on short-term commercial gains. In addition, the country has the advantage of ‘an established legal system and free and critical press.’

India’s inefficient bureaucracy and widespread corruption, however, have often put the brakes on its market reforms. In India, as opposed to China, things tend to occur at a much slower pace than many would like them to. And while both countries need to improve their transport infrastructures, India’s roads are said to be in a far worse state than China’s, with an inordinate number of unpaved and/or narrow roads continuing to hinder the internal transportation of goods.

‘Everyone recognises the need to develop better roads, seaports and airports in India,’ explains Potas, but achieving this goal requires greater involvement from international investors, who meanwhile argue that India will never ‘make it’ without resolving its market access issues. In other words, it is incumbent upon India’s government to implement a policy framework that is more attractive to investment. Nonetheless, despite these unresolved issues, India is perceived as a top investment destination – a rising star among the emerging markets (and an easier political bedfellow for Western democracies).

CAN INDIA CATCH UP?

China looks set to outpace India for the time-being, but most commentators think that India can catch up. The Indian government has behaved relatively conservatively, believing that a steadier growth pattern will ensure India’s victory in the long-run. Global investment bank Goldman Sachs estimates government spending in India at about 3 per cent of GDP this fiscal year, compared with 6 per cent in China.

In his Time magazine article, ‘India vs. China: Whose economy is better?’, Michael Schuman suggested that India has achieved substantial growth without putting its banking sector at risk. The word ‘conservative’ also applies to India’s banks, especially when compared to their Chinese counterparts. India’s credit growth in 2009 was much lower than it was in 2008. Economists are therefore confident about the comparative strength of Indian banks. Analysts are confident too – they are content with India’s monetary policies, and the likelihood of India’s real estate prices inflating into a precarious bubble (like the one now facing China) is small.

Robert O’Reilly, Vice-President of Wealth Management at LPL Financial, is even more optimistic. He seems to suggest that there will be temporary juxtaposition between the two countries during 2010, during which time he believes India will emerge as ‘the new economic torch bearer for growth within the region.’

O’Reilly argues that China lacks a recipe for sustainable growth, but his view doesn’t quite tally with World Bank forecasts, which predict that India’s economy will grow by 7.6 per cent in 2010 and by 8 per cent in 2011. Meanwhile China’s growth is expected to hover around 9 per cent during this period – still in the lead. A gap remains between these two economies, to be sure, but it is hard to tell just how big that gap is.

China’s rising political and economic power has made it ‘a key factor in the way it has helped to sustain growth and competitiveness of industry across the world,’ says Professor Merlin Stone, who teaches economics at the UK’s Open University. However, due to China’s need to restrain growth by tightening money supply, India is now seen as a market where there is comparatively greater future growth potential. There is, after all, no current threat of its economy overheating, and growth is likely to be financed both internally and via the foreign direct investment route.

The future certainly looks bright for India, and many think it could overtake China by 2020. This year alone, the country is looking forward to a political mandate for economic reform (following last year’s election results), forecasted strong consumer spending, solid industrial production and excellent performance on the Bombay stock exchange – all which makes India a viable investment alternative to China. It seems unlikely that the two countries will trade places in 2010, but the gap separating them could be closing faster than many of us imagine.