Two decades ago, investors bet that China would become the world’s largest growth nation. Global markets are undergoing a major shift, with investors pulling billions of dollars from China’s ailing economy.

Much of the cash is currently flowing to India, with Wall Street giants such as Goldman Sachs Group Inc. and Morgan Stanley endorsing the country as a major investment destination over the next decade.

This momentum is sparking a gold rush. Marshall Wace, the $62 billion hedge fund, has positioned India as the largest net long bet for its flagship hedge fund after the United States. Units of Zurich-based Vontobel Holding AG have built the country into the largest holding company in emerging markets, while Janus Henderson Group Plc is exploring fund house acquisitions. Even Japan’s traditionally conservative retail investors are embracing India and investing less in China.

Investors are closely watching the contrasting trajectories of Asia’s two powerhouses. India is the world’s fastest-growing major economy and under Prime Minister Narendra Modi has aggressively expanded infrastructure to lure global capital and supply chains away from Beijing. China, on the other hand, is grappling with long-term economic woes and a growing rift with the Western-led order.

“There are several reasons why people are interested in India – one of them is that it is not China,” said Vikas Pershad, Asia equities portfolio manager at M&G Investments in Singapore. “There’s a real long-term growth story here.”

While bullish sentiment about India is not new, investors are now more likely to see a market similar to China’s in the past: a large, dynamic economy that is opening up to global capital in novel ways. No one expects everything to be smooth sailing. The country’s population remains largely poor, its stock markets are expensive and its bond markets are isolated. But most people are crossing over anyway because they think shorting India is riskier.

History shows that India’s economic growth is closely tied to its stock market value. If the country continues to expand at a rate of 7%, the market size is expected to grow at least at this rate on average. Over the past two decades, GDP and market capitalization have increased simultaneously from US$500 billion to US$3.5 trillion.

Aniket Shah, global head of Jefferies Group LLC’s environmental, social and governance practice, said the latest investor call on India was one of the company’s most well-attended calls.

“People really want to figure out what’s going on in India,” he said.

follow the money

Reflects the enthusiasm for capital flow. In the U.S. exchange-traded fund market, major funds buying Indian stocks saw record inflows in the last quarter of 2023, while the four largest Chinese funds combined saw outflows of nearly $800 million. Since 2022, active bond funds have invested 50 cents in India for every dollar they have withdrawn from China, EPFR data shows.

In mid-January, India briefly surpassed Hong Kong to become the world’s fourth-largest stock market. For some investors, the South Asian country is only going higher. Morgan Stanley predicts that the Indian stock market will become the third largest stock market by 2030. Its weight in MSCI Inc.’s developing markets equity benchmark hit a record high of 18%, although China’s share shrank to its lowest level at a record high of 24.8%.

“In terms of index weighting, China will be lower and India will be larger,” said Mark Matthews, head of Asia research in Singapore at Bank Julius Baer, ​​which launched its first index last year. Indian fund. “This is the direction.”

new investors

Japanese retail investors, who have traditionally favored the United States, have also begun to favor the United States. Five of their India-focused mutual funds are currently among the top 20 for inflows. The largest asset – Nomura India Equity Fund – is at a four-year high.

Hedge funds including Marshall Weiss point to India’s strong growth and relative political stability as reasons to remain optimistic about continued growth, even if broad-market valuations remain expensive.

Karma Capital, which manages funds in India for institutions such as Norges Bank, said U.S. investors are particularly eager to enter and learn more about the market. Rajnish Girdhar, the fund’s chief executive, recalled one client who responded unusually quickly to several Indian questions.

“We would send something on Friday and she would respond before we got back on Monday morning, which meant she was working over the weekend,” he said.

old rival

India has taken advantage of changing power dynamics with its decades-old rival, China.

If China is seen as a threat to the Western global order, then India is seen as a potential counterweight – a country increasingly capable of asserting itself as a viable manufacturing alternative to Beijing. Countries such as the United States see the need to build strong commercial ties with India even as they criticize India’s tax policies. India currently accounts for more than 7% of global iPhone production and has invested trillions of rupees in upgrading infrastructure.

These efforts are part of Modi’s plan to turn India into the world’s new growth engine. Finance Minister Nirmala Sitharaman said in her interim budget speech last week that the government will increase infrastructure spending by 11% to 1.11 trillion rupees ($134 billion) in the next fiscal year.

“The investment cycle is accelerating with public capital spending and infrastructure initiatives,” said Jitania Kandhari, deputy chief investment officer for solutions and multi-asset at Morgan Stanley Investment Management.

India is also building a vast technology ecosystem aimed at attracting more people into the digital market. Alphabet Inc.’s Google Pay plans to expand the service beyond India by partnering with India’s mobile payments system, which generates billions of transactions every month.

“Hundreds of millions of Indians have bank accounts and access to credit for the first time,” said Ashish Chugh, money manager at Loomis Sayles & Co. “This is bound to attract multinational companies to India and work with them So do global investors.”

Perfect pricing

Some barriers do persist. This optimism has made Indian stocks among the most expensive in the world. The popular S&P BSE Sensex has almost tripled from its March 2020 lows, while earnings have only about doubled. The index trades at more than 20 times future earnings, which is 27% higher than its average between 2010 and 2020.

High valuations and recent attempts by the Chinese government to support the market have some investors considering a change of strategy. Global funds withdrew more than $3.1 billion from local stocks in January, the largest monthly total in a year, data compiled by Bloomberg showed.

“Indian markets have priced in huge success,” said Mark Williams, a fund manager at Somerset Capital Management. “But the question is how much of this is not priced in. There is definitely a risk of the Indian market going sideways over the next few years.”

Investors are bracing for a pullback after eight straight years of annual gains for local stocks. Modi is expected to win a third term in this year’s national elections, especially after his party’s sweep in recent state polls suggested current policies will continue. But a weakening of the ruling party could jolt markets in the short term.

“Judging by the state election results, we should have continuity in government. But you never say never,” said Peeyush Mittal, portfolio manager at Matthews International Capital Management LLC.

Critics say Modi’s social agenda benefits the country’s Hindu majority but also threatens the stability of a country home to more than 200 million religious minorities. Translating India’s potential into economic reality that benefits all citizens is a difficult task, especially in a multilingual democracy where there are huge cultural differences between countries.

“India still has a long way to go. Potential peak growth is still lower than what China has achieved,” said Charles Robertson, head of macro strategy at FIM Partners Ltd.

overall view

Despite these risks, Indian fans say their investment is for the long term. They say the country is laying the foundation for years of expansion and new market opportunities as per capita income remains low.

“The potential for scandal, social polarization and political noise is always there,” said Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management. “Still, if you believe in the future The economy will grow to about $8 trillion-plus by this time in the decade, so the volatility will be worth it.”

India’s once insular financial markets will remain open. With foreign ownership at just over 2%, the country’s $1.2 trillion sovereign bond market will be included in JPMorgan’s global debt index from June. The move could attract as much as $100 billion in inflows in the coming years, according to HSBC Asset Management.

India is also increasing its efforts to globalize the rupee, albeit on a smaller scale than China’s yuan expansion. Nonetheless, combined with the government-developed GIFT City, the potential remains. GIFT City is a free market pilot project in western India that aims to become a global financial hub unencumbered by rules and taxes. This prospect echoes what happened when Shenzhen opened its special economic zone in 1980.

Gaurav Narain, a fund manager who advises the India Capital Growth Fund, said confidence in India stems from the long-term impact of such moves and not necessarily from the near-term outlook for the country’s stocks and bonds.

“We no longer need to ‘sell the Indian story’,” he said. “This is a ‘buy’ into India from people who understand the positive changes in India.”