Are investors shifting from China to India?

The scale of operations and leverage of Chinese real estate giant Evergrande — 1,300 projects across 280 cities, 200,000 employees, debt amounting to $305 billion, money owed to over 170 banks — shocked financial markets in September, making many compare this crisis to the Lehman debacle. What is even more surprising is the Chinese government’s implicit nod to allow the real estate giant to sink.

While there was some turbulence in global financial markets on concerns about a contagion risk, it was short-lived. Holders of Evergrande’s offshore bonds seem resigned to write off a large part of the $20 billion owed to them with the company already defaulting on two interest payments over the last two weeks.

The Chinese government’s reluctance to bail out the real estate player seems to be part of a larger game plan. Not only is it trying to curb speculation and excessive leverage in the economy, it also seems to sending a signal to foreign investors to stay away from China. Data show that China has been among the largest recipients of FPI flows over the past year; which is partly responsible for pushing up asset prices there.

Foreign investors, disenchanted with the regulatory uncertainty in China, seem to be diverting funds to India, the other Asian economy with similar prospects. This is borne out by the surge in FPI as well as PE and VC flows into India in recent months.

China cooling its stock market

The Chinese stock market has been the worst performing in 2021, largely due to government actions. While the mainland stock market benchmark, Shanghai Composite Index, has been almost flat since the beginning of this year, Hang Seng, which captures movement in Chinese stocks listed on Hong Kong, is down over 12 per cent since January. This contrasts with the strong gains of over 25 per cent in the Sensex and more than 15 per cent in most US and European indices.

While the Chinese government’s displeasure over the inequity caused by the oversized gains in stock markets, excessive speculation and measures to cut output in various sectors to rebalance demand and supply kept investors on tenterhooks in the earlier months, the crackdown on the edtech sector and the consequent crash in edtech stocks caused a severe setback to sentiment towards Chinese stocks in July this year.

The Evergrande crisis and the Chinese government’s decision to not bail-out the company seems to be part of Beijing’s ongoing strategy to cool down stock prices in general.

Dissuading FPI flows

One way cool the overheated markets is by controlling foreign investment flows in to Chinese assets. Following the large stimulus funds pumped into the global economy by central banks after last March, global investment flows surged, which lifted most equity markets higher.

China seems to have been the preferred destination for these flows with net FPI flows of $238 billion into its equity market in the 12 months to June 30, 2021. With the Chinese economy recovering faster than other advanced economies from the pandemic last year, overseas investors made a beeline for Chinese equity as well as debt instruments. Indian stocks received $28 billion in the last 12 months while other Asian markets witnessed FPI outflows.

It’s the same trend in inflows into bonds as well, with Chinese bonds receiving inflows worth $233 billion over the last 12 months compared with inflows of $1.2 billion in to Indian bonds in the same period.

It was clearly a problem of plenty for Chinese authorities. The manner in which Evergrande has been repaying the dues of its domestic investors (it has repaid 10 per cent of the dues to its wealth management clients, who are largely domestic) and defaulting on its dues to overseas bond holders shows its scant regard towards future fund flows into the country or the impact of these events on FPI sentiment.

It also needs to be noted that numbers for FPI flows in to Chinese equities and bonds are available until June 2021 only. It is quite likely that there were outflows from Chinese markets after this period.

Impact on India

There will be no direct impact of the Evergrande debacle on India but the impact it has on the Chinese economy will impact all countries. The real estate sector in China accounts for over 25 per cent of GDP and the debt-fuelled growth in this sector has been boosting demand for all commodities including cement, steel, copper and aluminium. As the sector decelerates, global prices of all commodities are impacted.

With over 200,000 homes yet to be delivered by Evergrande, funds of thousands of home buyers are locked up.

Finally, the banks with exposure to Evergrande will see their capacity to lend shrink, causing a credit crunch. It is therefore not surprising that many brokerages are pegging down China’s growth rate for 2021 by at least one percentage point.

Slowdown in China can make India’s prospects look better in comparison and result in diversion of foreign portfolio, FDI as well as venture capital funds to India.

It can be seen that FPI flows into Indian equity as well as debt have reversed direction since August this year implying that the Chinese government’s action is already resulting in increased flows into India. Start-up funding by global PE and VC investors is also hitting record levels this year, and this too could be due to funds getting diverted from China.

The moot question is whether this is desirable. These inflows interfere with natural market corrections. The Indian market has been an out-performer since August while other global markets began declining due to fears about inflation. Valuations of listed stocks are already at record levels and this kind of inflows cause an unnatural situation. Unfortunately, there isn’t much that can be done at this juncture since the country needs FPI flows for external account stability; a catch-22 situation for regulators.