Exciting and differentiated opportunities lie ahead for Asia’s two economic giants, China and India. In the decade ahead, China will push further into hi-tech sectors as it seeks to develop indigenous innovation and technology industries. India is set to capitalize on its demographic dividends and improving geopolitical relations with the US to build up its fledging manufacturing industry.
China’s dynamic transition into the future
In five years, China’s transition from the world’s factory to a tech powerhouse should be more or less complete. In the years ahead, China will likely keep pouring more capital into its strategic industries in an effort to reduce its reliance on developed markets. And as a result, R&D spending will continue rising; as a percentage of GDP, R&D spending in China climbed to 2.1% in 2017, narrowing its gap with the US and Japan. The government’s ambition to become a global innovation leader has taken on more urgency in light of the spat with the US, especially after it added a group of 5G-related and facial recognition Chinese names into its “entity list.” Snow-balling momentum will likely produce more homegrown unicorns and technological breakthroughs.
Another important change that will likely play out is the splintering of supply chains – the US on one side, and China on the other. The current global supply chain is structured based on comparative advantages across markets. Apple, for example, designs and produces the iPhone’s core parts in the US and manufactures and assembles the devices worldwide. But potentially unresolvable differences in trade may crater this setup, forcing manufacturers to choose one or the other depending on their needs. Leveraging China’s would benefit from a large and skilled labor force, superior infrastructure and advanced industrialization, while the US’s would boast of more advanced core high technology and innovation output. The changes will bring both opportunities and challenges to all parties involved.
Finally, Beijing’s gradual opening up will likely continue and may accelerate in the coming years. In the past few months, for instance, China has committed to fully removing foreign ownership limits by 2020 for nearly the entire financial sector, QFII and RQFII quotas were lifted in September, and MSCI announced the A-share inclusion weighting will be raised. Foreign investment in the onshore market is therefore set to increase, which could help inflate asset prices.
China plans to open up the manufacturing, telecommunications, healthcare and education sectors; shorten the negative list; improve intellectual property protection; and establish more free trade zones. The central bank also recently con-firmed that it is almost ready to launch the world’s first national digital currency, which by design would reduce the dependence of the trading process on accounts and should help the circulation and internationalization of the renminbi. These trends should ensure continued investment prospects in China despite its slowing economy.
India in the starting blocks to run a marathon
India hasn’t filled China’s shoes as the world’s manufacturing hub and growth engine as many expected, but it should narrow the gap over the next five years. The ruling BJP’s majority in many states gives it strong execution power to push forward key economic reforms, from cleaning up banks to loosening labor market restrictions. A major focus is expanding the country’s manufacturing sector to 25% of GDP by 2022 (from 16% now), and creating more favorable business conditions. Following the recent corporate tax cut to China’s level, more pro-business policies are likely in the years ahead.
Indian labor costs are stagnant while China’s are soaring
India and China manufacturing wages in USD p.a.
India also stands to gain market share from the decoupling of supply chains between China and the US as well as China’s value chain ascent. Indian exports to the US rose sharply after tariffs were implemented. Samsung’s move to establish the world’s largest mobile phone factory in India also bodes well. But at a mere 0.8% R&D spending relative to GDP, India is unlikely to rule higher-end manufacturing in the years to come – but it should be able to raise this number. Instead, India offers much lower manufacturing wages than China (average wages are just 15% of China’s) and a vast domestic consumer market.
Assuming an average GDP growth rate of 5.75% for China and 7.25% for India, in the next decade, China would remain the dominant economy in the region. But banks and manufacturers (e.g., of vehicles and generics) in India are well positioned to ride this growth wave, in our view.
Kathy Li, CFA, Analyst, UBS AG
Hartmut Issel, Analyst, UBS AG