May 05, 2011

The India / China Contrast

Perhaps the most memorable experience of my trip to India was an early Sunday morning visit I made with my friend, the hedge fund manager Richard Chilton, and some of his team to a small village an hour and a half’s drive from Bangalore.  I had long wanted to get direct exposure to the rural poor in India.  The location was twelve kilometers off the main highway, and we went there to watch a meeting of a microfinance company with some of its clients.  Two groups of 45–50 women each sat on the ground in circles before a representative of the company.  Having taken off their shoes, they began with a chant about how they pledged to pay off their loans.  It was almost like a religious ceremony.  Each of the circles consisted of nine or ten subgroups of five, each of which had a leader who gave the company man cash representing their payment obligation.  Then several applications for new loans were made and the whole circle gave a voice vote approving the loan. 

The loans are a collective obligation and if someone cannot pay (which rarely happens) the subgroup disappoints the entire circle.  The typical loan is about $200 and its duration is 50 weeks.  Only women participate in the program and the loss ratio is 2%.  The annual interest rate is 25%, which is controversial, but before microfinance companies came into existence, loan sharks were charging 36%–72%.  Administrative costs, insurance and other expenses leave a margin of 2%–3%.  Women borrow money to buy water buffalo for milk, chickens for eggs, materials to build a cart for daily rental, a sewing machine, seeds for planting, inventory for a food stand in front of a home and a variety of other needs.  The 95 women in the two circles were from the same village; they had little education.  They spoke a local dialect and you had the feeling that their lives were similar to those of previous generations, and future generations would make little progress.  After the session, which lasted about an hour, I walked along the town’s pathways with one of the leaders.  All of the houses had electricity.  Many had satellite dishes, few had refrigerators, none had locks on the doors, very few had running water, and none had toilets.  Perhaps the most startling fact about India is that 650 million people have no toilet in their home.  The shanty people go to communal toilets and the rural poor go into the fields. 

The visit was both inspiring and sobering.  It was heartening to see these disciplined, neatly dressed women trying to provide a living for their families, but the pervasive poverty and the lack of opportunity was saddening.  In a country of 1.2 billion people, half the population can live in poverty and there can still be a vibrant economy.  India’s middle class is larger than the entire population of the United States.  Still, only 10% of the population pay taxes and a relatively small percentage work at conventional jobs, many for the government.  This is a country of shopkeepers and small-time entrepreneurs, but there are a number of world-class companies, some of which I visited on this trip.  Nevertheless, the regulatory framework is cumbersome, there is corruption at many levels, and the government is slow to respond to the many challenges facing the country.  An example is that Wal-Mart has been prevented from operating there to protect the 15 million small retailers.  The United States, with one-fourth the population, has fewer than one million stores. 

The contrast with China is striking.  Because it has an authoritarian government, the country can deal with some of the problems it shares with India quickly and decisively.  Older, run-down housing and office structures have been torn down, and roads have been rerouted and rebuilt.  There are no visible homeless.  The emphasis on infrastructure and export-oriented industries has resulted in China representing close to 20% of United States imports while India only accounts for less than 2%.  While their GDP growth rates are similar, China leads India by other measures with per capita income four times higher.  Life expectancy at birth is 73.5 years in China; 64.4 years in India.  Infant mortality in India is three times that of China.  Maternal mortality in India is six times that of China.  Mean duration of schooling is 4.4 years in India; 7.5 years in China.  Adult literacy is 94% in China; 74% in India.  Half of India’s children are believed to be undernourished. 

One day we visited several retail establishments in various parts of Shenzhen.  The city has changed totally since it was established as a manufacturing center just 50 miles from the border of Hong Kong.  Today it is a modern metropolis of office and apartment blocks with wide, beautifully landscaped highways and carefully planned open spaces.  Everything is incredibly clean and orderly; there is no clutter.  In contrast to India there are relatively few street vendors or small shops.  We first visited a sleek Audi showroom.  There were twelve models on the floor, three of which were being manufactured in China.  They ranged in price from $40,000 to over $100,000 and the dealership expected to sell 2400 cars this year, up from 1700 last year.  A few years ago they were only selling 500 cars a year.  Their marketing has improved and the number of buyers has increased as the economy has grown.  The shoppers we saw there were mainly in their forties.  Most (70%) purchases were for cash.  Many buyers were entrepreneurs.

We then visited two large department stores.  These multi-floor enterprises are mainly real estate operations where most of the departments are leased.  The stores were as modern as Bloomingdale’s and the product selection included every western brand you could name.  The merchandise was high in quality, whereas years ago this was not the case.  The shoppers were informally dressed but decorous.  Everyone was polite:  no shouting or rowdy behavior.  The store operator ran only four departments: the supermarket, cosmetics, furniture and appliances.  All other departments were staffed by the brand represented with a percentage of sales going to the store.

The sprawling, orderly urbanization of Beijing continues to be impressive.  Mile after mile of recently constructed office and apartment buildings stretch along wide avenues lined with greenery.  The occasional pagodas and hutongs (old style, tile roof family dwellings) have been restored, so everything seems to attest to the progress the country has made since the Cultural Revolution ended in 1976.  I discussed the possibility of a housing bubble with almost everyone I met and nobody seems to think it is a serious issue.  Housing prices are still rising modestly (5%–6%) and homes and apartments are still being built, but more slowly than five years ago.  There is a need to replace substandard housing beyond the major cities.  After I returned someone sent me a video of several modern Chinese cities with empty apartment complexes and retail stores, so perhaps I didn’t get the whole story.

During the week before I left for Asia, I discussed the possibility of a real estate collapse in China and its impact on the economy with Jim Chanos, the eminent manager of the short-oriented hedge fund, Kynikos.  One point Jim made was that the implied residential real estate value in China was at a level in relation to Gross Domestic Product comparable to Japan and the United States before those markets broke.  My response to that is that a developing market like China whose total housing stock is deficient is in a different position than a more mature economy.  There is probably a problem at the high end of the market, but I don’t think this condition will bring the economy down.

Inflation was a more serious near-term problem but restrictive monetary and bank lending policies seem to have brought that under control, with consumer prices rising about 5%, half the rate at the peak.  Wage inflation is a worry at most of the companies I visited, with year-over-year increases of 10%–15%.  In spite of that China still has a significant labor cost advantage over most western industrialized countries. 

Perhaps the most significant difference between my meetings with companies this year and last was the view presented regarding opportunities in the Chinese domestic market.  In previous years much of the focus of manufacturers has been on exports, but consumerism at home is now dominating product planning and the marketing effort.  With 300 million middle class people throughout the country there is plenty of demand for goods that improve a family’s standard of living.  Many companies are projecting earnings growth of 25% or more.  Even some banks and utility companies believe they can grow at that rate for a while.

Both China and India are bifurcated societies.  With over a billion people in each country there are several hundred million in each place that are living lives that could be considered comparable to those of middle class people in the United States or Europe.  At the same time both countries have hundreds of millions of people living in rural poverty.  In the case of India there is considerable urban poverty as well.  While neither country provides retirement benefits, substantial health care or other social services to its people, there is a major difference between India and China in terms of economic development.  The authoritarian government in China is determined to provide job opportunities for an increasing number of people and is committed to developing the infrastructure that will create viable businesses across the country.  As a result there will be increased urbanization with more people moving out of the countryside to seek jobs in the cities.  This goal will be accomplished so long as overall growth continues in high single digits and inflation remains moderate.  The government has enormous power.  It has cleared substandard housing in the major cities and encouraged the construction of apartments and offices.  It has also provided the capital for state-owned enterprises to expand.  As a result the country is achieving its objectives.

Unfortunately India’s government lacks China’s flexibility and decisiveness.  India is much more dependent on the entrepreneurial skill, capital and innovative ability of the private sector to make progress.  China operates on a series of five-year plans designed to expand the Gross Domestic Product and create economic opportunity for its population.  India has an objective of improving its infrastructure, but the government lacks the authority to make rapid progress.  The result is that Indian cities seem afflicted with a kind of dusty constructive chaos.  Plenty of business is being done, but traffic can be brutal, garbage is everywhere and street begging is a depressing distraction.

In spite of its problems, India is expected to grow at a high-single-digit rate.  Software and call center companies do not require a modern infrastructure, and there are banks, steel, construction, real estate, transportation equipment and natural resource companies that are doing well.  Management skill is imperative because coping with the regulatory framework can be daunting.  There are many established companies that are run sleepily and an aggressive management can take advantage of that.  An ambitious group from ABN AMRO took over a troubled bank 17 years ago and through targeted marketing and effective use of technology has transformed it into a very profitable financial service company.

The major difference between China and India is in their respective approach to the future.  Fifteen years ago China was a relatively unimportant struggling economy.  Through effective central planning and execution it now accounts for over nine percent of the world Gross Domestic Product and has passed Japan as the second largest economy in the world.  And it isn’t stopping there.  China was the most important economy in the world during seventeen of the past twenty centuries and it has an objective of achieving that position again.  Today India accounts for less than three percent of the world Gross Domestic Product and lacks an effective central economic planning function.  Whereas China recognizes that its major challenge is to give its rural young the chance to escape the poverty of the agrarian past and is hoping to do this by providing manufacturing jobs rather than through entitlements, India’s government appears to be less activist in developing economic opportunities. 

Both countries have entrepreneurial cultures which are driving their economies.  The major difference is that China feels a responsibility to raise the standard of living of its disadvantaged; in India the rural poor are very much on their own.  That doesn’t mean that investors can’t make money in both places.  There are a number of companies that are showing impressive earnings growth.  Inflation, led by food prices, is a problem in both countries, but China is dealing with the problem aggressively, having raised interest rates four times.  Consumers see the problem daily at the grocery market.  India has not been as successful in coping with the recent rise in prices.  What this means is that China will continue to dazzle the world with its economic progress and its drive toward modernity.  India will move more slowly and the chaos of its cities and the poverty of more than half of its people are likely to endure.

On all of my trips to China I try to have a beer with a diverse group of locals.  I ask them about their backgrounds, aspirations and views of the future.  I try to probe into whether an authoritarian government limits creative thinking.  In one of these sessions I asked whether not being able to vote bothered anyone.  One response was, “What’s the big deal about voting?  In the U.S. everyone can do it and only half the people do.  If voting were that great a thing, like sex for example, everyone would do it.”  I did not have a response, but I believe the focus on economic opportunity dominates the thinking of the average Chinese and concern about intellectual freedom is less important.

Most Chinese believe that the order in their system is a strong positive.  In India many believe the chaos is what gives the country its character.  “India’s slums are not like today’s American slums.  They are places of hope, not hopelessness,” says author and former banker Sanjeev Sangal.  Partha Mukhopadhyay of the Centre for Policy Research, a New Delhi think tank, says, “If you strive for too much formality, if you try to clean things up too much, you might end up with cities that are dysfunctional in a different way.”

So there is the dilemma.  There may be no single right answer for both countries; it may be that order is right for China and chaos is right for India.  Right now what each has is working and neither condition is likely to change in the future.

Contact Information:

The Blackstone Group L.P.
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Byron Wien
The Blackstone Group
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New York, NY 10154
Tel: 212.583.5055