Decoding the world’s love-hate relationship with China

Bond Yields

The ‘great escape theory’ of coronavirus, which was brushed aside last year, has been gathering momentum in the western hemisphere nowadays. As the stance has now shifted from ‘remote’ to ‘feasible’, a new controversy seems to be knocking on the doors of the global economy.

Will it exacerbate the trade conflict situation?

Unlikely, at least for now.

China plus one is one of the most popular themes amongst investors in India of late. It is based on the assumption that as the major economies diversify their supply chains away from China, India may become their preferred destination.

Well, the recent data shows encouraging signs but it’s too early to celebrate.

India’s performance on the FDI front has been the best ever in FY21 as the country attracted the inflows of USD 82 billion.

 But comparisons often reveal the true picture.   

According to Reuter’s data, China became the world’s largest FDI magnet, attracting USD 163 billion in 2020 and it even surpassed the US, which drew in FDI inflows of USD 134 billion. Notably, the global FDI flows of 859 billion in 2020 were the lowest in the last one decade. In other words, half the global FDI inflows went to three countries.

Do financial investors like China more?

Going purely by the net inflows of global Exchange Traded Funds (ETFs), China has been a favourite destination of global investors historically, as compared to India. However, this phenomenon has become even more pronounced over the last few months. Global investors have given a cold shoulder to India but have increased their bets substantially on China.

Are investors more bullish on China than on India?

Inflation

Data as on May 31, 2021
(Source: Bloomberg)

If you thought the second-wave of COVID-19 is to be blamed for India’s recent underperformance, you might be perhaps missing the bigger picture. During the last 5 years, China has recorded 40 instances of positive net inflows by global ETFs. In comparison, India has recorded net positive inflows by offshore ETFs only in 24 months.

Let’s consider some more data.

China’s industrial inflation, measured by the movement of the Producer Price Index (PPI), jumped 6.8% in April but the retail inflation remained low at 0.9%.

Besides corporate profits, rising industrial inflation in China affects countries largely depending on Chinese exports. China has already hinted at taking stern action against commodity hoarders in an attempt to curb industrial inflation.

In contrast, retail inflation in the US quickened 4.2% on a Y-o-Y basis in April. This was the highest monthly increase since September 2008. Although the low base effect is one of the most crucial factors behind this rise, energy, auto and shelter prices have witnessed inflationary pressures.

Is inflation hurting the US more?

Treasuries

(Source: World Bank, *OECD estimates)

OECD Economic Outlook, May 2021 edition, suggests that the impact of rising inflation on consumer prices is likely to affect an average American more than a Chinese citizen. Since the US believes the inflationary pressure has been transient in nature, any immediate change in the monetary and fiscal policy stance is unlikely.

On this backdrop, the yield spreads between the US’ 10-year treasury and China’s 10-year bond might appear strikingly appealing to global investors.   

Yield spreads: US 10-year treasury vs. 10-year Chinese bond

Bond Yields

Bond yields in %
Data as on June 01, 2021
(Source: Bloomberg)

Where does India stand at this juncture?

RBI expects retail inflation in India to be around 5% in FY22 and India’s 10-year bond offers a yield of ~6% at present. Not so surprisingly then that RBI has paid Rs 642.95 crore to primary dealers as underwriting commissions in 2020-21 as against Rs 60.9 crore in 2019-20.

It’s a no brainer to guess which country may look attractive on the basis of inflation-adjusted returns.

Interestingly, US household savings as a percentage of disposable income are expected to be 16.4% in 2021 and 10.2% in 2022. In 2019 (i.e. during pre-pandemic times) the savings ratio was just 7.5%.

Assuming that the interest rates stay low in the US and inflationary pressures keep mounting, investors might look to diversify their portfolios across other markets. In that case, Asia, particularly China, might look attractive to them.

If India accelerates growth and contains inflation, global investors might make a beeline for Indian markets again.  Until then it remains crucial to see where the Indian markets draw their support from.

You see, everything boils down this: how quickly can India vaccinate its large population and resume economic recovery efforts.  

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Disclaimer: The blog is for information purposes only. Asset allocation is an extremely important decision. We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances.

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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