India overtakes China as top EM market, but China's achievements noteworthy

According to Morgan Stanley, India crossed China to become the largest market in the emerging markets (EM) universe at the end of August. This is based on India’s weight in the MSCI All Countries World IMI (investible large, mid and small cap) index. This will soon be reflected in the MSCI Emerging Market indices as well.

The MSCI All Countries World index is the primary measure of global stock market performance. Today, India ranks as the fifth-largest market in this global index, tied with France, with a weight of 2.35 per cent. The US has the highest weighting at nearly 65 per cent, followed by Japan, the UK and Canada. Given India’s relative performance, it is not unrealistic to expect it to soon be among the top four markets. This effectively implies that even for global investors, India is no longer irrelevant. If it becomes a top four market, investors cannot just ignore it.  This is where the incremental foreign money into India will come from.

The EM asset class is facing challenges, with its very construct being questioned now. EM investors are not dramatically underweight. Where the underweights are more severe is for global investors. How many global investors have serious money in India? While flows may not pick up till we see a correction, the eventual quantum of foreign portfolio investment (FPI) into India will exceed anything we have seen so far, given the broader universe of investors who will need to engage.

The relative performance of India and China has been remarkable. As recently as September 2020, China had a weight of 5 per cent in the same index and India was stuck at just 1 per cent. The real breakout of India has happened since 2021. If you look at a relative chart of MSCI India versus MSCI China (in US$), starting from 2011, their performance went through cycles but was very much in line till mid-2021, after which India broke out. The ratio between India/China has moved from 1 to 2.7, from mid-2021 to the present. I still remember the days when India had a lower weight than Thailand and Malaysia. How times have changed!

While it is easy and fashionable to dismiss China today, one should not lose sight of the country’s accomplishments. It is true that China is going through a balance sheet recession, with a property market bust and weak consumer confidence. The country will have to deleverage, and growth will slow. Consumption has slowed and many are predicting a “Japanification” of the country, implying it will take decades to fully recover.  The country is really struggling with demographics and the geopolitics could not be worse.

However, we must acknowledge the progress China has made in gaining leadership in higher value-added industries and becoming self-reliant in key technologies. The Made in China 2025 policy, which aimed at global leadership, self-reliance, and dominance in critical technologies, has largely played out successfully. There is much for India to learn from China. Their progress in creating global scale and industry-leading companies across sunrise sectors is worth understanding.

Artificial intelligence (AI) and the energy transition are two of the biggest structural themes over the coming decades, which will fundamentally reshape economies and business. Trillions of dollars will be invested. The US leads in AI, with China a close second, despite the constraints imposed by the US. However, in energy transition, China is dominant, with leadership across renewables, nuclear, electric vehicles and lithium batteries. China’s leadership in renewables is well-known — they were early movers, have the largest installed capacity, and control 50-70 per cent of the renewable supply chain. Many countries, including India, are trying to reduce dependence on China for renewables.

What China has achieved in battery energy storage technology, particularly in lithium batteries, is both impressive and scary. Today, China has 80 per cent global market share, and has five times the production capacity of the rest of the world combined. One Chinese company, CATL, commands 36 per cent of the global market, making it larger than the rest of the world combined.

Chinese batteries are about 40 per cent cheaper than those produced in the West, and the country is a leader in the technology. Lithium iron phosphate (LFP) chemistry batteries have been entirely commercialised by China. Initially dismissed as inferior by Korean and Japanese manufacturers, LFP batteries are now considered the most cost-efficient and safest technology. CATL and other companies are leading the world in improving the energy density and charging time of batteries. CATL spends more on battery research than the Japanese and Korean companies combined. CATL’s capital costs for setting up new plants are 50 per cent lower than those of its competitors.

China also controls the supply chain, with direct and indirect control of over 50 per cent of the mined metals needed for EV batteries and over 80 per cent of the market share in refined intermediates and battery components. In battery chemicals, China has over 90 per cent of the global market. Chinese companies are setting up plants across the world, and have taken market leadership even in the EU.

China has smartly used incentives and policy measures to encourage the shift towards EVs. Today, it is the largest market for EVs, with a sales penetration of 50 per cent, and this figure is likely to exceed 80 per cent by 2030. In comparison, the US currently stands at 10 per cent penetration, while the EU is at 25 per cent.

The Chinese auto industry has used this transition to EVs to gain share from foreign brands. From almost nothing when internal combustion engines were the standard, Chinese auto companies today have over 50 per cent of the domestic market and export over 5.5 million passenger vehicles globally, of which 1.5 million are electric. BYD is challenging Tesla for global leadership and there are numerous credible domestic EV pure plays. Chinese EVs are not only cheaper, but also offer better technology and specifications. Starting from a clean slate, these vehicles have superior software and simpler platform architectures, and they have managed to reduce model cycle times to just three-four years.

The Chinese auto industry has leapfrogged Western incumbents, which had a 100-year head start in internal combustion engines and power trains.  As autos move to electric, there is no reason why multiple Chinese companies will not be in the top 10 list.

What China has managed to accomplish in certain new industries is incredible. The playbook is similar: China first quickly adopts new technologies and becomes the largest market, using industrial policy and subsidies to ensure global scale for local players with technology leadership. Subsequently, it uses capital to scale up massively and control the supply chain. Their execution has been breathtaking.

China is creating emerging industry leaders, and regardless of what happens in the Chinese stock market, the country cannot be ignored as a fierce competitor. The rest of the world will have to figure out how to handle this playbook of dominance China is employing across industries. It will have to be some combination of trade restrictions and industrial policy to give our domestic industry the time and scale to compete. We in India must also aspire for global leadership in our chosen sectors. China’s achievement, especially in EVs and lithium batteries, is worth studying.

The writer is with Amansa Capital