Japan and India: Two themes capturing foreign investor interest

The Asian economies that saw the most inflows from foreign investors are at opposite ends of the development spectrum.

Several weeks into the final quarter of 2024 and Asian investors are starting to reflect on a year in markets that looks far away from the lofty expectations they might have had back in January.

Investors hoped that the rapid lifting of China’s zero-COVID policy would unleash animal spirits across the domestic economy, potentially driving a rally in global growth as revenge spending and investing would lift risk assets across stocks, real estate and even commodities.

But these hopes were quickly dashed as consumer spending flatlined and the property market continued to contract.  

The latest GDP figures for China show a Q3 growth rate of 4.9%, certainly an improvement from the near-deflationary conditions seen over the summer. Investors both domestically and globally remain on edge over China’s economic recovery.

As the investing spotlight has been drawn away from China global investors have turned to alternative Asian growth stories, and the two investing theses could not be more different.

According to Bloomberg data, the Asia equity markets with the highest foreign portfolio investment flows this year have been Japan (at US$29.2bn in net flows as of Oct 13) and India (US$14bn as of Oct 17). Figures for China haven’t been updated since June 30 when it marked US$6.8bn in net foreign flows.

Investor interest in Japan equities has been relatively consistent throughout this year as the investment case has solidified - with big markets like the US and Europe facing economic uncertainty and potential recession, newly opened Japan was seeing consumer spending accelerate with a wave of tourist arrivals on the way. Inflation and wages have picked up this year, and there is excitement that longstanding productivity and capital efficiency concerns will be addressed through new listing rules at the Tokyo Stock Exchange.

Despite the demographic decline in Japan over the past few decades, the economy has been able to grow through efficiency and productivity gains, coupled with overseas investment and trade. Huge Japanese conglomerates are eyeing significant capital and infrastructure investment opportunities across Asia, including in China, Indonesia, India and Vietnam.

The Japanese yen remains incredibly weak again the USD and Japan government bond yields are still very low when compared to global peers.

Any material changes to Japan’s ultra-loose monetary policy aren’t expected until after the Spring time wage growth negotiations. A shift away from the current yield curve control (YCC) policy would lead to an appreciation in the currency, which could attract further interest from global investors.

Going forward, investors are looking for improved corporate earnings among Japanese corporates this quarter, especially from those with large global operations that will benefit from the weak yen.

Meanwhile, on the other side of Asia, India has captured investor interest for completely different reasons. As the country overtook China to become world’s most populous this year, optimism around the economy has surged, with many investors buying into the narrative that the nation will take the baton from China as the world’s fastest growing large economy in coming decades.

India’s opportunity to generate longer-term growth comes primarily from its attractive demographics. Although India’s total fertility rate has already dropped to 2.0 births per woman, below replacement rate, the current median age of 28 in India means that the country can expect to have double China’s population by the end of the century.¹

There are reasons to believe in the demographic dividend: a large and youthful population brings with it the potential for greater productivity and acceleration in economic growth.

Indeed, the rapid ascent of many East Asian economies coincided with a rapid rise in their working age populations. Japan, Singapore, and Hong Kong entered this phase in the 1960s and grew rapidly to become developed economies. China’s economic reforms along with favorable demographics in the 1980s set the stage for decades of unprecedented growth.

How sustainable are the Japan and India investment theses? Both face clear risks.

It’s impossible to ignore the many false dawns that Japanese equities have seen since the bursting of the asset bubble in 1991. The biggest risk to the current investment thesis is the end of YCC – the tweaks from earlier this year had limited effects on equities or the currency, so an orderly policy exit may indeed be possible although it would almost certainly take some steam out of the equity rally.

India’s major risk is that the demographic dividend morphs instead into a disaster. Although the country has high economic growth, it has thus far failed to create enough jobs with unemployment rate hovering around 7-8% and youth employment even substantially higher², partly because the main pillars of growth have been services sector industries.

There is also a skills mismatch, as only 5% of the country’s workforce is formally categorized as skilled.³ This will make it difficult to expand manufacturing’s share of Indian GDP, a stated policy goal of the government, from around 14% today to around 30% and comparable to China.⁴ India requires huge, consistent, and targeted investments into underdeveloped and overstretched infrastructure and human capital for decades to come.

Japan and India can certainly claim to be the investor darlings of 2023, but I think they have also benefited by the overwhelmingly negative sentiment around China this year. Global capital that might have in earlier years gone to China went instead this year to other Asian destinations which remain core drivers of global growth.

A defining theme of 2024 will be whether these markets can sustain this high level of investor interest even as sentiment turns positive again in China. If yes, then we could be looking at new stage of regional development. 

A version of this article appeared in South China Morning Post on October 24, 2023.