India set to close in on China as emerging-market stock anchor

India is poised to narrow the gap with China in MSCI Inc.’s gauge for developing nations.

Analysts from firms including Smartkarma and IIFL Securities Ltd. expect India’s weight in the MSCI Emerging Markets Index to rise by at least one percentage point following the index provider’s review this week. This would bring the country almost on par with China, which currently accounts for 22.33 per cent of the benchmark. India lags at 19.99 per cent.

A higher weighting for India will position it to become the new anchor for emerging market equities, likely driving increased flows into the country. Fund managers say that India’s rising heft may make the EM gauge more appealing to global investors who have been wary due to China’s sway over the index. 

“It can make the EM index more balanced, where secular growth stories like India receive higher allocation” compared with more cyclical markets like China and Korea, said Vivek Dhawan, portfolio manager at Candriam Belgian NV. 

This shift has a side effect: index followers may be forced to allocate funds to India’s already-expensive stocks at a time when crowded trades are taking a hit due to the turmoil in global markets.  

India — long touted as the “next China” — has emerged as a favorite among investors, driven by its robust economic growth, a growing middle class and burgeoning manufacturing sector. Meanwhile, China is dealing with long-term economic challenges and increasingly strained relations with the West.

“Many global investors who didn’t look at India as a standalone allocation in the past would now look at it more favorably,” said Hiren Dasani, co-head of Emerging Markets Equity and lead portfolio manager of India Equity strategies at Goldman Sachs Asset Management. 

China’s standing in emerging markets has shrunk in the past few years, while India’s has steadily expanded. At its peak in 2020, China accounted for 40 per cent of the MSCI EM Index, but that weighting has dropped amid Beijing’s regulatory crackdowns and efforts to deleverage its indebted property sector.

As of end of July, India’s weight was just 2.34 percentage points away from China’s in the MSCI Asia Pacific Index, a regional benchmark, a recurring pattern across most gauges from major index providers. MSCI didn’t respond to an email seeking comment outside of regular business hours.

“With a rising equity market, increase in free float for companies and new large listings in India, the gap in the weightings should continue to narrow heading into year-end,” said Brian Freitas, an analyst at Smartkarma.

Meanwhile, Taiwan is competing fiercely with India in the race to replace China’s top spot in emerging market equity portfolios. As of the end of July, Taiwan accounted for 18.39 per cent of MSCI’s EM index. 

While India has benefited from the infrastructure boom brought about by Prime Minister Narendra Modi’s modernization projects, Taiwan’s rise has been supported by global interest in artificial intelligence chipmakers. It’s home to the world’s largest contract chipmaker Taiwan Semiconductor Manufacturing Co. 

In its review, MSCI is likely to add six stocks to its key India index, including Samsung Electronics Co. supplier Dixon Technologies (India) Ltd. and property developer Oberoi Realty Ltd., according to Abhilash Pagaria, head of alternative and quantitative analysis at Nuvama Wealth Management Ltd. HDFC Bank Ltd., India’s largest by market value, may also see a gradual increase in its weighting, he wrote.

While Chinese stocks have struggled, the NSE Nifty 50 Index has risen 12 per cent this year, following Modi’s third consecutive term in the office. The benchmark gauge is set for a ninth straight year of annual gains.

The contrasting trajectories highlights investors’ preference for India even as China’s equities remain very cheap. It also underscores Beijing’s inability to stem the downtrend in its markets.

“We do look at India as a bit of a diversifier against some of China’s weakness,” said Seema Shah, chief global strategist at Principal Asset Management. “A lot of the potential that people have been speaking about for years and years is now looking to be fulfilled.”