At first glance, the global financial landscape is undergoing a significant shift, with FIIs increasingly diluting their share in Indian stocks and turning their attention towards the Chinese market. This trend, often referred to as the ‘Buy China – Sell India’ trade, is not a distant possibility for FIIs. The primary reason behind this shift is the perceived greener pastures in the Chinese stock market compared to the frothy valuations of Indian markets.

Over the last two weeks, Shanghai’s stock market has rallied close to 30% from its September lows, following the Chinese government’s all-out effort to revive economic growth. This is a stark contrast to the situation a few weeks back when multinational firms were pulling out money from China at a record pace, and global economists were trimming their forecasts for China’s economic growth.

However, the ground realities of the Chinese economy have not changed. The country’s real problems range from half-built houses to bad debts. The government is widely believed to be forging data and suppressing sensitive economic facts. Over the past few years, China’s monetary stimuli have become political rather than economic decisions.

China’s Economic Challenges and Investor Capital

This has led to a growing mistrust of information about China, making the allocation of capital in the country very difficult. China’s workforce is shrinking, and manufacturing productivity is dwindling. The country needs to pivot away from cheap credit and construction to more innovative industries. That is why investor capital is pouring into electric vehicles, semiconductors, and AI-led technologies. Yet, if the investments are based on the sustainability of the economic boom, there could be more shocks in the offing.

China’s real estate bust has left behind tens of millions of empty housing units. The historic glut of unoccupied property is colliding with China’s shrinking population, leaving cities stuck with homes they might never be able to fill. The country could have as many as 90 million empty housing units, enough homes for the entire population of Brazil.

Another measure of the unbalanced state of China’s economy is the size of the credit market bubble. According to Harvard professor Kenneth Rogoff, housing now constitutes a third of the Chinese economy and exposes it to massive risks. Chinese private sector credit has increased by around 100% of its GDP in the past decade.

The Future of China’s Economy and Global Impact

That rate of credit expansion is larger than that which preceded Japan’s lost economic decade in the 1990s and the 2008 US housing and subprime credit market bust. Yet another measure of the unbalanced state of the Chinese economy is the quantum of state-funded investment.

This accounts for as much as 42% of China’s GDP, approximately double the rate of the advanced economies. China now has a major problem of excess manufacturing capacity. With domestic household demand unable to fully absorb its manufacturing output, China has become dependent on foreign markets to take up its manufacturing surplus.

Without curtailing excess debt and investments, China could experience a Japanese-style lost economic decade. And that could have major consequences for the world economy given that China is the world’s second-largest. Moreover, it continues to remain the largest consumer of international commodities.

So, FIIs have a lot to ponder over before taking the ‘Buy China – Sell India’ trade too seriously. Nevertheless, such a strategy could work well in the near term as valuations of Indian stocks seem frothy. A deeper correction in Indian stock markets could be possible only if the money that FIIs pull out is higher than that which domestic investors pump in.