India vs China 2026: The Great Decoupling of Emerging Market Giants

In 2020, India and China’s equity markets were valued within 10 percent of each other. Five years later, they have diverged so dramatically that they no longer share the same investment thesis. India’s total equity market capitalisation has reached $4.8 trillion, surpassing Hong Kong and challenging Japan for third place globally. China’s A-share market, despite a rally from its January 2024 lows, remains 22 percent below its February 2021 peak.

This divergence is not merely cyclical — it reflects fundamental differences in governance, demographics, capital account policy, and the willingness of foreign investors to underwrite growth. Understanding these structural drivers is essential for any portfolio allocating to emerging markets in 2026.

India’s market rally rests on three pillars. First, demographics: India’s working-age population of 950 million people is growing at 1 percent annually, while China’s is shrinking. This provides a domestic consumption engine that few economies can match. Indian consumer staples companies like Hindustan Unilever and ITC are growing revenue at 12-15 percent annually, far outpacing global peers.

Second, domestic institutional flows have transformed the market’s structural underpinning. Systematic Investment Plans (SIPs) through Indian mutual funds now attract $3.2 billion per month, creating a steady bid for equities that is independent of foreign portfolio flows. In 2025, domestic institutions absorbed $18 billion of foreign selling without the Nifty 50 falling more than 8 percent from its peak.

Third, India’s manufacturing sector is finally scaling. The Production-Linked Incentive (PLI) scheme has attracted $42 billion in committed FDI, with Apple now assembling 25 percent of global iPhones in India (up from 7% in 2023). Tata Electronics’ $10 billion semiconductor fab in Gujarat will begin production in 2027, reducing India’s chip import dependency.

China’s market malaise extends beyond property sector distress. The core issue is a crisis of confidence in private enterprise. Regulatory crackdowns on technology (2021), education (2021), and gaming (2023) destroyed approximately $2 trillion in market capitalisation and convinced a generation of entrepreneurs that policy risk outweighs business risk.

Foreign investors have voted with their feet. Overseas holdings of Chinese equities fell from $900 billion in 2021 to $540 billion in 2026, a 40 percent decline that is unprecedented for a major economy. The MSCI China index has underperformed MSCI India by 74 percentage points over five years.

Demographics compound the problem. China’s population is now shrinking, with births falling to 9 million in 2025 (down from 17.9 million in 2016). The dependency ratio is rising, consumer confidence is at record lows, and household savings rates have increased to 38 percent as citizens prioritise precautionary saving over consumption. This deflationary mindset echoes Japan’s experience after 1990.

Global asset allocators are executing a generational rebalancing. In 2020, the average emerging market fund had 38 percent in China and 8 percent in India. In 2026, those weights have converged to approximately 22 percent in China and 20 percent in India. Several major funds, including Norway’s Government Pension Fund (NBIM), have moved India to their single largest EM overweight.

This shift is self-reinforcing. As allocators sell China and buy India, Chinese equity valuations compress further (CSI 300 at 11x forward P/E vs historical 13x), while Indian valuations stretch (Nifty 50 at 21x vs historical 18x). The valuation gap creates a temporary contrarian argument for China, but structural investors note that cheap can always get cheaper when capital is structurally exiting.

The ETF market reflects this rotation. Flows into India-focused ETFs (INDA, EPI, INDY) totalled $8.2 billion in 2025, while China-focused ETFs (FXI, KWEB, MCHI) experienced $5.1 billion in outflows. This is the third consecutive year of net negative China ETF flows.

Three scenarios could narrow the India-China gap. First, a Chinese stimulus package equivalent to 5+ percent of GDP, targeting consumption rather than infrastructure, could trigger a violent short-covering rally. China’s 2024 stimulus attempts focused on local government debt restructuring rather than consumer transfers, which is why they failed to sustain equity momentum.

Second, Indian valuations could correct if the RBI raises rates in response to food inflation or if the BJP loses its parliamentary majority in upcoming state elections. A 15-20 percent Nifty correction would bring India back to historical average valuations and reduce the relative attractiveness gap.

Third, geopolitical realignment could shift capital flows. If US-China trade tensions de-escalate meaningfully (unlikely in 2026 given the tariff regime), some supply-chain diversification away from China would slow, reducing the urgency of ‘China +1’ strategies that have benefited India.

In the base case, however, the divergence continues. India’s structural advantages — demographics, governance credibility, domestic capital formation — are durable, while China’s challenges — demographics, deflation, policy uncertainty — are structural rather than cyclical. Portfolio construction should reflect this asymmetry.