With economic growth slowing in both China and India and policymakers facing increasing challenges, analysts tell CNBC that investors should look beyond these two countries for profitable returns in 2012.

As these two economic powerhouses begin to lose some of their competitive edge, experts recommend the economies of Southeast Asia, which have seen a surge in foreign investment and rising incomes in the past few years.

"China is becoming an increasingly expensive place to produce and India is a regulatory quagmire," Amar Gill, Head of Thematic Research, CLSA, told CNBC. On the other hand, Gill says countries from the Association of South East Asian Nations (ASEAN) are in a "sweet spot."

"Foreign direct investment (FDI) into ASEAN has tripled in the last three years. This is a region which is gradually integrating, where the buying power of consumers is rising and it is attractive to manufacture and (to build) production bases here," Gill said.

On the other hand there are growing worries over rising manufacturing wages in China and a policy paralysis in India, which is coming in the way of attracting foreign investment.

"India doesn`t have leeway to move...(it is) in a policy trap right now," Stephen Roach, former Non-Executive Chairman of Morgan Stanley Asia, told CNBC. "The budget deficit underscores how that trap gets tougher and tougher to get out of."

On Friday, India`s stock market dropped and bond yields jumped after the government released a budget that lacked bold reforms.

While in China data over the weekend showed the country`s property prices fell for a fifth consecutive month.

Frederic Neumann, Co-Head of Asian Economics Research at HSBC wrote in a report on Monday that investors should take note of the fact that Southeast Asian economics had regained a competitive niche, even as China`s wages were soaring and India`s manufacturing sector suffered from inadequate infrastructure.

Neumann said a declining dependency on external demand coupled with increasing consumption and investment spending has boosted ASEAN economies.

For investors though, betting on Southeast Asia isn`t a slam-dunk case based on their mixed performance this year.

While Vietnam`s stock market is up 25 percent this year, making it the best performer in Asia, other markets in Southeast Asia haven`t fared that well.

Indonesia`s benchmark Jakarta Composite (Jakarta Stock Exchange: .JKSE) has risen only 5% this year, while Malaysia`s Kuala Lumpur Stock Exchange (Kuala Lumpur Stock Exchange: .KLSE) is up 3%.

That`s much less than the MSCI Asia ex-Japan Index, which is up 14%. On the other hand, India`s Sensex is up 11.8%, while China`s Shanghai Composite (Shanghai Stock Exchange: .SSEC) is up 9.6%.

"Indonesia in particular is the result of strong performance from last year, and concerns right now that some key sectors will be affected if China sees a major slowdown," Gill told CNBC. "Malaysia might face some political uncertainties ahead of a general election that is expected some time in coming months."

Despite these challenges, Gill is bullish on the region and says there are a number of companies that have returns on equity of 25 to 30%.

Gill`s top picks for the region include Indonesia`s Bank Rakyat, Malaysia`s Public Bank and Thailand`s CP Foods.

Copyright 2011 cnbc.com

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First Published:Mar 20, 2012 12:10 PM IST