(Bloomberg) — Emerging markets such as India and Indonesia, with robust population growth, are positioned to benefit as demographics start to play a bigger role in investment decisions, according to Fidelity International and the BlackRock Investment Institute.
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Investors are keeping an eye on the two emerging Asian nations, likely due to a surge in infrastructure spending that bodes well for their economies. India and Indonesia both coincidentally hold elections this year and have signaled to the world their ambitions to leverage their dynamic populations to transform into economic powerhouses.
The two nations stand out as other countries in the region, including China, struggle with rapidly aging populations. India is set to overtake China as the world's most populous country in mid-2023, a historic milestone that has sparked efforts to identify potential winners in the South Asian nation's stock markets.
BlackRock's analysis shows a positive correlation between a country's working-age population growth and stock valuations, while Fidelity sees the financial sector as a major beneficiary amid growing demand for credit from both businesses and consumers.
“India and Indonesia have young workforces and demographic dividends far outpacing their major neighboring economies,” said Ian Samson, a fund manager at Fidelity in Singapore. “All businesses, big and small, need capital. This partly explains why bank stocks are generally correlated with GDP growth in emerging markets.”
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India and Indonesia are expected to see their populations grow by at least 10% by 2040 compared to this year, while China's population is expected to fall by nearly 4%, according to World Bank data.
A more important indicator will be the change in the working-age population, defined as those between the ages of 15 and 64. China's working-age population had been declining for years, even before its total population began to decline historic numbers, while India has the youngest working-age population of any major economy.
A faster growing working-age population typically translates to higher future earnings growth, strategists at BlackRock Investment Institute led by Jean Boivin said in March, adding that immigration, rising labor force participation and automation are also influencing factors.
The demographic dividend, along with a range of idiosyncratic factors such as hopes for market-friendly election results, forms part of the optimism that has driven the rally in both stock markets.
The Nifty 50 index, which is trading at an all-time high, is set to record its ninth consecutive year of gains if the trend continues. The Jakarta Composite Index hit an all-time high in March.
Structural reform
Analysts say structural reforms to reduce regulatory red tape, increase labor market flexibility and encourage foreign investment are essential for the economy to take advantage of the tailwinds from population growth.
“Ultimately, the growth equation is jobs x productivity,” Fidelity's Samson said. “Solid structural reforms, as we've seen in both India and Indonesia, should enable them to create enough jobs to reap the benefits of their demographic dividend.”
Some progress has been made but more needs to be done: Indonesia's next president, Prabowo Subianto, who takes office in October, is aiming for annual GDP growth of 8 percent, even though the country is performing much worse than that.
Investors are watching to see whether state governments in India will follow through on labor, land and other policy changes passed at the national level. If Prime Minister Narendra Modi's party wins a narrow majority in the election, his broader reform plans could face obstacles and spark more volatility in financial markets.
Read: Indian markets brace for sell-off as Modi's election goals in doubt
For government bond investors, age dependency ratios – the proportion of people considered too old or too young to be in the workforce – and fiscal burdens are among the indicators to take into account when considering long-term investments.
Global funds have poured $5.5 billion into Indian government bonds this year on the prospect of index inclusion, according to data compiled by Bloomberg. Investors were comforted by India's interim budget, released in February, which focused on infrastructure spending rather than populist policies ahead of a general election that began in April.
Meanwhile, the new government's pledges to increase spending have raised concerns about fiscal health, leading international investors to pull out $1.8 billion from Indonesian government bonds.
“An ageing population will increase health care and pension costs, but developed countries have better social security than most emerging markets,” said Sanjay Shah, director of fixed income at HSBC Global Asset Management. “Pension systems in emerging markets could be more graduated and less biased towards fixed benefits,” easing the financial burden on states, Shah said.
What to see
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China is due to release its manufacturing and non-manufacturing PMIs for May, with investors waiting for solid signs of a recovery.
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South African financial markets are awash with optimism ahead of a general election on May 29. The country's central bank will announce its interest rate decision on Thursday.
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The Bank of Israel is expected to keep interest rates unchanged at 4.50% on Monday
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Taiwan and the Czech Republic will release their first-quarter GDP data, while Brazil and Poland will release their latest inflation statistics.
–With assistance from John Cheng and Zijia Song.
(Updates with Indian election progress in paragraph 14)
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