What with terror attacks in Mumbai and an economy going rapidly downhill, there’s more than enough doom and gloom all around us. For a change, let’s focus instead on a more congenial subject. And since it’s difficult to find much to get enthused about in the near future, let’s resolutely ignore the short-term and instead take a look at more long-term trends.
Consider, for instance, the International Monetary Fund’s recent study on demographics in Asia, part of its Regional Economic Outlook for Asia and the Pacific released last month. One of its chapters is titled “The Greying of Asia”, which seems to indicate, at first glance, that it’s hardly cause for celebration. But dig a bit deeper and we find that while it’s true that much of Asia will be filled with ageing populations by the middle of the century, India and much of the Asean (Association of Southeast Asian Nations) will still be relatively young.
Why does demographics matter? The report lists several ways in which ageing affects economic growth. Growth potential could decline as the labour force shrinks, pension and health care costs could go up, a shrinking income tax base could erode government finances, savings could decline as an older population draws down money accumulated during their working years, and older people may prefer less risky assets, thus reducing the demand for stocks and increasing that for bonds.
There’s actually a theory that correlates the huge boom in US equities since the late 1980s with demographic changes. A baby boom occurred in the US after World War II, and this “baby boomer” generation reached age 40 around 1985. People in the age group of 40-65 are known as “prime savers” because that’s the age they save the most. The ratio of prime savers to the rest of the population (those aged 0-39 and those above 65) has a remarkable degree of correlation to the S&P 500. The theory, also known as the “asset meltdown hypothesis”, goes on to say that since the baby boomer generation will shortly move into the 65+ age bracket, asset prices in the US will take a nosedive. By extension, that would hold true for any ageing society, including much of Asia. Ageing in Asia will be rapid over the next four decades, with the old-age dependency ratio tripling to approach the US level by 2050.
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The IMF study says that for the more advanced Asian economies, a lower share of prime savers would result in a lower demand for financial assets, because older people do not add to their financial assets but instead live off the assets accumulated over their working life. IMF estimates that this will raise bond yields in Japan, Hong Kong and Singapore between 100 and 200 basis points. A reverse effect will, however, be felt in India, as a rise in the share of prime savers increases the amount of funds available for investment, which in turn will lower bond yields. The IMF estimate is for Indian bond yields to fall by around 600 basis points on account of this effect by 2050.
There will be a similar impact on stock returns. According to IMF, stock returns in Japan could fall by 10% by 2050 due to this effect. On the other hand, the impact of demographics on Indian stock returns could be around 30% by 2050. China, which will be a much older society than India at that time, will see stock returns go up by a comparatively lower 10%, due to the ageing effect.
The report points out: “A rise in the elderly share tends to decrease the role of the banking sector in the economy, reflecting lower demand for consumer borrowing during old age, and reduces the size of the equity market while increasing bond market capitalization, consistent with a substitution toward safer assets in old age. However, demographics do not affect the overall size of the financial sector, but only the structure.”
Demographics also have an impact on a country’s current account balance. Empirical evidence collected by IMF shows that the higher the ratio of prime savers in an economy, the lower the current account deficit. As the number of old people rises, both savings and investment should fall. But the empirical evidence shows that the impact on savings is more than that on investments. As a result, the ageing economy will run a current account deficit. And since that deficit will have to be financed, the younger economies will have to run a current account surplus. This offers a new reason for the pressure on the US current account deficit.
Fifty years from now, demographics alone could make our current account balance rise by 6% of the gross domestic product.
Of course, not all of these trends are due to demographics alone. As the report points out, “The actual impacts may turn out to be more limited. For instance, more fully integrated global capital markets could change the picture in coming decades: in particular, capital flows from younger economies in the region could help support asset demand and prices in rapidly ageing countries. Equally, firms in fast-ageing countries could diversify their operations toward faster-growing and younger economies to offset declines in their valuation. Moreover, other determinants of asset values, such as productivity gains and fiscal and monetary policy, may offset demographic influences.” And then, of course, there’s the all-important question of a country’s workers being able to find enough employment for the demographic magic to do its bit.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org