Much is being made of India’s “demographic dividend", which is supposed to propel the country’s growth rate even ahead of China’s in the near future. The argument is simple and is based on the decreasing dependency ratio for India—this is the proportion of the sum of the population below 14 years of age and the population aged more than 65 years to the population aged between 15 and 64.

The assumption is that the population aged between 15 and 64 support the rest of the population. A lower dependency ratio, therefore, means a higher proportion of people of working age. This also results in higher savings, thus, accelerating investment and economic growth. In India, for instance, the dependency ratio, according to UN calculations, fell from 65% in 2000 to 56% in 2010.

Also See No Demographic Dividend in Markets (Graphic)

Over this period, the savings rate went up from 24% to a projected 36% or so. In the next decade, the dependency ratio is expected to go down further to 49%, further increasing savings. China’s dependency ratio, however, is expected to bottom out at 39% this year, according to the UN computations and it will rise to 44% by 2020.

That suggests China’s highest growth rates are already behind it.

Demographics, however, is not destiny. A larger working age population will be able to save more, provided there are more jobs. There are many examples of countries that have seen a similar demographic dividend, but have not really benefited.

Take Bangladesh, for instance. Its dependency ratio fell from 67% in 2000 to 53% in 2010, better than India’s, yet, we hear few stories about Bangladesh’s great economic potential. India’s size matters, as does its relatively developed productive base.

Or consider Brazil. While the country is part of the Bric (Brazil, Russia, India and China) group, its dependency ratio improved from 70% in 1970 to 54% in 2000, yet its growth rate has been nowhere near the current growth rates notched up by India and China. A February report by Deutsche Bank AG had this to say on the demographic benefit: “To what extent this potential is realized will depend on several other factors (e.g. inflation, economic stability). Empirical support for this relationship is mixed, at best. However, more complex models such as the ‘variable rate-of-growth effect’ model, which includes economic growth as an additional variable, has received a fair degree of support."

Significantly, Bloom-Williamson (1998) estimate that demographic factors may account for as much as one-third to half of the East Asian economic “miracle" during 1965-90." The success stories of Japan and South Korea, for instance, coincide with a reduction in their dependency ratios. It may be a coincidence that Japan’s dependency ratio bottomed in 1990, the year from which its long stagnation started, but its ageing society certainly imposes extra burdens on its working population. Finally, institutions also play a major role. For instance, Iran’s dependency ratio fell from 58% in 2000 to 40% in 2010, but nobody is touting Iran as the next great investment story.

Will the demographic dividend also lead to better stock market performance? Several analysts have pointed to the MY (middle to young) ratio as having a bearing on stock market performance, where the MY ratio is defined as the population aged 40-49 years/the population aged 20-29 years. The rationale is that the period between 40 and 49 years is when most of the investments in the stock market are made, while the period 20-29 years coincides with the period of high spending.

There are two strands to the argument: first, a higher MY ratio means higher growth and, therefore, higher stock market prices; and second, a higher MY ratio means a higher price-earnings multiple because a larger number of people will be chasing stocks.

Citi Investment Research has recently done some work on the relationship between the MY ratio and stocks in the Asia ex-Japan region. They find that, “Indonesia will see its MY ratio expand by 2.2% per annum over the next decade, followed by Taiwan at 1.7% and India at 1.1%. Singapore shows the biggest contraction (-4.5% per annum), ahead of Hong Kong (-1.1%) and Korea (-0.3%). In the latter markets, non-demographic factors will have to play a larger role in generating demand."

But what’s the correlation between the MY ratio and real (inflation-adjusted) stock prices? The chart gives the numbers. Note that for India, the correlation is a low 0.4. Notice that the correlation is negative for Thailand and the Philippines. Clearly, many factors aside from demographics affect stock markets.

What about the other argument that better demographics will translate into higher economic growth, which will be reflected in stock prices? Morgan Stanley in a recent report—“India’s coming growth acceleration: does it also mean higher equity returns?"—points out that apart from economic growth, valuations and returns on equity matter for stock returns. Their conclusion: “We do not believe that long-term returns from Indian equities are likely to move significantly from recent trends (the trailing ten-year CAGR (compounded annual growth rate) in returns is 14% in rupee terms)." That growth rate is not very different from the expected growth rate in nominal gross domestic product.

Graphic by Yogesh Kumar/Mint

We welcome your comments at