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Where will the money come from and where will it go?
In this week’s Brief, we cast our eyes further out along the investment horizon and report the findings of QIC’s demographic, potential growth and sovereign risk indexes, and what they are telling us about the long-term global investment landscape.
The global population is ageing. Consequently, dependency rates and the share of the population that lies beyond the working age are rising. But not all countries are ageing at the same rate, and those countries most exposed to negative demographic trends are facing the fastest rise in the costs of supporting an ageing population. In those countries, pressure is mounting on institutional investors to raise the rate of return on funds in order to support the aged. Hence, countries with the weakest demographic trends will likely be a source of capital for the global economy, especially those countries with high domestic savings rates. But where will the funds go? A consequence of a global slowdown in population growth is a slowing in the rate of growth in the global labour force, and hence, a slowdown in the potential growth rate of the global economy. Countries with higher rates of potential growth are more likely, inter alia, to generate higher returns on their assets. Hence, countries with higher rates of potential economic growth will become desired investment locations for international capital.
What do the data tell us? Let’s start with the demographics. QIC has developed a demographic index that projects trends out to 2050 based on UN data and data from a range of national statistical agencies including the ABS. The index covers 196 countries, which we reduce to the 48 major global economies for reporting purposes. The index is based on 10 factors across 4 broad categories: population growth & level, population ageing, fertility rates, and mortality rates. The index shows that by 2050 the bottom 10 (~bottom quintile) countries with the worst demographics are geographically concentrated in Europe and Asia. However, not all countries with weak demographics would necessarily be worthwhile targets for those seeking funds. A key deterrent is sovereign risk and to filter countries with excessive sovereign risk we have developed a governance index based on factors relating to ease of doing business and perceptions of corruption.
Excluding Ukraine, due to excessive sovereign risk, the countries with the weakest demographics, and therefore likely to be a potential source of investment funds cover: five Asian and five European countries; and two Emerging Market (EM) countries and eight Developed Economy (DE) countries. In good news for Australian companies seeking funding, among the group are five DE Asian countries: South Korea, Hong Kong, Taiwan, Japan and Singapore. In addition to having poor demographics, these Asian economies have strong international balance of payments and very high home biases towards domestic assets in the portfolios of their institutional investors. This last point means that, not only will investors be incentivised to seek returns abroad due to the pressures of ageing populations, but they will also be incentivised to seek foreign investment opportunities to attain better geographical diversity in portfolios. At the other end of the demographic index, Australia ranks 4th and is one of only five countries with positive index scores.
Which countries will be in strong positions to offer high returns? To measure the growth potential of countries, we have developed an index that covers 5 factors: participation rates, employment growth, real GDP growth, real GDP per capita, and the share of global GDP. The top ten countries with the best potential growth rates are diverse and dispersed across regions and across EM & DM countries. However, when thinking of these countries as a suitable place to invest, we must again account for sovereign risk. Using our governance index to filter out countries with unacceptable sovereign risk, we exclude five of the top ten countries from the point of view of growth potential. Those countries are Nigeria, Philippines, Pakistan, Vietnam and Bangladesh. Replacing those countries, with the next best five potential-growth countries, results in the top ten consisting of: Indonesia, India, US, Saudi Arabia, Australia, Sweden, Ireland, Canada, UK, Singapore and Malaysia. Due to the general decline in the growth potential of the global economy over time, of the adjusted top ten, only Indonesia, India, US, Saudi Arabia, Australia and Sweden have positive index scores.
In summary, the global economy is faced with an ageing population and slowing rates of economic growth. This raises the question of how countries will fund the needs of societies that have an increasing dependency rate and a falling capacity to generate returns on savings. However, the pace of ageing and the potential growth rates of economies are not evenly distributed across the globe. Australia is in a fortunate position for three reasons. First, Australia has strong demographic fundamentals. Second, many of those countries most likely to be in search of higher rates of return on investment (i.e., those with the poorest fundamentals) lie within our region and, hence, give us an advantage in attracting funds from those countries, through existing trade, diplomatic/political, and cultural/migration linkages. Third, Australia has one of the strongest growth potentials among the 48 major global economies, which should allow us to generate superior returns on our assets compared to most other countries.
Although the global economy is facing twin long term headwinds of deteriorating demographic fundamentals and slowing potential rates of economic growth, Australia is well positioned to take advantage of the consequences of these headwinds. Australia is located in the region where deteriorating demographics is at its most intense, meaning many of our close trading and diplomatic partners will be looking abroad to source returns to their portfolio and Australia, with a high potential rate of economic growth, will continue to be an attractive destination of capital.