Asia’s emerging market equities have been hurt by recent fears over China’s recovery and geopolitical risks. But while the region’s markets have historically been correlated with Chinese assets, investors are missing a stealthy decoupling from the country’s giant economy.
Tailwinds from supply chain shifts, favourable demographics and resilient economic fundamentals are set to support long-term gains in Asia emerging markets, despite China’s risks.
First, global companies are actively tilting supply chains beyond China, resulting in business and investment flows to its regional neighbours.
Apple’s recent move to diversify iPhone production from China to India is the most striking example. According to the IMF, China’s global market share of greenfield foreign direct investments in strategic sectors, such as semiconductors, has been declining since 2021, while the market share of the rest of Asia has risen. In the US, the percentage share of imports from China has been falling since 2018 and is set to be overtaken by imports from India, Taiwan and Asean economies.
Moreover, this is likely to be just the start of things. For Asian emerging markets, the scale of potential “friendshoring” — sourcing material from friendly countries — is vast. China’s manufacturing output is 10-fold that of India, the next largest emerging economy in Asia, and more than 50-fold of Vietnam’s.
Diversifying supply chains out of China will require sizeable investments over years, resulting in significant impact on major friendshoring destinations. Part of China’s global competitive edge in manufacturing is the relative low cost of its labour force. Many Asian economies, such as India, Indonesia and Vietnam, are competitive with China in this regard.
Relative to China, however, the lack of high-quality infrastructure and large pools of educated workers has made these economies more suited to labour-intensive industries and lower-value goods, such as apparel, for now.
Over time the demand for higher value manufacturing, such as electronics and machinery, will be increasingly met in these friendshoring destinations. Although overall development, in terms of manufacturing automation and supply chain ecosystems, is less advanced across emerging economies in Asia relative to China, this provides scope for faster long-term growth.
Second, in contrast to China’s ageing population, the most populous emerging Asian countries, including India and Indonesia, are set to reap the benefits of favourable demographics in the coming years.
China’s population is on a downward trend because of its weakening fertility rate. China’s dependency ratio — defined as the number of dependents in its population relative to those aged between 15 and 64 years — is likely to rise unfavourably. At the same time, the working-age population is projected by the UN to potentially fall by a quarter by 2050.
Currently, the median age in China is about 38. In contrast, India, Indonesia and Vietnam enjoy more youthful demographics with median ages below 33. The dependency ratios in these countries are expected to remain favourably low over the next decade. China’s regional rivals are therefore likely to enjoy the comparative advantages and consumption power of younger, energetic workforces for years.
Third, Asian emerging markets enjoy relatively resilient fundamentals. The region has been less affected by inflation, as much of the world’s supply chains run through Asia, significantly reducing transport costs for local companies. Several central banks were early to tighten monetary policy to curb inflationary pressures, including the Bank of Korea and Monetary Authority of Singapore.
Moreover, the People’s Bank of China, faced with tame inflation in the country, is likely to maintain its accommodative policy stances, helping liquidity conditions across the region. Likewise the Bank of Japan, which is determined to entrench inflation around its 2 per cent target after three decades of weak inflation and growth.
Additionally, China’s post-Covid reopening is likely to increase demand for the rest of Asia’s goods and services and lead to stronger flows of tourism in the region. The reopening also should help shield Asian economies this year from recession against a difficult global growth backdrop.
For investors concerned about China’s risks, recognising that Asian emerging markets are a universe beyond the Middle Kingdom will yield significant opportunities. Friendshoring, demographics and fundamentals are all helping the region’s economies become less correlated with their giant neighbour.
