News analysis

A world in transition and its long-term economic implications

A clerk counts Chinese 100 yuan banknotes at a branch of a foreign bank in Beijing.
A clerk counts Chinese 100 yuan banknotes at a branch of a foreign bank in Beijing.PHOTO: REUTERS

We are now wading through a world in transition as a new economic status quo takes shape. Crucially, meaningful change is not always a smooth process, and has the potential to significantly derail long-term performance.

It is essential to filter short-term noises from structural developments, particularly pertinent in today's hyper-globalised world. A sell-off in Shanghai can trigger a wave of capital flight from equity markets worldwide, as seen in the first trading week in 2016. But what's most important are the key structural developments that will ultimately shape an investment portfolio through the upcoming business cycle, that is, the next five to seven years. Three evolving global developments will greatly influence the future investment landscape in Asia - the testing of the US' economic leadership, the search for new growth drivers in emerging markets and the upcoming internationalisation of the Chinese yuan.

A SUPERPOWER'S VITALITY TO LEAD

The US economy has proven its grit. Unlike most of the world, its post-crisis recovery has been nothing short of exceptional. Its vigour following the 2008 financial crisis reaffirms its position as global leader. But for how much longer will its hegemony last?

In recent years, US companies have unleashed waves of technological innovation onto the world. American universities and businesses are attracting the best and brightest from around the world to lead the next generation of disruption. And flush with cash, entrepreneurs are taking their creations to market faster in the US than anywhere else. This blend of hearty talent and ample resources will protect its technological prowess for many years.

The nation's extraordinary energy transformation has helped it become energy independent for the first time in nearly a century. This boom has helped spur massive investment spending, job creation and economic development within and beyond the oil industry. Once unimaginable, the US is now slated to become a net energy exporter in the next five years, which would stimulate growth and dramatically improve its balance of trade.

Yet undermining its potential is a byzantine tax code that discourages firms from expanding at home and repatriating funds from overseas operations. Federal regulation has also taken its toll. According to the Competitive Enterprise Institute, government intervention cost US consumers and businesses nearly US$2 trillion (S$2.8 trillion) a year in lost productivity and higher prices.

Demographic trends and increasing political dysfunctional also threaten US competitiveness. Federal spending on social security and healthcare programmes is set to soar to 14.2 per cent of GDP by 2040 from around today's 6.5 per cent as the baby boomer generation eases into retirement.

Already ranked a measly 133 of 144 countries for its fiscal profligacy, measured as the ratio of government debt to GDP, an additional fiscal deterioration will further inflate a mounting federal budget deficit.

Meanwhile, political polarisation and partisan bickering have inhibited Congress' ability to pass important laws. This has affected growth and will become more of a burden in the years to come.

The US will continue to assume the role of global growth leader, thanks to an adaptable corporate sector, flexible labour force and creative entrepreneurial class. But it may not be strong enough to carry the rest of the world on its back for much longer.

THE SEARCH FOR NEW GROWTH DRIVERS IN EMERGING MARKETS

Emerging markets became a victim of their own success in the 2000s, when their booming economies concealed structural flaws. But without a voracious China gobbling up commodities and investment and amid tighter monetary conditions, emerging markets now need to reduce their reliance on cheap capital and traditional industries to focus on higher-value-added sectors and domestic consumption.

China's economic rebalancing is under way but the path ahead will be rocky. Elsewhere in emerging markets, reforms and restructuring are slow in materialising, and will keep growth sluggish in the coming years. Regional commodity exporters such as Malaysia and Indonesia have suffered against this new economic backdrop and need to push through structural reforms, attract foreign investment and maintain monetary and fiscal discipline to find success in this transitioning world.

THE YUAN'S QUEST TO ATTAIN GLOBAL RESERVE STATUS

China is the world's second-largest economy, yet the yuan is only the fourth most-transacted currency, with its global share still minor at under 3 per cent. This is poised to change. Great strides to move ahead with its internationalisation have led to the yuan's inclusion in the International Monetary Fund's Special Drawing Rights basket. This path towards global integration, however, will be a bumpy one for China and its neighbours alike.

While concerns of a full-blown yuan devaluation seem unfounded, the more market-determined currency regime has added a new element of volatility to regional currency and interest rate markets. With the US dollar-yuan likely to weaken to 6.80 by end-2016, the entire Asian currency complex will likely fall a further 5 per cent against the greenback this year. The Singapore dollar will be hurt as well, likely falling to 1.45 by end-2016, with three-month interbank rates poised to rise further to above 2 per cent in the next 12 months.

In this world of transition, where the state of key global issues will not be settled for years to come, selecting the right mix of investments will be crucial. Investors should continue to bear in mind that diversification across asset classes and geographies as well as regular rebalancing of portfolios will remain key to long-term wealth preservation and protection.

  • Tan Min Lan is Apac regional head at the chief investment office of UBS Wealth Management
A version of this article appeared in the print edition of The Straits Times on January 11, 2016, with the headline 'A world in transition and its long-term economic implications'. Print Edition | Subscribe