By: Izak Odendaal, Old Mutual Wealth Investment Strategist

The shocking assassination attempt on former US president and current Republican presidential candidate, Donald Trump, will no doubt revive an age-old debate among historians. Does the arc of history depend on such fluke events as a bullet missing its target by a few millimetres, or is it determined by deep structural forces beyond the influence of individuals? The short answer is both, though given our human love of storytelling and our ingrained hindsight bias (everything is obvious after the fact), we probably tend to elevate such historical “hinge moments”.

Structural forces matter, however, even if they are not absolute destiny. One such force is geography. Some countries are in good neighbourhoods, others aren’t. It is safe to say that South Africans don’t think too much about neighbouring countries, unless there is trouble. This is probably a byproduct of our colonial history. We know more about what is happening in UK politics, for instance, than in Botswana. Perhaps southern Africa is not exciting enough, or South Africa’s economy is simply too large, bigger than all its neighbours combined.

But there is another neighbourhood South Africa belongs to, and it holds great promise.

Oceans connect

Arthur C. Clarke famously observed that our planet shouldn’t have been called Earth, but rather “Ocean” since nearly three-quarters of Earth’s surface is covered by sea. And while vast oceans separate the continents, they also connect them in important ways, particularly economically. That is because, given decent ships, it has always been significantly cheaper and easier to move goods by water than over land.

The Mediterranean is sometimes called the Cradle of Civilisations and it lay at the heart of ancient empires. For most of the past three or so centuries, the Atlantic Ocean, particularly the North Atlantic, has been the centre of the global economy. Today, the Pacific has a strong claim to that throne, since it connects the two superpowers, the US and China.

Could it be the Indian Ocean’s turn to take its place as a great economic region? The Indian Ocean and its seas, such as the Red Sea and Gulf of Arabia, are of course already important links in the global economy. The Carnegie Endowment estimates that almost 90,000 vessels, carrying 9.8 billion tons of cargo, travel through the Indian Ocean annually. This includes two of the five busiest shipping channels feeding into it, namely the Suez Canal and the Strait of Malacca.

Map 1: The Indian Ocean Rim

Source: Microsoft

But it is the current rapid economic growth of south and south-east Asia that will really put this region on the map, and fittingly, given the ocean’s name, India is increasingly at the core of this growing economic ecosystem. India is the only large economy forecast by the International Monetary Fund (IMF) to grow by more than 6% per year over the next five years in real terms. However, the likes of Indonesia are not far behind with growth forecast to average 5% over the medium term, while Malaysia is expected to grow around 4%. Notably, however, the IMF projects that East African countries Tanzania and Kenya will also post rapid growth rates of 5% to 6% per year off a low base.

Depending on how you define the Indian Ocean Rim, it is home to a 2.8 billion people. Half of them live in India, but Indonesia is home to 275 million people and Pakistan 230 million. Bangladesh and Egypt are each home to more than 100 million souls. Between them, Kenya, Tanzania and Mozambique are home to another 120 million. These are a lot of potential customers, and a massive potential workforce.

Sparsely populated Western Australia can also connect into this ecosystem, since Perth is closer to Singapore than to Sydney. With a large and sophisticated navy, Australia is a particularly important player in maintaining the security of the region.

India sits at the geographic centre of this region and has unimpeded access into it on its eastern and western coasts, with around 7 500km of coastline and hundreds of ports. This contrasts with China, which despite its massive landmass, faces potentially inhibited access to the Pacific Ocean due to the proximity of US allies Taiwan, Philippines and Japan. As a side note, this again emphasises that the US absolutely won the geo-strategic lottery with free access to the Pacific and Atlantic Oceans. While Australia and Canada are also continent-sized countries with access to two oceans, they are too dry and cold respectively to sustain a large population. Russia has oceans, land mass and population, but its ports tend to freeze over in winter, and its land borders offer little natural protection.

Largely poor

Despite very dynamic economies, the Indian Ocean Rim remains largely a poor region. The Gulf States have oil wealth, Singapore is a trading and financial global hub, Mauritius an emerging offshore financial centre, and Australia is a rich developed country. For the rest, real per capita incomes are mostly below $20,000 (adjusted for living costs).

Chart 1: Real GDP per head, selected countries

Source: International Monetary Fund

The glass half empty view is that poor countries stay poor because they cannot mobilise the internal resources necessary to invest in skills, infrastructure and technology. They also often suffer from political instability and weak institutions. The glass half full view is that there is lots of room to leapfrog technological adoptions and benefit from the research and development work done elsewhere. Since infrastructure is underdeveloped, there are high returns to improving it, even only a little bit. A single new highway in a country with poor roads can unlock huge economic value, whereas it will only make a small contribution in countries with well-developed road systems. Finally, and importantly, small and poor countries can grow by tapping into much bigger global markets. Growth comes not only from export revenues, but also from the learning process of competing in tough markets.

For now, trade in the Indian Ocean is still dominated by raw materials, notably oil and petroleum from the Gulf, and iron ore from Western Australia, but also coal from Richards Bay. And of course it serves as conduit for Chinese goods travelling to Europe.

The big question is whether countries in the region can increase the share of manufactured exports to sustain economic growth. An opportunity to do so is presented as the West increasingly aims to de-risk from China and shift production to friendlier locations. If Trump wins, which seems increasingly likely (though anything can happen in an election that is still four months away), trade tensions between the US and China will only increase. The other question is whether trade between the countries in the region can accelerate.

If so, the Indian Ocean presents a more practical prospect for South African firms than BRICS, which remains an incoherent collection of countries with few deep historical or geographical connections. And while South African policymakers have pushed a pan-African agenda since 1994, looking simply at logistics costs, it is easier to trade with Malaysia or Indonesia than landlocked Chad or Niger.

It means Durban and other east coast ports need to be world class, instead of languishing at the bottom of the World Bank’s ranking table year after year (though Transnet disputes this assessment). Private sector investment is key to improving the ports, and the appointment of a Philippines company, ICTSI, to run Africa’s busiest container terminal, Pier 2 in the Port of Durban, is a major step forward.

Financial minnow

South Africa has one of the more sophisticated financial systems in this region, and this can be a competitive advantage. But overall, the region is still tiny compared to global financial markets. The market value of all the stock exchanges that form part of the 47 country MSCI All Country World Index, a global equity benchmark, is 5.6%, with Australia contributing 1.8% and India 2%. By comparison, Japan’s weight is 6% and the UK’s is 3.6%. The three biggest companies in the index – Microsoft, Apple and Nvidia – each have a weight of more than 4%. Unsurprisingly, there is no pan-Indian Ocean equity index yet, and most investors sitting in New York or London will probably just view this region as part of emerging markets as a whole or part of Asia. Fair enough. However, as thematic investment grows in popularity, don’t be surprised if an Indian Ocean ETF pops up in future. Moreover, this doesn’t mean that individual companies, irrespective of where they are listed, cannot benefit from increased trade links across the region.  

Chart 3: MSCI All Country World Index country weights

Source: MSCI, as at Dec 2023

Flashpoints

Of course, this doesn’t mean that everything is hunky dory. There are real geopolitical risks and areas of fragility. Somali pirates and Houthi rebels are a nuisance to maritime transport around the Horn of Africa and through the Red Sea.. Iran is a perennial source of concern, since it could close the Strait of Hormuz, a key chokepoint in the transport of oil. The recent election of the moderate Mazoud Pezeshkian as president, another surprise in a year of unexpected election outcomes, probably limits extreme actions from Iran for now.

The biggest flashpoint is probably the decades-long tension between India and Pakistan, nuclear-armed neighbours. However, as the economic gap between India and Pakistan widens, the nature of the rivalry is arguably changing. India is booming, and Pakistan is stagnating. The latter could not hope to win a conventional war since it already teeters on the edge of bankruptcy. It could export its domestic instability in the form of terrorism, however. Either way, there is probably less risk of an India and Pakistan conflict triggering global war than is the case in the South China sea and Strait of Taiwan.

Put slightly differently, so far, unlike China, India has shown little interest in being a regional hegemon that throws its weight around unfairly. This might change, but for now bodes well for economic cooperation in the Indian Ocean Rim.  

China itself is a significant player in the region, even though it sits outside it geographically. It is a major trade partner for many countries on a bilateral basis and was until recently a big source of foreign direct investment through the Belt and Road Initiative (BRI). However, enthusiasm towards the BRI has faded in many quarters, partly because China has less money to throw around these days, and partly because many developing countries are wary of being saddled with large debts. The poster child for a BRI investment gone wrong is the Hambantota Port in Sri Lanka, built at huge cost with Chinese loans, but widely considered to be economically unviable. With Sri Lanka unable to service the associated debts, China has now taken it over, and faces accusations of “debt-diplomacy” and bullying.

In conclusion, a growing and increasingly interconnected Indian Ocean economy is probably not on the radar screens of most South Africans and businesspeople. It should be. For now, it is still the Cinderella of the large ocean regions, and it faces many obstacles, but that won’t necessarily always be the case.