By: David Rees, Senior Emerging Markets Economist at Schroders

As ties between the world’s superpowers continue to loosen, we look at the implications for investors and the emerging market countries that could benefit.

A decoupling of economic and political ties between the US and China is likely to be one of the most important drivers of financial markets in the emerging world during the next decade.

Ever since Donald Trump swept to power by promising to put “America First”, policies aimed at clawing back political, economic and military power from China have become popular on both sides of the aisle in Washington.

The victory of President-elect Joe Biden is unlikely to change this. And, if anything, a more methodical, consensus-building approach from a Democrat government may ultimately be more effective in driving decoupling. Meanwhile, the global pandemic may also cause companies to reassess the risk of having supply chains concentrated in China.

However, it is not just the US that is pulling away. Policymakers in China have for some time been expressing more overtly a desire to topple the US from number one spot through strategies such as “Made in China 2025” and “Dual Circulation”. The former seeks to establish China as a global leader in manufacturing, with a focus on more technology-intensive production. Dual circulation incorporates the goal to strengthen the domestic economy, while continuing to grow China’s importance internationally.

Meanwhile, Beijing’s push to re-orientate supply chains around itself through the “Belt and Road Initiative” implies a major shake-up of the world order. US aggression has only accelerated these ambitions.

As a result, the recent agreement of the Regional Comprehensive Economic Partnership (RCEP) may be a sign of things to come. This brings together fifteen Asia-Pacific countries to form the largest trade bloc in the world with China at its centre.

We explore the next steps that each side could take if tensions continue to grow, and discuss which other emerging markets might be the winners and losers from differing degrees of decoupling.

In the scenario that the status quo is maintained and tariffs remain in place, low-cost manufacturers could relocate to countries such as India and Indonesia. This would give a boost to economic activity and the performance of local markets.

Alternatively, in a scenario with further escalation, some reshoring and diversification of supply chains could be favourable for Mexico in particular.

In the unlikely scenario of a breakdown in relations, the impact could be more stark, causing the world to split into two markets; one around China and another around the US and the rest of the world. Needless to say, all of this could have significant long-term implications for asset allocation in emerging markets.

Overview of different scenarios  

Read the full report here.