The pandemic shock is likely to have lasting impacts on supply-side GDP potential in some of the largest emerging market (EM) economies, but such “scarring” effects will be limited overall, says Fitch Ratings in a new report.
Shocks to GDP on the scale of those seen in 2020 can result in scarring through reduced business investment and credit availability, widespread bankruptcies and human capital losses through labour market detachment.
However, several factors mitigate the risk of scarring for EMs as a whole. The pandemic was not preceded by the build-up of large macro or financial imbalances. Moreover, the scale and speed of the macro policy response has been unprecedented.
Nevertheless, India, South Africa, Indonesia and Mexico look more vulnerable to permanent GDP losses. This partly reflects a much sharper GDP shock as they rolled out less policy support in the early stages of the crisis. The investment shock was also particularly large in these countries. In India we see a fragile banking system limiting the investment recovery in coming years.
India, South Africa, Indonesia and Mexico saw the largest downward revisions to potential growth compared with a previous projections published in 2019. In view of this Fitch has moderately reduced its projections for China, Korea and Turkey, reflecting weakening demographic trends, and slightly cut the projection for Brazil. Poland’s potential growth rate is unchanged. It has also slightly raised the estimate for Russia following pension reforms that are improving the outlook for labour supply growth.
For Brazil, Russia, India, Indonesia and Mexico, the latest short-term forecasts imply that GDP will remain significantly below potential in 2023. This means that actual output should be able to grow somewhat more quickly than supply-side potential over 2024 to 2026 as the output gap closes.
