Pandemic raises risk of GDP losses in some largest EM economies: Fitch Ratings

July 19, 2021: 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.

The report titled “EM scarring limited, but likely is some cases” noted that 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 have been unprecedented, helping to cushion private-sector balance sheets and supporting aggregate demand. A credit crunch has also been avoided. However, strains on private-sector balance sheets will increase as policy support is withdrawn.

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.

Going by the report, India, South Africa, Indonesia and Mexico saw the largest downward revisions to potential growth compared with our previous projections published in 2019. We moderately reduced our projections for China, Korea and Turkey, reflecting weakening demographic trends, and slightly cut the projection for Brazil. Poland’s potential growth rate is unchanged.

Fitch Ratings 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 report's 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, the report said.

Fitch Ratings