- We now project a deeper GDP decline in 2020 for most emerging market economies, mostly due to the worsening pandemic and a steeper fall in exports. Our forecast is for the average emerging market GDP (excluding China) to contract by 4.7% this year, and then to grow 5.9% in 2021.
- Better financial conditions and a gradual recovery in key trading partners are supporting the return to growth in emerging markets, but investor sentiment remains fragile.
- We expect permanent output losses from the pandemic for all emerging markets, with the gap relative to pre-COVID GDP path as large as 11% in India, 6%-7% in most of Latin America and South Africa, 3%-4% in most of Emerging Europe, and 2% in Malaysia and Indonesia.
- The evolution of the pandemic and the effectiveness of policy response will be key in influencing the recovery path. The starting point of each emerging market, the dynamism and adaptability of the private sector, and external factors also matter for recovery prospects.
S&P Global Ratings now forecasts a deeper economic contraction in 2020 for most key emerging market (EM) economies. Our downward GDP revisions mostly reflect the overall worsening pandemic for many emerging markets and a larger hit to foreign trade compared to our expectations at the end of April. We project the average EM GDP (excluding China) to decline by 4.7% this year and to grow 5.9% in 2021 (Chart 1). Risks remain mostly on the downside and tied to pandemic developments.
We expect the COVID-19-related downturn to leave long-lasting scars on EM economies, with higher debt levels, subdued investment, and in some cases considerable damage to labor markets leading to permanent output losses. In other words, we forecast EM economies to be permanently smaller compared to our pre-COVID projected GDP trajectory, with the gap relative to the pre-COVID GDP path as large as 11% in India, 6%-7% in most of Latin America and South Africa, 3%-4% in most of Emerging Europe, and 2% in Malaysia and Indonesia (see chart 2 for regional aggregates).
Pandemic Situation Has Worsened For Many EMs
The coronavirus outbreak for many EM economies has worsened since our previous macroeconomic update. New reported infections have yet to peak in some cases, and in others, they remain uncomfortably high (Chart 3). The situation varies by region and country, and differences in testing levels make direct comparisons difficult. It is nevertheless clear that compared to our initial expectations, it will take longer for many EMs to contain the virus and the economic fallout.
Latin America has become the global epicenter of the COVID-19 pandemic, with the number of new daily reported infections in most major economies on the rise, or remaining close to recent peaks. Brazil has the highest number of new daily confirmed cases in the region (although Chile has the highest number in per capita terms). In Mexico, the infection curve remains very steep, with the number of new daily infections twice the amount at the beginning of June.
In emerging markets in Asia, Malaysia and Thailand have been broadly successful in taming the pandemic, but India, Indonesia, and the Philippines are still reporting an increasing number of new cases.
In emerging markets in the Europe, Middle East and Africa region, new daily cases have surged in South Africa and they remain high in Saudi Arabia. In contrast, infection curves are flattening in key EMs in Europe. In Russia, new cases have begun to decline, although they remain elevated (which in part reflects very high testing levels). Turkey has made good progress in containing the virus, and while the pace of new daily cases recently picked up slightly, it has now stabilized.
A worsening overall outbreak led many emerging economies either to extend lockdowns or to slow the relaxation of containment measures. It has also made consumers and businesses more risk-averse.
Our Baseline Assumptions About Pandemic Developments
The evolution of the pandemic is central for our macroeconomic forecasts. The virus hit EMs at different times and there has been a wide cross-country variation in the ability to control the virus and approach to mitigation policies. Some EMs are lifting the lockdowns after taming the pandemic: for example, Malaysia and Thailand. Some countries enforced tight lockdowns only briefly, or eased containment measures despite increasing COVID-19 cases, such as Indonesia, Brazil, and Mexico. Emerging markets have now embarked on a complex transition between lockdowns and a "new normal," which will begin after a vaccine or effective treatment are widely available.
We have divided EM economies into three groups: early, mid, and late exiters. This determines not only how quickly we expect containment measures to be relaxed, but also the risks of large, renewed outbreaks in the months ahead. For each group, we've made different assumptions about the timeline of the pandemic, exit from governments' mitigation policies, and households and businesses' behavior.
China is the only EM in the "early exiters" group. The "late" group includes key EMs in Latin America, India, Indonesia, and South Africa. Emerging Europe, Malaysia, and Thailand are in the middle.
Our baseline scenario assumes that some social distancing measures will remain in place for all groups during the transition period, although they are likely to be more volatile in late exiters, reflecting only partial success in virus containment.
We do not assume any countries in these groups will re-impose strict nationwide lockdowns, although we don't exclude partial and localized lockdowns. In the countries where the virus has not been brought under control, consumers and businesses are likely to be more risk-averse and that could keep the economy at a lower gear for longer.
S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
A Severe Hit To Foreign Trade
The initial shock from the COVID-19 pandemic to emerging markets was external: a hit to trade and tourism, a slump in commodity prices, and capital outflows. Oil-exporting economies, such as Saudi Arabia, Russia, and Colombia, as well as economies with high exposure to Chinese demand such as Chile, suffered losses in export revenues starting in the year's first quarter. For emerging markets exposed to the U.S. demand (Mexico), or to European demand (Poland, Turkey), the hit to external demand and exports revenues came later, towards the end of the first quarter.
While exposure differs, trade flows across EMs globally fell steeply between February and April, driven by the decline in both export volumes and prices (see Chart 4). Exports revenues were hit particularly hard in April, dropping by as much as 60% year-on-year in India and South Africa, more than 50% in Colombia, and 35%-40% in Mexico, Russia, and Turkey. In addition to a collapse in global demand, widespread domestic containment measures prevented some exporters from operating in April.
Trade data for May showed an improvement in most economies, but export revenues were still 25%-40% lower than a year ago (in US$ terms). A recovery in key trading partners--China, the Eurozone, and the U.S.--should lift demand for EM exports in the second half of the year. Oil prices have partially recovered; however, for key oil producers--Saudi Arabia and Russia--the agreed production cuts as part of the supply deal are restricting output. Based on the available data and weaker 2020 global growth forecast, we have lowered our projections for external demand and exports this year for most key EMs. The ongoing global recovery will support emerging market exports in 2021. Still, the outlook for external demand from advanced economies is generally weak, with the U.S. and the Eurozone's economies projected to contract by 5.0% and 7.8% in 2020, respectively, and GDP not returning to 2019 levels for at least 18 months. Economies exposed to Chinese demand, including commodity exporters, should receive a stronger and earlier boost from trade.
After A Precipitous Decline, Economic Activity Is Gradually Picking Up
As the COVID-19 outbreak evolved into a domestic health crisis, domestic demand in EM economies has taken a severe hit. The combination of external and domestic shocks has pushed the EM economies into recession. Economic indicators confirm the severity of the COVID-induced downturn in key emerging market economies, with a precipitous decline in activity in April amid lockdowns at home and abroad. The services sector bore the heaviest brunt, in line with global trends, but industrial production also contracted by as much as 45% in India and by double-digits almost everywhere (see Chart 5). The drop in industrial production was milder in Russia and Chile. This illustrates that the impact of the COVID-19 shock has not been uniform across emerging markets and reflects, beyond the differences in pandemic management and policy response, different economic structures--including the share of state enterprises and the prevalence of small and midsize enterprises (SMEs)--as well as exposure to external demand.
Available hard data for May, and more recent sentiment and non-standard economic indicators such as mobility indexes suggest that the worst of the slump in economic activity is behind us--we believe the trough seems to have been April for most EMs outside of China. The data also signal that the road back to normal for many EM economies will be a long one, with activity likely remaining below pre-pandemic levels for a significant amount of time.
Manufacturing Purchasing Managers' Indexes (PMIs) point to a continuing recovery in activity since April (see Chart 6). Brazil and Turkey's PMIs were back above the 50.0 threshold, and in Russia, it was very close at 49.4. In Mexico, however, the PMI remained at depressed levels in June at 38.6--very close to its April low of 35.0. Even though manufacturing PMIs are now in the expansionary territory for many EMs, this only signals the improvement compared to the previous month, not a return to pre-pandemic activity levels.
The index we constructed from Google Mobility Data in retail centers, transit systems, and the workplace, which tracks mobile usage in these locations, suggests that activity is gathering pace across emerging markets globally as lockdowns ease, but remains well below pre-COVID-19 levels (see chart 7). According to this data, the Latin American, Indian, and South African economies appear to have the largest gap from their pre-COVID levels of activity, while emerging European economies are getting closer to pre-pandemic levels but still have a substantial gap. In emerging Asian economies, Malaysia and Indonesia are closest to pre-virus levels, despite very different paths: Malaysia is easing lockdowns after bringing the virus under control, while Indonesia hasn't severely restricted mobility and its cases continue to rise.
Financial Conditions Have Improved, But Investor Sentiment Remains Fragile
Financial conditions for EMs have improved over the last quarter, in line with our expectations. Ultra-accommodative monetary conditions in advanced economies amid the massive expansion of the balance sheets by the Federal Reserve and other major central banks, as well as the expectation of a more evident global economic recovery in the second half of the year, are shoring up investors' appetite for higher-yielding, riskier EM assets. Institute for International Finance estimates that after pulling US$90 billion out of EMs in March, cross-border investors bought back US$60 billion of EM assets in April-June; predominantly debt (see Chart 8). However, we note that the high levels of uncertainty surrounding the evolution of the pandemic, in EMs but also globally, could generate periods of high volatility and tighten financial conditions once again.
Looking at bond spreads in secondary markets, two observations stand out. First, it's apparent that financial conditions were tightest towards the end of March, and while they have eased substantially since then, they're still not back to pre-COVID levels. For instance, if we look at J.P. Morgan's EMBI Global Spread Index, which looks at U.S. dollar-denominated sovereign debt in EMs, the spread peaked at around 660 basis points (bps) at the end of March and has since narrowed to 420 bps, but is still above the 300 bps level in January. Second, Latin American assets have underperformed and EM-Asian assets have outperformed, which is generally consistent with the evolution of the pandemic across those regions. This is clear in chart 9 below, which shows corporate bond spreads across emerging market regions.
Monetary Policies In EMs Will Start Diverging Next Year
We expect monetary policy to remain loose in key EMs this year. In previous episodes of stress, many EM central banks were forced into pro-cyclical tightening to counteract exchange rate and inflationary pressures. However, this time, central banks in key EMs have been able to lower rates, including to historical lows in several countries such as Brazil, Russia, and South Africa. Although exchange rates depreciated sharply following the COVID-19 shock and recent currency gains haven't fully offset previous losses, there has been very limited pass-through to domestic prices in most major emerging markets. Deflationary pressures have dominated across EMs, with core inflation falling almost everywhere, reflecting the severe slump in demand. As demand has begun to recover, core inflation has picked up. However, inflation rates are below target in most EMs, with the notable exception of Turkey, where it has been at double digits and accelerated in June.
In some cases, worsening investor sentiment--linked to the spread of the pandemic or concerns about the fiscal trajectory--may lead to renewed exchange rate pressures, which can show up in prices. This could prompt some central banks to start raising interest rates. By the end of 2021, we forecast higher policy interest rates across Latin America, in Turkey, and in South Africa. For emerging Asian economies and Russia, we expect policy rates to remain on hold until 2022.
Protracted And Uneven Economic Recovery
The COVID-19-induced recession has resulted in significant short-term output and job losses across EM economies. Until a vaccine or effective treatment is found, the recovery will be constrained by various degrees of social distancing policies and risk aversion on the part of households and businesses. But how quickly can economies return to normal once the pandemic is no longer a threat, and what will this "new normal" look like? Will EM economies return to their pre-pandemic growth trajectory in the next few years?
In our view, the road to recovery for emerging markets will be a long one for several reasons. First, the pandemic will leave many governments, corporations, and households in EMs with higher debt levels. This means that across EMs, households and businesses will spend less in order to restore their balance sheets: the so-called "balance sheet recession" phenomenon. The pandemic-related fiscal support measures in EMs have generally been less generous compared to advanced economies, reflecting less fiscal space, or less willingness to use it. Even so, these fiscal packages, coupled with the slump in budget revenues, will significantly push up debt levels in many emerging markets. In our view, many EM governments will choose, or in some cases be forced by the markets, to start consolidating their fiscal positions sooner rather than later.
We also expect a protracted recovery because the pandemic will likely shift demand preferences and make some sectors of the economy permanently smaller. It will take time to redeploy capital and labor from these sectors to other sectors that will expand post-pandemic. How quickly this can be done depends largely on how dynamic and adaptable the private sector is in exploring new opportunities.
With domestic demand held back by debt overhang, boosts from foreign trade will vary. Countries that are exposed to faster-recovering trade partners or sectors will benefit, while others will face weak export prospects for a prolonged period.
In 2023 and beyond, the supply side will determine output. Key factors of production are labor force (human capital), physical capital, and total factor productivity. In our view, the COVID-19 crisis has damaged at least one and in some cases several production factors in EMs. We expect slower capital accumulation, even if interest rates remain low, because the deterioration of balance sheets will constrain private investment, while governments are not likely to step in to bridge the gap (or will even scale back their own investment plans). In some countries, we also expect permanent damage to labor market dynamics. Long spells of unemployment can erode human capital, and sectoral reallocation requires reskilling. The effectiveness of government policies will be key to prevent the temporary shock to employment from becoming permanent. Even if unemployment falls back to pre-COVID levels by 2023, with less capital at their disposal, workers will be less productive.
Sometimes an economic crisis can trigger a positive change, creating reform momentum that leads to rapid increases in productivity and economic growth. It is too early to make firm conclusions, but so far, we haven't seen evidence that COVID-19 is boosting reform efforts in key EMs. On the contrary, it appears that it instead has taken attention away from reforms at least temporarily, as in the case of Brazil.
Overall, the new normal in EM economies will look different from our expectations before the COVID-19 shock, with higher debt, lower capital stock, less productive workers, and permanently smaller economies. We expect recovery paths to be uneven across EMs, and permanent losses to vary widely. Table 1 summarizes our forecast. The evolution of the pandemic is key in influencing the recovery path, but there is no one-to-one mapping. The effectiveness of policy response that helps cushion the blow and limits the damage to labor and investment dynamics is another major factor. Initial conditions, the dynamism and adaptability of the private sector, and external factors also matter for each EM's recovery prospects.
|Forecast GDP Gap In 2023 Versus Pre-COVID-19 Projected GDP Path|
|GDP--Gross domestic product. Source: S&P Global Ratings.|
Overview Of Our Regional Macroeconomic Assumptions
We have lowered our 2020 GDP projection for EM-Asia by nearly two percentage points, and now see the region contracting 0.7%, but then growing 7.6% in 2021. The revision to our 2020 GDP EM-Asia aggregate is mainly driven by a large downward adjustment to India's growth forecast. We expect the Indian economy to contract by 5% this fiscal year before rebounding in 2021, due to difficulties in containing the virus, an anemic policy response, and underlying vulnerabilities, especially across the financial sector. The scars from the pandemic will leave the Indian economy 11% smaller compared to our pre-COVID-19 expectations in the medium term; the largest gap across key EMs.
We still see China's economy expanding 1.2% in 2020 before growth surpasses 7% next year. Strong stimulus, resilient electronics manufacturing, and a gradual recovery in the service industries are helping the economy. However, still tight COVID-19 mitigation measures, a large hit to household incomes during the first quarter, weak labor demand, and the lingering effects of trade tensions on manufacturing investment (which is dominated by private firms) are dampening spending.
The pandemic is largely under control in Malaysia, paving the way for a gradual economic recovery. Policymakers have undertaken sizeable fiscal stimulus, and have relied on the financial sector to cushion the blow. We expect permanent output losses of about 2% for Malaysia, among the lowest in EMs. While Thailand has also been broadly successful in containing the virus, we forecast the gap with the pre-COVID GDP path to be twice as large, given the severe impact of the pandemic on the country's large tourism sector. In Indonesia, a sizable fiscal stimulus combined with aggressive monetary and macroprudential policy easing is helping to limit the contraction in activity. The financial sector entered the crisis with strong balance sheets, which will also help prevent large-scale permanent economic loss. There are still risks, however, particularly if the outbreak continues unabated, which could lengthen the duration of the shock and hinder economic recovery.
For more details on our EM-Asia macro assumptions, as well as on the rest of Asia-Pacific, see "Asia-Pacific Losses Near $3 Trillion As Balance Sheet Recession Looms," published on June 25, 2020.
In Emerging Europe, our forecast remains close to our previous expectations. We still predict Russia's economy to contract by 4.8% this year and grow by 4.5% in 2021, supported by global recovery and a rebound in oil prices. Russia's fiscal framework helps to absorb the oil price shock, but additional support to address the fallout from COVID-19 remains relatively modest, despite available policy space. The impact of the pandemic on Russia's GDP growth is less pronounced compared to many developed and emerging markets due to the structure of its economy, including its larger state sector and lower share of SMEs, requiring less policy support. Still we see permanent losses of about 3% in the medium term, due to weaker investment and the lack of economic dynamism that makes it more difficult to reallocate resources away from shrinking sectors, hampering productivity.
We expect Turkey's economy to contract by 3.3% in 2020, followed by growth of 4.5% in 2021. Turkey entered the coronavirus pandemic with strong growth momentum, but we estimate that the pandemic-related restrictions, deep economic contraction in the Eurozone, and a steep decline in tourism revenues have pushed the economy into recession. In response, the government has adopted a range of support measures, mostly off-budget. While the challenges posed by the pandemic are unique, the policy response follows a familiar script of pushing more credit into the economy at negative real interest rates. This could help accelerate the recovery, but risks reigniting macroeconomic imbalances. In fact, we're already observing an acceleration in inflation and a widening of the current account deficit. It will take a while for the tourism sector to recover, which will weigh on growth and foreign currency inflows. Positively, we note that the Turkish private sector has a long track record of contending with volatile domestic and external conditions, which should help Turkey weather a period of weaker foreign trade conditions and high uncertainty. However, businesses are still dealing with the fallout from the 2018 balance-of-payments shock, and further hit to their balance sheets will constrain investment.
We now see a deeper contraction of 6.9% in South Africa, down from our previous expectations of a 4.5% decline in GDP. The pandemic situation in the country has worsened since our previous macroeconomic update, leading to a further hit to confidence, which was already low before the pandemic, amid lack of growth and concerns about the fiscal trajectory. The sizeable fiscal package will only partially mitigate the economic toll, but coupled with lower revenues, will lead to a significant increase in government debt, further impairing public finances. We expect a muted recovery, constrained by debt overhang and long-standing structural weaknesses. Unemployment is likely to spike in 2020, and remain above (already high) pre-COVID-19 levels. We see significant permanent output losses from the COVID-19 related downturn of about 6%.
The worsening pandemic in Latin America, which has led to the extension of stringent lockdowns in some cases, and has slowed the ongoing relaxation of such measures in others, has prompted us to reduce our growth expectations for the major economies in the region. We have lowered our 2020 GDP forecast for Latin America by just over 2 percentage points to a contraction of roughly 7.5%. We expect growth to be just shy of 4.0% in 2021.
In Brazil, we expect GDP to decline by 7.0% this year, and then grow 3.5% in 2021. Risks are firmly to the downside given the rapidly worsening outbreak in the country--it is becoming a global epicenter of COVID-19 infections. The government's positive reform momentum that preceded the COVID-19 pandemic will likely take a backseat, at least temporarily, because fiscal efforts are concentrated on supporting workers and companies heavily affected by the downturn.
Latin American economies will have among the weakest economic recoveries from the COVID-19-related downturn, with permanent GDP losses of 6%-7% for most major countries in the region. We see economies that have stronger policy support, such as Chile, having smaller permanent GDP losses. On the other end of the spectrum, we expect Mexico to have among the weakest economic recoveries in EMs from the pandemic for several reasons. First, the economy had structural weaknesses before the pandemic, with a mild contraction in 2019 due to unfavorable investment growth. Second, the policy response has been relatively small, with fiscal stimulus so far amounting to about 1% of GDP, mostly focused on direct transfers and with limited support to SMEs.
For more details on our Latin American macro assumptions, see "Latin American Economies Are Last In And Last Out Of The Pandemic," published on June 30, 2020.
|GDP Growth %|
|EM ex. China||4.0||2.6||(4.7)||5.9||4.6|
|f--S&P Global Ratings forecast. GDP--Gross domestic product. Source: Oxford Economics.|
|Changes In GDP Forecast From April 2020|
|EM ex. China||(2.9)||0.5|
|F--S&P Global Ratings forecast. GDP--Gross domestic product. Source: Oxford Economics.|
|Real GDP %|
|For India, 2019 = FY 2019 / 20, 2020 = FY 2020 / 21, 2021 = FY 2021 / 22, 2022 = FY 2022 / 23, 2023 = FY 2023 / 24. F--S&P Global Ratings forecast. GDP--Gross domestic product. Source: Oxford Economics.|
|CPI Inflation % (Year Average)|
|For India, 2019 = FY 2019 / 20, 2020 = FY 2020 / 21, 2021 = FY 2021 / 22, 2022 = FY 2022 / 23, 2023 = FY 2023 / 24. f--S&P Global Ratings forecast. GDP--Gross domestic product. CPI--Consumer price index. Source: Oxford Economics.|
|Unemployment % (Year Average)|
|f--S&P Global Ratings forecast. Source: Oxford Economics.|
|Policy Rates % (End Of Period)|
|f--S&P Global Ratings forecast. Source: Oxford Economics.|
|Exchange Rates % (End Of Period)|
|f--S&P Global Ratings forecast. End of Period - Q4 values. For India, 2019 = FY 2019 / 20, 2020 = FY 2020 / 21, 2021 = FY 2021 / 22, 2022 = FY 2022 / 23, 2023 = FY 2023 / 24. Source: Oxford Economics.|
- Credit Conditions Emerging Markets: Slow Recovery, Prevalent Risks, June 30, 2020
- Eurozone Economy: The Balancing Act To Recovery, June 25, 2020
- The U.S. Faces A Longer And Slower Climb From The Bottom, June 25, 2020
- The Global Economy Begins A Slow Mend As COVID-19 Eases Unevenly, June 1, 2020
This report does not constitute a rating action.
|Lead Economist, Emerging Markets:||Tatiana Lysenko, Paris (33) 1-4420-6748;|
|Senior Economist, Emerging Markets:||Elijah Oliveros-Rosen, New York (1) 212-438-2228;|
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