London: New estimates of supply-side potential GDP growth over the next five years highlight the importance of demographic factors and investment rates and place India at the top of the list among the ten largest emerging markets (EMs) covered in Fitch Ratings’ Global Economic Outlook (GEO) forecasts.
India’s projected potential growth is 6.7% per annum (p.a.). China and Indonesia jointly rank second-highest, both with projected potential growth of 5.5% p.a. The estimate for China represents a significant slowdown from recent historical average growth and reflects both a deteriorating demographic outlook and a slowdown in the rate of capital accumulation as the investment rate has declined. Broader measures of productivity growth in China have also slowed since the late 2000s.
Turkey’s potential growth rate is also projected to be rapid at 4.8% p.a. but this hinges crucially on continued high investment rates, which could be vulnerable to a sustained slowdown in capital inflows.
Potential growth in Mexico, Poland and Korea is projected to be lower, in the 2.5% to 3% p.a. range, while South Africa, Brazil and Russia are expected to see supply-side growth potential below 2% p.a. over the next five years.
“Population dynamics are a key supply-side growth driver. For countries such as Mexico and Brazil, and to a less extent South Africa, population growth has been the main or the sole engine of GDP growth historically,” said Brian Coulton, Chief Economist at Fitch.
India in particular, but also Indonesia, Mexico, Turkey and Brazil are set to see continued robust growth in the working-age population in the next five years, bolstering GDP growth potential. In contrast, in Russia, Poland, China and Korea headwinds from deteriorating demographics will sharpen and weigh on growth.
Nevertheless, rising labour force participation rates give some grounds for encouragement as they can be a powerful offset to decelerating working-age population growth. For instance, the participation rate has risen steeply in Russia, Korea and Poland over the last 10 years or so.
Capital accumulation and investment also have a crucial role in boosting GDP growth.
“China has been the standout country with the highest investment-to-GDP ratio and fastest growth in the capital stock per worker, allowing it to record the strongest improvements in labour productivity and GDP growth over the last three decades,” added Maxime Darmet-Cucchiarini, Associate Director at Fitch’s Economics team.
“However the extremely rapid rise in the investment rate in China after 2008 was associated with a decline in total factor productivity growth”, added Darmet-Cucchiarini.
India and, to a lesser extent, Turkey have also seen an impressive rate of capital accumulation per worker, but in the latter's case this has been funded externally, with associated downside risks. In contrast, in Brazil, Mexico and South Africa, the growth in capital per worker has historically been much more muted. This has weighed on the growth rate of living standards.
Total factor productivity (TFP) growth – which captures improvements in the efficiency of the production process – has been subdued in the large EM’s in recent years, slowing across virtually all the countries covered in the report. This reinforces the importance of accelerating structural reforms to enhance convergence with advanced economy productivity levels.
China, along with Indonesia more recently, have seen the best TFP growth historically and both have made good progress since 2009 in enhancing governance, on the basis of the World Bank's ease of doing business and rule of law measures. By contrast, Turkey, Brazil, Russia, South Africa and Mexico have seen lacklustre TFP growth. India’s TFP performance has also been surprisingly weak given its low level of GDP per capita, while Korea has been the mirror image with strong TFP growth over the last 20 years despite already high income levels.