Fiscal space watch: No time to sit on laurels

Amid weakening growth prospects and tightening global financial conditions, most emerging market and developing economies have limited fiscal space and greater exposure to international risk sentiment than before previous episodes of financial stress. In more than 80 percent of these countries, government debt is now higher than before the 2008-09 global financial crisis. Many of these economies need to urgently improve fiscal positions within credible medium-term fiscal plans and tilt borrowing towards longer maturities and domestic currency.

Emerging market and developing economies (EMDEs) saw their fiscal space eroded significantly during the COVID-19 pandemic (Global Economic Prospects 2021). In the subsequent strong growth rebound of 2021, their fiscal positions improved. However, they now face a considerable risk of financial market stress accompanied by a sharp global downturn as major advanced-economy central banks increase policy interest rates to bring inflation back to target from multi-decade highs (Global Economic Prospects 2022; “Global Stagflation,” Discussion Paper, Centre for Economic Policy Research, London, 2022). Economic slowdowns may need to be smoothed with fiscal support measures and rising borrowing costs and currency depreciations may test governments’ ability to fund financing needs on sustainable terms.

An analysis based on the World Bank’s latest update of the Cross-Country Database of Fiscal Space suggests reasons for concern about many EMDEs’ ability to weather the next financial shock (“A Cross-Country Database of Fiscal Space”, Journal of International Money and Finance, 2022). […]