Developing countries need to rebuild fiscal space to weather growth slowdowns

Faced withweaker export prospects, an impendingrise in global interest rates, and fragile financial market sentiment, developing countries need to rebuild fiscal buffers to support economic activity in case of a growth slowdown, says the new edition of Global Economic Prospects,released today by the World Bank Group. For many developing economies, lower oil prices have provided a timely opportunity for doing so.

In countries with elevated domestic debt or inflation, monetary policy options to deal with a potential slowdown are constrained. In the foreseeable future, these countriesmay need to employ fiscal stimulus measures to support growth.But many developing countries have less fiscal space now than they did prior to 2008, having used fiscal stimulus during the global financial crisis. Andin recent years, private debt levels have risen substantiallyin some developing countries.

A key finding from the analysis in the reportis that in countries where debt and deficits have widenedfrom pre-crisis levels, each fiscal dollar spent on activities designed to boost consumption and national incomewill haveroughly a third less impact than it did in the run-up to the global financial crisis.Because the so-called fiscal multiplier effect is weaker now for many developing countries, they need to rebuild budgets in the medium-term, at a pace determined to country-specific conditions. For a number of oil-importing countries, lower oil prices offer a chance to improve fiscal positions more quickly than might have been possible before mid-2014.

“With oil likely to remain cheap for some time, oil-importing countries should lower oreven eliminate fuel subsidies and rebuild the fiscal space needed to carry out futurestimulus efforts. On the policy front, both the size and the quality of fiscal deficits matter, as do spending decisions. Emerging market economies would do well to invest in infrastructure and support social schemes vital to poverty reduction. Such policies can raise future productivity and reduce the fiscal deficit in the long run,” said KaushikBasu, Senior Vice President and Chief Economist at the World Bank."This year’s Global Economic Prospects now goes beyond prediction and deepens ourunderstanding of our global economic predicament."

The report documents how well-designed and credible institutional mechanisms—such as fiscal rules, stabilization funds, and medium-term expenditure frameworks—are instrumental in fostering growth and restoring depleted fiscal buffers.

“Therebuilding of fiscal buffers will provide the room required to support activity during times of economic stress. The need for additional fiscal buffers is more pronounced now in an environment of uncertain growth prospects, limited policy options, and likely tighter global financial conditions,”saidAyhanKose, Director of Development Prospects at the World Bank.

The study on fiscal space is available at www.worldbank.org/globaloutlook