Emerging Economies Need To Rebuild Fiscal Space To Weather Growth Slowdowns

By The World Bank

Faced with weaker export prospects, an impending rise 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 countries may 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. And in recent years, private debt levels have risen substantially in some developing countries.

A key finding from the analysis in the report is that in countries where debt and deficits have widened from pre-crisis levels, each fiscal dollar spent on activities designed to boost consumption and national income will have roughly 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 or even eliminate fuel subsidies and rebuild the fiscal space needed to carry out future stimulus 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 Kaushik Basu, Senior Vice President and Chief Economist at the World Bank. “This year’s Global Economic Prospects now goes beyond prediction and deepens our understanding 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.

“The rebuilding 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,” said Ayhan Kose, Director of Development Prospects at the World Bank.

Read the full report from The World Bank: Having Space And Using It: Fiscal Policy Challenges In Developing Economies – Global Economic Prospects, January 2015

Courtesy of The World Bank, © 2015 The World Bank Group, All Rights Reserved