The Sovereign Spread Compressing Effect of Fiscal Rules during Global Crises

Ergys Islamaj, Agustin Samano and Scott James Sommers

No 10741, Policy Research Working Paper Series from The World Bank

Abstract: Do fiscal rules help suppress sovereign spreads during periods of global financial stress Yes! This paper examines whether fiscal rules contribute to mitigating sovereign spreads in emerging markets and developing economies during periods of heightened financial and economic volatility worldwide. It finds that the presence of fiscal rules is statistically significantly associated with lower sovereign spreads during the COVID-19 crisis — about 350 basis points lower on average. Interestingly, this correlation persists even when nations deviate from these rules, indicating an expectation of post-crisis compliance. The study shows that deviations from fiscal rules are typically short-lived, with fiscal balance rules reinstated within 3.5 years. Robustness checks, including controls for institutional quality, fiscal rule strength, and global and regional factors confirm these results. Overall, the findings suggest that fiscal rules can help emerging markets and developing economies signal fiscal responsibility during episodes of global financial stress, reducing borrowing costs relative to countries without fiscal rules.

Date: 2024-03-28
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