Fiscal Challenges in Small States: Weathering Storms, Rebuilding Resilience

Samuel Christopher Hill and Jeetendra Khadan

No 10913, Policy Research Working Paper Series from The World Bank

Abstract: The COVID-19 pandemic and the global shocks that followed have worsened fiscal and debt positions in small states, intensifying their already substantial fiscal challenges—especially the need to manage more frequent climate change–related natural disasters. Forty percent of the 35 emerging market and developing economies (EMDEs) that are small states are at high risk of debt distress or already in it, roughly twice the share for other EMDEs. Larger fiscal deficits since the pandemic reflect increased spending to support households and firms, and weaker revenues. To improve their fiscal sustainability and resilience to future shocks, small states need to strike a balance between maintaining adequate fiscal buffers and increasing investments in human capital and climate change–resilient infrastructure. Comprehensive fiscal reforms are essential. First, small states’ revenues, which are highly volatile and dependent on sometimes unreliable sources, should be drawn from a more stable and secure tax base. Second, spending efficiency needs to be improved, especially on transfers to public enterprises, subsidies, and the public wage bill. Third, these changes should be complemented by reforms to fiscal frameworks, including better utilization of fiscal rules and sovereign wealth funds. Finally, to help these countries stay on sustainable fiscal paths, well-coordinated and targeted global policies are also needed. Policies supported by the global community can help to improve fiscal policy management, provide technical assistance, address debt challenges, and bolster funding for small states to invest in climate change resilience and adaptation, and other priority areas.

Date: 2024-09-17
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