Overcoming Fiscal Pressures: Strengthening Economic Resilience in Low-Income Countries

The World Bank's report highlights the severe fiscal challenges facing low-income countries, marked by rising debt, widening deficits, and revenue mobilization difficulties. It emphasizes the need for strengthened domestic resource management, improved expenditure efficiency, and international support to address these vulnerabilities.

The World Bank's report delves into the financial challenges facing low-income countries (LICs), which account for a small portion of global output but a significant share of the world's poor population. Compiled by economists including Joseph Mawejje under the World Bank’s Prospects Group, this study sheds light on the precarious fiscal situations in LICs, worsened by a combination of external shocks and systemic weaknesses. LICs, representing over 10 percent of the global population, have seen their fiscal positions deteriorate sharply in recent years due to escalating debt, rising deficits, and challenges with revenue collection. The onset of the COVID-19 pandemic, followed by overlapping global crises, has only worsened the fiscal outlook in these countries, delaying progress towards development and widening the income gap with other economies.

Escalating Debt and Widening Deficits

By 2023, the average debt-to-GDP ratio in LICs had risen to 72 percent, marking a significant increase of nine percentage points in just one year, and the highest annual surge in over two decades. This increase has been driven largely by fiscal deficits, which have widened significantly in recent years. LICs, which previously maintained a deficit of around 1.2 percent of GDP in 2019, saw this figure balloon to 2.4 percent in 2023, with deficits playing a significant role in driving up government debt. The global economic downturn exacerbated this situation, pushing LICs further into financial distress. Interest payments on government debt now consume over 10 percent of government revenues, the highest in two decades, further limiting the fiscal space available for investment in critical sectors like health, education, and infrastructure.

Revenue Mobilization Challenges

Revenue mobilization remains a persistent challenge for LICs. On average, these countries have been able to collect only about two-thirds of their potential tax revenues. Structural impediments, such as underdeveloped financial sectors, high levels of informality, and inadequate tax collection systems, have significantly hampered efforts to raise sufficient revenues. Informality, which accounts for an estimated 37 percent of economic activity in LICs, undermines tax collection efforts and reduces the fiscal base. This is exacerbated by ineffective tax exemptions and subsidies, which absorb a significant share of revenues. Fuel subsidies alone, for example, cost LICs an estimated 2 percent of GDP on average in 2022, which is often higher than government spending on health. Furthermore, public sector inefficiencies, such as high defense spending and bloated government wage bills, crowd out growth-enhancing investments in human capital development and infrastructure.

Vulnerability to Global and Domestic Shocks

LICs' fiscal positions are particularly vulnerable to global and domestic shocks. Global recessions tend to have a severe impact on these countries, leading to an average deterioration in fiscal balances by 1.7 percentage points of GDP in the year of the recession, with the effects lasting for two years. For commodity-exporting LICs, reduced demand for commodities during global recessions leads to sharp declines in fiscal revenues, which are compounded by falling remittances and lower development assistance. Similarly, domestic armed conflicts take a heavy toll on fiscal positions, with conflicts typically causing fiscal balances to deteriorate by 1–1.5 percentage points of GDP. Conflicts disrupt economic activity, destroy physical and human capital, and increase military spending, further weakening the fiscal health of these nations. In addition to these challenges, climate-related natural disasters are becoming more frequent and severe, imposing significant economic costs on LICs, whose adaptation capacities are limited.

Strategies for Fiscal Strengthening

Given the deteriorating fiscal landscape, LICs must adopt strategies to strengthen domestic resource mobilization, improve expenditure efficiency, and manage rising debt levels. In terms of resource mobilization, LICs need to reform their tax policies and administration systems to broaden the tax base and enhance compliance. Strengthening institutions, upgrading information technology in tax systems, and curbing tax exemptions can all contribute to increased revenue collection. Improving expenditure efficiency is another critical area, focusing on reallocating resources toward more productive sectors like health, education, and infrastructure. Reducing wasteful subsidies and controlling the public sector wage bill can free up resources for these priority areas. Additionally, LICs must establish robust fiscal frameworks, such as fiscal rules and stabilization funds, to smooth revenue and expenditure fluctuations over time. These frameworks can help insulate LICs from the volatility caused by external shocks and build fiscal space for future investments.

The Role of Debt Management and International Support

Debt management is also a top priority, given the high government debt levels across LICs. Effective debt management practices, such as transparent reporting of public debt and the use of sovereign wealth funds, can help LICs reduce debt vulnerabilities. The World Bank underscores the importance of international support in addressing these challenges. External concessional financing, debt relief, and technical assistance are essential for helping LICs stabilize their fiscal positions. The international community, including organizations like the International Development Association (IDA), must continue to support LICs through financial assistance and capacity-building initiatives to ensure that these countries can pursue sustainable development goals while managing fiscal risks.