Large needs, few means: fiscal policy challenges in low-income countries

|

This page in:

Image
World Food Programme's food distribution. | Flickr Creative Commons, ©EC/ECHO/Anouk Delafortrie
Food insecurity has intensified and is concentrated in fragile- and conflict-affected low income countries.

The room to maneuver fiscal policy has narrowed in low-income countries (LICs) over the past decade. Since 2011, government debt in the average LIC has grown by 30 percentage points of GDP amid chronic revenue weakness and spending pressures. As a result, 14 out of the 28 LICs are now assessed as being in, or at high risk of, debt distress. Rising debt and chronically low revenues have constrained spending, especially on health and education—areas that the average LICs spent significantly less on than other Emerging Market and Developing Economies (EMDEs).

Development challenges in LICs

LICs are faced with formidable development challenges, which have been compounded by the pandemic, growing climatic vulnerabilities, and the effects of the Russian Federation’s invasion of Ukraine.  The pandemic reversed gains in poverty reduction, delayed progress toward the achievement of Sustainable Development Goals (SDGs), and widened gender disparities. About 4 out of 10 of the world’s extreme poor reside in LICs. The income per capita in LICs is projected to remain below its pre-pandemic trend in the next few years, adding to the existing development challenges and the number of poor (figure 1). Food insecurity has intensified and is concentrated in fragile and conflict affected LICs and those that have faced natural disasters. Adverse shocks such as extreme climate events and conflict are more likely to tip households into distress in LICs than elsewhere because of limited social safety nets.

Figure 1: Development challenges in LICs

Source: Integrated Food Security Phase Classification (IPC); World Bank.
Note:  A. The extreme poverty rate is measured as the share of people living on less than $2.15 per day. Per capita income is calculated as each group’s GDP divided by each group’s population. Dashed lines indicate per capita income assuming its growth rate equals to 2000-19 average after 2019. The sample excludes the Democratic Republic of Congo and Niger—both with over half of the population experiencing extreme poverty.  B. The number of people in food crisis is classified by the Integrated Food Security Phase Classification (IPC/CH) Phase 3, that is, in acute food insecurity crisis or worse.

Severely constrained fiscal resources

The near-doubling of LICs’ government debt (in percent of GDP) and interest spending (in percent of government revenue) since 2011 severely constrains these countries’ ability to address their development challenges. In the average LIC, government debt has risen since 2011 by 30 percentage points of GDP to 67 percent of GDP in 2022—its highest levels (outside 2020) since 2005 . Net interest spending in the average LIC has risen by 4 percentage points of government revenues to 10 percent of government revenue in 2022. The buildup was widespread among LICs: government debt rose in nine out of ten LICs. As a result, 14 out of the 28 LICs were assessed as being in debt distress or at a high risk of debt distress as of end-April 2023; this compared with six such LICs in 2015 (figure 2).  

The debt deterioration has mainly reflected chronic revenue weakness that translated into persistent fiscal deficits. In the average LIC, government revenues amounted to 18 percent of GDP during 2011-22, 11 percentage points of GDP below those of the average emerging market and developing economy (EMDE; figure 2). In part, this overall revenue weakness reflected a decline in grant financing for LICs, from 6.5 percent of GDP in 2011-15 to 2.7 percent of GDP in 2016-21.  

Figure 2: Fiscal policy challenges in LICs

A. LIC government revenues B. LICs in, or at risk of, debt distress
A bar chart showing Figure A. LIC government revenues
A bar chart showing Figure B. LICs in, or at risk of, debt distress
Source: International Monetary Fund, World Bank.
Note: LICs = low-income countries. Other EMDEs = non-LIC emerging market and developing economies. A. Bars (lines) show the unweighted average, with whiskers showing interquartile ranges. Based on up to 26 LICs. B. Number of LICs and other EMDEs in debt distress or at risk of debt distress, as of April 30, 2023.

Weaker social spending and spending efficiency

Chronically weak revenues also constrained spending. Compared with the average non-LIC EMDE, government spending was 10 percentage points of GDP lower during 2011-22. This shortfall compared to their peers particularly affected education and health spending: At 3.4 and 1.2 percentage of GDP, LICs’ spending on education and health, respectively, was statistically significantly weaker than in other EMDEs during 2011-21. By contrast, defense spending was broadly in line with that in other EMDEs. In fact, LICs spent about one-half more on defense (1.8 percent of GDP) than they spent on health (1.2 percent of GDP) (figure 3).  

In addition, every dollar spent was used less effectively in LICs than elsewhere. Since 2011, government spending efficiency has been statistically significantly weaker in LICs than in other EMDEs in most major spending categories and, especially, in infrastructure and health  (figure 3).

Figure 3: Composition and efficiency of government spending in LICs

A.  Expenditures on major spending categories, 2011–21 average B. Spending efficiency
A bar chart showing Figure A. Expenditures on major spending categories, 2011-21 average
A bar chart sowing Figure B. Spending efficiency
Source: Dabla-Norris et al. (2011); Herrero and Ouedraogo (2018); International Monetary Fund; World Bank.
Note: LICs = low-income countries. Other EMDEs = non-LIC emerging market and developing economies. *** shows the significance level at 1 percent, ** at 5 percent, and * at 10 percent. Unweighted averages for LICs and other EMDEs for each spending category in percent of GDP. A. Data for up to 26 LICs. B. Spending efficiency overall and for infrastructure is the Public Investment Management Index by Dabla-Norris et al. (2012); Spending efficiency for education and health is the output efficiency calculated by Herrero and Ouedraogo (2018).

Policy implications

Faced with large development needs, deteriorating fiscal positions, and shrinking grant finance, LICs need to prioritize a combination of policies, including domestic revenue mobilization, improved spending efficiency, and structural interventions to generate stronger growth . High debt levels require strengthened debt management and, in some cases, may warrant debt relief. These measures need to be embedded in domestic reforms to improve institutional frameworks, ease structural constraints, and address informality, and need to be supported by well-coordinated global policies to improve fiscal management, deal with illicit financial flows, and address emerging debt challenges.

Authors

Joseph Mawejje

Economist, Prospects Group, World Bank

Join the Conversation