A Closer Look at Fiscal Space in Climate Vulnerable Developing Countries

Whether or to what degree climate-vulnerable developing countries have fiscal space is a key question confronting the international public finance community today.

new technical paper by Toby Melissa C. Monsod, Mary Anne Majadillas and Maria Socorro Gochoco-Bautista for the Task Force on Climate, Development and the International Monetary Fund studies the availability of fiscal space among a sample of climate-vulnerable developing countries from the Vulnerable Group of 20 (V20) membership who speak of being poised to undertake urgent climate adaptation and transition investments but describe being restricted by “narrow fiscal space.” The authors suspect that many governments are unable to maneuver not because of “narrow fiscal space” but because of a so-called “financial death trap,” whereby developing country governments are pushed into default, not out of bad faith or because of long-term insolvency, but for lack of cash on hand. The researchers estimate debt limits per country, reflective of a country record of fiscal adjustment consistent with long-term solvency, and find that with few exceptions, fiscal space is fairly ample. They also find that economies may be converging to long-run debt ratios that are in the vicinity of International Monetary Fund Debt Sustainability Framework (IMF-DSF) debt thresholds, confirming that IMF-DSF thresholds should not be construed as limits to fiscal space per se, and suggesting that the differences between our estimated debt limits and IMF-DSF thresholds— which are substantial—represent an opportunity cost that arises when otherwise solvent governments cannot mobilize funds in the immediate-term for important long-term, climate-related investments.

Overall, these findings imply that governments with ample fiscal space should be afforded a second look and perhaps be supported by lenders, particularly if they have well-articulated climate adaptation and resilience investment plans, which promise large multiplier effects, since growing the economy in a sustainable way also contributes to debt sustainability. The findings also suggest that actions to obviate the financial death-trap are warranted, if indeed otherwise solvent, able and ready governments are unable to access required finance for urgent climate investments, since the opportunity costs of letting things be cannot be insignificant to either individual economies or the global community. These results should also encourage climate vulnerable governments, who are not quite ready with fitting climate-aligned investment plans, to endeavor to complete these, so that their fiscal space can be leveraged for sustainable development.