Fiscal positions in small states, those with a population of 1.5 million or less, have deteriorated significantly over the past decade. The COVID-19 pandemic and subsequent global shocks have worsened fiscal and debt positions in small states, intensifying their existing fiscal vulnerabilities. Forty percent (14) of the 35 emerging market and developing economies (EMDEs) that are small states are at high risk of debt distress or already experiencing it, roughly twice the share for other EMDEs.
Despite recent fiscal consolidation efforts that have helped narrow deficits in some cases, the precarious fiscal positions of many small states pose increased risks to fiscal sustainability. These risks are likely to be exacerbated by a projected slowdown in growth for these countries this year and next.
Government debt in small states increased by about 11 percentage points of GDP between 2011 and 2023, reaching an average debt-to-GDP ratio of 61 percent in 2023, which is higher than in other EMDEs. Debt accumulation has been widespread, occurring in about 60 percent of small states.
About one-third of the debt build-up between 2011 and 2023 occurred after the onset of the COVID-19 pandemic, highlighting the economic and broader damage it inflicted. During the 2020 pandemic-induced recession, average debt levels for small states surged by 15 percentage points of GDP, far outpacing other EMDEs.
Additionally, natural disasters, such as a volcanic eruption in St. Vincent and the Grenadines in 2021, contributed to the increase in debt in some small states. Although average debt levels for small states have subsequently declined, they remain higher than on the eve of the pandemic.
Fiscal deficits and borrowing costs have been key drivers of the increasing debt burdens in small states. The sharp increase in the average debt-to-GDP ratio for small states between 2011 and 2023 is attributed to persistent primary fiscal deficits and interest costs, which together outweighed the debt-reducing impact of growth and other factors.
Debt drivers varied somewhat before and following the pandemic. From 2011 to 2019, solid growth was sufficient to offset primary deficits. In contrast, between 2019 and 2023, widening fiscal deficits outweighed the debt-reducing effects of growth, which had diminished due to pandemic-induced contractions in output and slow recoveries.
Forecasts for 2023-26 indicate that average government debt in small states will decrease by around 2 percentage points of GDP, with continued, albeit slower, growth expected to partially offset persistent primary deficits. However, even if this outcome materializes, average debt in small states, relative to GDP, would remain slightly above its pre-pandemic level.
The pandemic-induced recession severely worsened the already weak fiscal positions of small states. Between 2011 and 2023, small states’ primary deficits averaged 1.4 percent of GDP, with about 70 percent of them having primary deficits. Primary deficits in small states surged from an average of 0.6 percent of GDP before the pandemic (2011-19) to 3.3 percent of GDP in 2020-23. Despite narrowing since 2020, by 2023, the average primary deficit in small states, at 2.1 percent of GDP, was still substantially higher than it was on the eve of the pandemic, and more than double the average in other EMDEs.
Since the pandemic, higher government expenditures, and to a lesser extent, weaker revenues, have driven the increase in average primary deficits in small states more than in other EMDEs. About three-quarters of the increase in primary deficits in small states between 2011-19 and 2020-23 is attributed to higher spending and the remainder to lower revenue.
Spending in small states rose by 4 percentage points of GDP from 2019 to 2020, reflecting a sharp GDP contraction and increased expenditures to address the pandemic’s economic effects. In comparison, spending in other EMDEs increased by 2.6 percentage points during the same period. Although small states’ expenditures returned to pre-pandemic levels by 2022, they remained significantly higher at 41 percent of GDP in 2023, compared to 28 percent in other EMDEs.
The pandemic had a delayed but lasting negative impact on small states’ revenues, leading to a nearly one percentage point of GDP drop from 2019 to 2023, reflecting a sharp economic downturn and slower recoveries. By contrast, revenues in other EMDEs increased by one percentage point during the same period.
In summary, worsening fiscal and debt positions in small states, coupled with increased vulnerability to external shocks, including from climate change, and the need to address long-standing development needs, demand action through both domestic policy measures and international support. These policies are discussed in Chapter 4 of the latest Global Economic Prospects report.
Source:blogs.worldbank.org