2023 reflected rising primary fiscal deficits and interest costs, which together outweighed the debtreducing effects of real growth and other factors (figures 5 and 6). In countries where the debt ratio increased, the contribution from fiscal deficits varied, but in most cases it was greater than onehalf. However, 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 overwhelmed the debt-reducing effects of growth, which shrank on account of the pandemic induced contractions in output and slow recoveries.

Between 2023 and 2026, average government debt in small states is projected to moderate by around 2 percentage points to 58 percent of GDP, supported by economic growth that is expected to partially offset persistent primary deficits. In most countries, projected growth over this period exceeds the pre-pandemic average, reflecting tailwinds from the pandemic recovery. If growth falls short of expectations, however, there is a risk of weaker fiscal outcomes. Even if the projections materialize, average debt in small states, relative to GDP, would remain a little above its pre-pandemic level.

# **3.5 Reliance on official creditors**

Governments in small states have limited access to borrowing from domestic or foreign private sources, so they often rely heavily on official sources (World Bank 2023a, 2023d). Reflecting their considerable development challenges, 14 of the 35 small states are eligible for concessional financing through the World Bank’s International Development Association (IDA), with an additional seven classified as IDA-blend countries. Reliance on official borrowing reflects generally low creditworthiness and underdeveloped domestic financial systems—particularly in the smallest and poorest economies and in fragile and conflict-affected small states. Government borrowing from private sources is often reliant on local commercial banks. Several factors influence the ability of governments to borrow from private creditors, including a country’s macroeconomic stability and a government’s record in meeting its financial obligations (Reinhart, Rogoff, and Savastano 2003). The debt-carrying capacity of small states tends to be smaller than that of other EMDEs, partly reflecting structural constraints on economic growth and susceptibility to external shocks (World Bank 2023b). This is underscored by the fact that higher risk ratings from debt sustainability analyses are on average triggered at lower debt levels in small states than in other EMDEs.

On average, in 2022, small states owed around 90 percent of their external public debt to official creditors, more than they did on the eve of the pandemic—and well above the 75 percent average share for other EMDEs. A little less than half of small states’ external debt is owed to multilateral creditors. The remaining approximately 40 percent is owed to bilateral creditors including a diverse mix of Paris and non-Paris Club members, the latter including notably China. In some small states, loans owed to Chinese entities account for a substantial share of total external debt (Horn, Reinhart, and Trebesch 2021).<sup>3</sup> The large share of official borrowing reduces rollover risks and enables

> 3 According to estimates by Horn, Reinhart, and Trebesch (2021), external debt owed to China as a share of GDP exceeded 25 percent in three small states: Djibouti, Maldives, and Tonga.

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