and financial market fluctuations (Acevedo, Cebotari, and Turner-Jones 2013).<sup>1</sup> Natural disasters adversely affect fiscal balances and debt ratios by reducing economic growth and government revenues, and increasing government spending (Cabezon et al. 2019; Lee, Zhang, and Nguyen 2018; Melecky and Raddatz 2011). For example, it has been estimated that following an average hurricane shock, tax revenues in a sample of Caribbean small states dropped by up to 5.3 percent in the short-term because of reduced economic activity, especially in private consumption (Auffret 2003; Mohan and Strobl 2021). Revenues from transactions in goods and services and international trade are especially vulnerable to tropical storms—one of the most damaging kinds of shock faced by small island states (Mohan and Strobl 2021). After a disaster, higher government spending is needed to finance emergency relief efforts and reconstruction (Cabezon et al. 2019; Lis and Nickel 2009). These increases in government spending are sustained for at least two years after the shock (Ouattara and Strobl 2013). Tropical storms have also increased government debt in some small states, particularly to external creditors (Cavallo et al. 2024; Mohan and Strobl 2020).

Global recessions can significantly worsen countries’ fiscal positions, with debt ratios rising for up to five years after the start of a recession (Kose et al. 2021). During global recessions, pressure on real household incomes in advanced economies can lead to cuts in spending on international travel, on which many small states depend heavily. For example, the 2009 global recession significantly reduced government revenues in tourism-reliant Caribbean small states, contributing to sharp increases in their fiscal deficits (Mercer-Blackman and Melgarejo 2013). Global recessions are often associated with job losses or reduced wages in advanced economies, which can also decrease remittance flows to small states that rely on them, leading to reductions in consumer spending and consumption-based tax revenues. In addition, higher social spending is often required to support vulnerable groups during global recessions, exacerbating already strained public finances in small states.

Natural disasters and global recessions weaken small states’ fiscal and debt positions. An event analysis of global recessions and natural disasters since 2000 shows that both types of event significantly weaken fiscal balances and increase government debt, relative to GDP, in small states (figure 2).<sup>2</sup> For example, on average, large natural disasters are associated with a 0.7 percentage point deterioration in the fiscal balance and a 2.4 percentage points increase in the debt ratio in the year of the shock, with the deterioration of both measures continuing in the subsequent two years. Fiscal balances initially deteriorate even more in the year of a global recession, around 3 percentage points, on average, but the impact is less persistent than in the case of natural disasters. In the year of a global recession debt ratios rise by around 8 percentage points but then begin to

> 1 In contrast, over the past decade or so, small states have typically been less affected by other events such as domestic financial crises, armed conflict, and wars.

> 2 Alternative methods for the event analysis including regression analysis were explored but not used owing to data limitations.

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