# **I. Introduction**

Commodity-exporting emerging markets and developing economies (EMDEs) face significant fiscal challenges: Government debt in these countries has grown rapidly over the past decade—from about 33 percent of GDP in 2010 to about 60.9 percent in 202, on average. Over the same period, their primary fiscal deficit (which does not include interest payments) averaged about three times that of commodity importers. Increased spending during the pandemic amplified the challenges confronting commodityexporting EMDEs. The higher cost of servicing elevated debt levels, coupled with weaker growth prospects, is increasing the risk of debt distress among some of these economies (World Bank 2023). Along with the wide swings in commodity prices in recent years, these developments have brought to the fore the complex task of formulating fiscal policy in these economies (Figure 1.A).

The main challenge faced by policy makers in commodity-exporting countries is coping with the swings in commodity prices. Commodities are important sources of export and fiscal revenues for almost two-thirds of EMDEs, including three-fourths of low-income countries (LICs) (Figures 1.B and 1.C; World Bank 2022). Shocks to commodity prices are often large and persistent. Commodity prices have undergone frequent cycles over the past five decades, with the average cycle lasting almost six years (Figure 1.D). Price slumps, on average, lasted somewhat longer (39 months) than booms (30 months), with prices falling and rising by 1 to 4 percent per month over the course of the average cycle, respectively (World Bank 2022).

Commodity dependence makes it harder for policy makers to formulate appropriate fiscal responses to commodity price fluctuations. Fiscal policy tends to be more procyclical—that is, expansionary in good times and contractionary in bad times—in commodity-exporting EMDEs than in other EMDEs.<sup>2</sup> In <mark>commodity-exporting EMDEs, rising commodity prices can lead to procyclical increases in public spending and tax cuts. Conversely, declines in commodity prices can trigger procyclical tax increases and cuts in public expenditures as a result of reduced revenues from commodity production and exports. Moreover, because tax cuts and increases in public spending are generally easier to implement and more difficult to reverse, politically, than tax increases and reductions in public spending, government deficits and debt positions tend to ratchet up, deteriorating from cycle to cycle. This secular deterioration, in turn, will make it more difficult to implement countercyclical fiscal policy in bad times. In sum, the procyclical tendency of fiscal policy in commodity exporters can m</mark> agnify <mark>the impact of commodity price movements on economic activity, lead to inefficient stops-and-starts in government investment and in the provision of government services, and introduce a bias toward a deterioration in fiscal positions.</mark> Fiscal policy also tends to be more volatile in commodity-exporting EMDEs than in other EMDEs. Swings in commodity prices often result in highly volatile commodity-related fiscal revenues in these countries, leading to more volatile business cycles, which historically move in tandem with commodity price cycles.<sup>3</sup> Over the past three decades, output volatility in commodity-exporting EMDEs was more than double that in commodity-importing ones. <mark>Revenues derived from the commodity sector are also prone to policies associated with rent-seeking behavior. In addition, fiscal policy volatility can act as a transmission mechanism for the “resource curse”—the term coined to describe how commodity abundance,</mark> if not

> 2 See Kaminsky, Reinhart, and Végh (2004) and <mark>Talvi and</mark> Vég <mark>h (2005)</mark> for early contributions to empirical research on the procyclicality of fiscal policy. More recent contributions include Carneiro and Garrido (2016), Frankel, Végh, and Vuletin (2013), and Richaud et al. (2019), as well as studies documenting evidence for select groups of commodity-exporting countries, including Bova, Medas, and Poghosyan (2016) and Céspede <mark>s and Velasco (2014).</mark>

> 3 See IMF (2015a); Jacks, O’Rourke, and Williamson (2011); Richaud et al. (2019); and World Bank (2009, 2020, and 2022).

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