policy frameworks and calibrate international reserves, particularly in economies that have experienced rapid increases in debt and have become more exposed to debt-rollover risks, currency volatility, or spikes in interest rates. Countercyclical macroeconomic policies and financial stability can lean against pro-cyclical fluctuations in capital flows. EMDE policymakers must also prepare for spillovers from disorderly market adjustments and policy shocks in advanced economies.

# 2.1 Shore up fiscal positions

Since 2007, government debt in the average EMDE has increased by 10 percentage points of GDP, reaching 54 percent of GDP at end-2018 (Figure 1). The increase was broadbased, with debt rising in three-quarters of EMDEs and all regions experiencing higher average debt. The largest increases in average government debt occurred in Europe and Central Asia (ECA) (from a low base), the Middle East and North Africa (MNA), and Latin America and the Caribbean (LAC). Debt rose by more than 20 percentage points of GDP in one-third of EMDEs. The rapid accumulation of debt was due to a significant shift in fiscal policy from 2007: fiscal deficits widened substantially in the post-crisis period and reached a peak in 2016, particularly in commodity-exporting countries that suffered from falling commodity prices. As a result, many EMDEs have deficits well in excess of debt-stabilizing levels, particularly those in South Asia (SAR), LAC, and Sub-Saharan Africa (SSA). This has also been reflected in credit rating downgrades for many EMDEs.

Large fiscal deficits and elevated levels of government debt may constrain the ability of policymakers to respond to a downturn. There is also evidence that government stimulus tends to be less effective when debt is elevated (Brinca et al. 2016; Hagedorn, Manovskii, and Mitman 2019; Huidrom et al. 2016, 2019; Huidrom, Kose, and Ohnsorge 2018). Policymakers need to take steps to improve fiscal positions and sustainability to ensure they are able to take effective action in response to the next downturn.

For those EMDEs that need to achieve more sustainable fiscal positions, policies need to be geared towards minimizing the negative short-term consequences of fiscal consolidation for economic activity; current economic conditions permitting. This requires safeguarding critical poverty-reducing expenditures, implementing growth-enhancing spending, and implementing tax reforms that promote investment and revenue mobilization (Ramey 2019; World Bank 2019a; Gaspar, Obstfeld and Sahay 2016).

In many EMDEs, weaknesses in revenue collection and mobilization are an important part of the problem. Revenues in EMDEs averaged 29 percent of GDP in 2018, 10 percentage points of GDP below those of advanced economies. They were particularly low in Low-Income Countries (LICs), SSA and SAR. Part of this reflects large informal economies where labor market participants are poor and collecting taxes is difficult, requiring complementary policies that address the challenges of informality but do not undermine its advantages with regard to flexibility and employment. The informal sector accounts for about one third of GDP in EMDEs and is largest in SSA, LAC, and ECA, while informal employment is most common in SSA and SAR (World Bank 2019b). In EMDEs with the most pervasive informal sectors, government revenue is 5-10 percentage points of GDP lower than in those with the least pervasive informal sectors (World Bank 2019b).