commodity‐exporting EMDEs have limited monetary policy space as inflation is already above target (Figure 17). A number of commodity‐importing EMDEs (especially in Central and Southeastern Europe, and in South and East Asia) have below‐target inflation and thus have some room to counteract shocks with further interest rate cuts. However, this room may narrow once monetary policy tightens in major advanced economies.

EMDEs typically have less developed financial systems than AEs, which limits the transmission of monetary policy. EMDE policymakers face a variety of challenges that differ significantly from those facing their counterparts in AEs: a susceptibility to rapid reversals in capital flows and the risks of contagion and full‐ blown financial crises; a limited influence on global markets combined with time‐varying external credit constraints; generally limited ability to borrow internationally in domestic currency; the management of generally large international reserves; and higher degree of pass‐through from exchange rate fluctuations to domestic prices (Chinn 2014; Mishra et al. 2014).

# **6.3 Structural reforms**

The environment for EMDE investment growth is likely to remain challenging. AE growth is expected to remain subdued. Commodity prices are forecasted to rise only very gradually as excess supply, accumulated with strong pre‐crisis investment in natural resources, is unwound slowly (World Bank 2016a). As monetary policy in AEs is expected to gradually normalize over the next few years, financing conditions could tighten and capital flows to EMDEs may ease. To offset these challenges, sustained improvements in the business climate and labor and product markets are needed to stimulate private investment.

Efforts to increase public investment are most effective in stimulating private investment and growth when implemented in a conducive business environment. Improvements in the business climate can both stimulate investment (domestic and FDI) and amplify the crowding‐in effects of public and foreign direct investment—in addition to indirect benefits through higher growth, less informality, and more dynamic job creation (Didier et al. 2015).<sup>15</sup> Business climate improvements include various areas. Lower startup costs are associated with higher profitability of incumbent firms, greater investment in information and communications technology, and more beneficial effects of FDI for domestic investment. Reforms to reduce trade barriers can encourage FDI and aggregate investment (Appendix 5). Corporate governance and financial sector reforms can improve the allocation of resources, including capital, across firms and sectors. Labor and product market reforms that increase firm profitability can encourage investment. Stronger property rights can encourage corporate and real estate investment. Improved access to power supplies can increase firm investment and productivity.

The panel regression aforementioned suggests that past major reform spurts in EMDEs have been associated with higher investment growth. This is also apparent in an event study of large spurts and setbacks in reforms among 97 EMDEs during 1996‐2015 (Figure 19). In the period of the Great Moderation, about half of governance spurts occurred in commodity importers. Details of the approach are discussed in Annex 2E. Reform spurts were associated with significantly higher (by more than 4 percentage points) investment growth, on average, in the period of the reform.

> 15 For the linkages between these reform measures and investment growth, see Reinikka and Svensson (2002); Field (2005); Wacziarg and Welch (2008); Schivardi and Viviano (2011); Munemo (2014); Corcoran and Gillanders (2015); Calcagnini, Ferrando, Giombini (2015); and Andrews, Criscuolo and Gal (2015).

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