Market Reforms Can Stabilize Debt and Foster Growth in Developing Countries

IMF Blog, September 12, 2023

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Countries that enacted reforms saw their debt-to-GDP ratios fall by 3 percentage points, on average, over a multi-year period.
Major changes in regulations are associated with a 3 percentage point reduction in the ratio of debt to gross domestic product.
Improved market functioning lowers the debt ratio both by increasing GDP (the denominator effect) and by strengthening public finances through higher tax revenues and lower borrowing costs.
The estimated effect of major market reforms is comparable to the effect of major fiscal consolidations described in recent IMF work.

Analysis draws on the IMF Structural Reform Database, covering 90 advanced and developing economies over the past four decades.
The context includes multiple shocks to the global economy in the past three years that have affected emerging markets and developing economies.

Higher tax revenues resulting from improved economic activity can offset revenue losses directly linked to some reforms.
Narrower sovereign debt spreads reflect improved investor confidence following reforms.
Reforms boost economic output by improving how markets work in five broad areas: trade, domestic finance, external finance, product market, and labor market.
Some reforms (for example, lowering trade barriers) may reduce tax revenue in the short term (e.g., scrapping tariffs) and could temporarily increase debt, with potential partial offset in the longer term through increased economic activity.

Debt reduction associated with reforms is larger when:
- governments are better at collecting taxes;
- initial debt levels are higher;
- reforms are implemented during an economic expansion.
Reforms do not guarantee debt reduction in every circumstance; outcomes vary by country conditions.
Increased government spending historically has dampened gains from reforms, as developing countries have sometimes used fiscal gains to fund other policy initiatives.
Political dynamics during implementation can limit fiscal gains from reforms.

Direct fiscal gains from reforms based on countries’ initial debt burdens and potential inequality effects:
- Decide whether fiscal gains should be directed toward debt reduction, growth-friendly spending, or income inequality concerns.
Improve efficiency in tax collection to enhance gains from an enlarged tax base; for example, invest in digital infrastructure to strengthen revenue mobilization and improve spending efficiency.
Exercise fiscal discipline in the use of reform-related fiscal gains to ensure reforms successfully reduce debt ratios.
Design reforms recognizing short-term fiscal trade-offs (e.g., tariff reductions) and potential longer-term benefits to economic activity and revenues.

Market reforms are essential to improve how markets work and spur long-term growth.
Such reforms also have important potential to help countries navigate the balancing act of supporting growth while stabilizing debt that many emerging market and developing economies currently face.

Based on the staff discussion note “Market Reforms and Public Debt Dynamics in Emerging Markets and Developing Economies.”

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