What options do emerging market policymakers have? – Part two

Summary

With emerging market economies, in our view, most vulnerable to the global economic and policy landscape in 2025, we continue our series of reports on policy response options by examining fiscal policy space (i.e., capacity for governments to deploy fiscal stimulus). Similar to our work on monetary policy space, we built a framework to analyze public finance positions. Our framework is designed to identify countries that can deploy fiscal stimulus without experiencing major financial market or economic consequences. In short, most developing economies do not have adequate space for fiscal stimulus, complicating growth prospects across the emerging markets. Despite constrained policy space, select governments—such as in Brazil and Mexico—may pursue looser fiscal policy, which in our view, risks local financial market stability.

Worsening public finances complicates fiscal policy space

In Part I of this series of reports on policymaker options in the emerging markets, we made the point that emerging market economies are particularly vulnerable to the 2025 global economic and policy landscape. We pointed out how, in our view, the global growth environment is likely to be lackluster this year due to expected Trump administration tariffs, levies that emerging nations are particularly sensitive to. Part I also highlighted that central banks across the developing markets may not have adequate monetary policy space to lower interest rates by enough to materially offset the economic impact of tariffs. As of now, our monetary policy space framework indicates that only select institutions can cut interest rates multiple times without experiencing severe negative financial market and economic consequences (i.e., FX depreciation, renewed inflationary pressure, financial instability, etc.). Less-than-adequate central bank capacity for lower interest rates means policymakers have to rely on other forms of policy intervention to support economic growth. In that sense, support mechanisms will need to come in the form of more expansionary fiscal policy. But, is looser fiscal policy an option finance ministers can pursue? Public finance positions have worsened over time as debt burdens have risen and fiscal balances have shifted deeper into deficit. To that point, in aggregate, the emerging market sovereign fiscal deficit has widened from 2.3% of GDP in 2010 to over 5.5% of total emerging economy economic output at the end of last year. Similar trends exist for the sovereign debt burden as debt levels have jumped from 37% of GDP immediately after the Global Financial Crisis to 70% of GDP at the end of 2024.

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