By: Staff Writer
October 6, 2023
Budget constraints have Latin American and Caribbean (LAC) countries scrambling to make reforms to address the strain on public spending, but the World Bank says strong growth can be the pathway forward out of the rigid budgetary dilemma.
The World Bank, in its latest report on budget rigidities in Latin America and the Caribbean, also said: “In recent years, budget rigidities have become more relevant to policy makers in the region because tools for fiscal adjustment used in the past are no longer available. With lower inflation, governments have lost a revenue source and a mechanism to reduce in real terms nominal debt and other contracts.
The World Bank’s report recommended strategies for overcoming these challenges and fostering more dynamic and inclusive societies in LAC. It advocated for digital connectivity and improved agricultural policies as key measures to make existing sectors cleaner and more productive.
The digital connectivity approach is seen as a potential driver of economic growth by opening up new avenues for innovation and productivity. On the other hand, refined agricultural policies could enhance efficiency in one of the region’s most critical sectors, contributing to cleaner production methods and potentially creating more jobs.
Many Latin American countries are facing daunting fiscal challenges following a considerable surge in debt–to–gross domestic product (GDP) ratios in recent years, particularly during the pandemic years of 2020-2022.
The report also said: “Governments in LAC seem unable to initiate fiscal consolidation, in contrast with other regions. Although Organisation for Economic Co-operation and Development countries have already gone through successful fiscal consolidation processes, in Latin America, fiscal deficits have increased.
“A significant portion of the increase in fiscal deficits in South America can be explained by higher spending levels. Additionally, fiscal pressures continue to build because of population aging (in some cases) and the need to invest in human and physical capital to foster long-term growth.”
Budget rigidities are constraints that limit the ability of the government to change the size and structure of the public budget in the short term. Budget rigidities stem from different institutional arrangements and therefore can take different forms
Rigidities play a critical role in determining how a country can recover from economic shocks. Following such shocks, it is crucial that governments can return quickly to normal spending and revenue levels, and this is where rigidities become important. With large rigidities, spending and revenue shocks are more likely to push governments into default than with small rigidities. The authors show how rigidities affect the tail risk of government debt (that is, the probability of default under rare and extreme circumstances). Rigidities can have large effects on tail risk even if their effect on expected revenue and expenditure streams is small.
The report continued, “Many countries in Latin American need to (and can) tackle rigid expenditures to be able to adjust public finance and put their debts on a sustainable path. This calls for urgent action, as many countries in the region are facing worrisome fiscal challenges due to surging debt-to-GDP ratios. Given low inflation levels, which prevent governments from using inflation to reduce the debt in real terms, and large infrastructure gaps (due to historically low capital spending), which prevent governments from adjusting public investment, governments have no choice but to reduce the more rigid components of spending.”