An IMF Public Finance Management (PFM) Blog, written by Talal Rafi (a Director at EY Sri Lanka) and published on 27 January 2025, looked at the measures developing countries can take to reduce public debt levels.
The author notes that more than 3 billion people live in 48 developing countries where governments pay more on interest payments than on education or health. Many developing country governments are not in a position where they can create a buffer against any future global or local economic downturn. There are pressures on economies from increased security needs, energy transition and demographic changes. Higher interest costs resulting from the increasing debt reduce the available fiscal space.
Governments need to look at the level of their debt sustainability and how to reduce it. Developing economies are vulnerable to any increases in global interest rates as their borrowing costs are much higher than developed nations. The fiscal positions of many developing countries are precarious and a natural disaster or bad economic policy missteps could lead to debt becoming unsustainable.
Government revenue in developing countries remains significantly lower as a percentage of GDP than revenue collected by developed countries. The author refers to a World Values Survey indicating that people in developing countries generally prefer progressive taxes that can reduce income inequality.
The author notes that although indirect taxation tends to be regressive in nature it can be an efficient means of collecting revenue. Indirect taxation includes value added taxation, customs duties and service taxes where the tax paid is not related to the income level of the payer.
In the case of direct taxes such as personal income tax and corporate income tax an increase in tax collection does not necessarily require an increase in tax rates. In most developing countries, the tax base is low because a large number of people are operating in the informal economy and have not been brought into the tax net. The tax administration may suffer from insufficient digitization and lack of resources. Revenue collection can be increased by improvements in all these areas.
Developing countries tend to have problems arising from inefficient government spending and wastage. A large public sector often adds to the fiscal burden. One option to raise revenue and increase spending efficiency is the privatization of commercially oriented state-owned enterprises. Greater transparency and digitization of procurement systems in developing countries can reduce waste.
IMF research has indicated that improved governance in Africa could increase efficiency in government spending. The analysis indicated that, on average, countries waste around a third of their infrastructure spending due to inefficiencies; and the loss can be more than 50% in low-income countries. Greater efficiency in expenditure can improve the fiscal position and help reduce debt levels.
To attract large-scale foreign investment, developing countries need to improve the ease of doing business. Trade liberalization and trade facilitation are also important in creating a favourable climate for investment. Government investment is required in education, health and infrastructure.
