Fiscal Policy in Developing Nations: How Governments Can Finally Take Control

The bills are coming due — and many developing nations are discovering they have almost no tools to pay them.

In March 2026, the United Nations Conference on Trade and Development published a figure that should have stopped finance ministers in their tracks. As of September 2025, 49% of countries eligible for concessional financing from the IMF were either in or at high risk of debt distress — and three quarters of them had been in that position since at least 2018. That’s not a crisis. That’s a chronic condition. And it points to something more alarming than any single budget blowout: a systemic failure to build the fiscal architecture that allows governments to govern. UNCTAD

The question isn’t whether developing nations face fiscal pressure. Every one of them does. The question is which instruments they have at their disposal to manage it — and whether the political will exists to use them.

The Structural Trap: Why Fiscal Policy Is So Hard to Control

Controlling fiscal policy in developing nations requires confronting a peculiar paradox. These economies need to spend more — on infrastructure, health, education, and social protection — precisely when they have the least capacity to raise revenue. The gap between what’s needed and what’s available isn’t a policy failure. It’s structural.

About 74% of low-income countries and 48% of lower-middle-income countries collect less than 15% of GDP in taxes — a level the World Bank considers too low to fund essential services and achieve sustainable growth. In countries affected by fragility, conflict, and violence, the average tax-to-GDP ratio was less than 12% in 2024. World Bank Group

Compare that to the OECD baseline. In low-income countries the average tax-to-GDP ratio sits around 10–15%, against the 34.4% average that most high-income OECD countries achieve. That’s not a gap. It’s a chasm. Center for Strategic and International Studies

Globally, countries spend about 33% of GDP on public expenditure, but low-income nations average only 20%. A large share of budgets goes to current spending — over 80% — reducing space for pro-growth investment. The arithmetic is punishing: when governments spend most of what they collect on wages and subsidies, there’s nothing left to build the roads or train the tax collectors who might eventually change the equation. World Bank Group

Yet the roots of this problem run deeper than budget line items. They reach into the informal economy, into weak institutions, and into the political economy of reform — where the people who would gain most from better fiscal management are often the least able to demand it.

What Does Fiscal Policy Control Actually Require?

The Revenue Side: Broadening the Base Before Raising Rates

What are the main challenges of fiscal policy control in developing nations? The answer begins with revenue — not its level, but its composition. Most developing economies have tax systems that are simultaneously too narrow and too punishing: they rely heavily on trade taxes, commodity royalties, and a thin slice of formal-sector workers, while leaving vast informal economic activity untouched. Raising rates on those already inside the system rarely works. Widening the base almost always does.

In El Salvador, the informal economy is estimated at 60% of GDP; in the Philippines, 45%; in Kenya, over 70% of the workforce is employed in the informal sector. These aren’t marginal populations. They’re the majority of economic activity. A tax system that ignores them isn’t merely leaving money on the table — it’s guaranteeing that revenue growth will always lag behind spending needs. Center for Strategic and International Studies

Research published in September 2025, tracking 25 African economies from 2000 to 2021, confirmed that the informal economy and weak institutions have a statistically significant negative effect on tax effort — the ratio of actual collections to potential revenue. The implication is direct: you can’t fix fiscal policy without fixing the conditions that keep economic activity informal. That means reducing the compliance cost of formalisation, building trusted property registries, and creating public goods — schools, clinics, roads — that give citizens a reason to participate in the formal economy. Taylor & Francis Online

The practical toolkit includes value-added tax reform (broadening the base, reducing exemptions), digital tax administration, and property tax modernisation. None of these is painless. All of them are necessary.

The Expenditure Side: Spending Smarter Before Spending More

Revenue mobilisation gets most of the attention. Expenditure management deserves far more.

The IMF’s October 2025 Fiscal Monitor, Spending Smarter, was unambiguous: there is a measurable public investment efficiency gap in developing economies, and it correlates directly with weak governance and corruption. Governments that struggle to collect taxes also tend to struggle to deploy what they do collect. The money disappears into procurement corruption, bloated state payrolls, and energy subsidies that disproportionately benefit the wealthy. IMF

Government support for fossil fuels surged to over $1.4 trillion across 48 OECD and partner countries in 2022 — nearly doubling from 2021. For oil-producing developing countries, the subsidy bill is often the single greatest drain on fiscal space — consumed not by the poor, who use little fuel, but by middle-class consumers and industry. Redirecting even a fraction of that spending toward health or infrastructure would transform development outcomes. OECD

The OECD’s 2025 Quality Budget Institutions report argues that clear fiscal objectives — whether established politically or legislated as binding fiscal rules — are core to achieving fiscal goals. They set limits on debt, deficits, or expenditure, and act as accountability benchmarks against which governments can be held to account. Fiscal rules are not magic. A rule without enforcement capacity is just a number in a document. But credible, well-designed expenditure ceilings — particularly medium-term expenditure frameworks that lock in multi-year budget paths — have proven effective at curbing the spending excesses that tend to accumulate in election cycles. OECD

The Debt Overhang: When Fiscal Control Becomes Crisis Management

The picture is more complicated when debt is already high and rising. For many low-income and lower-middle-income economies, fiscal consolidation isn’t an option being considered. It’s a constraint being imposed — by creditors, bond markets, or the IMF’s Debt Sustainability Framework.

Global public debt rose to just under 94% of GDP in 2025 and is set to reach 100% by 2029 — one year earlier than projected in April 2025. That’s the aggregate figure, dominated by China, the United States, and large emerging markets. The situation in the most vulnerable developing economies is considerably starker. International Monetary Fund

Already, 53% of low-income developing countries and 23% of emerging market economies are either at high risk of debt distress or already in it. Analysis from the IMF links increased geoeconomic uncertainty to a rise in public debt of about 4.5% of GDP in the medium term — a result of widening fiscal deficits, with rising expenditure and falling revenues. IMF

When a government is spending more on debt service than on public health — a reality in a growing number of sub-Saharan African and South Asian economies — fiscal policy has effectively been seized by creditors. The question of how to deploy public spending becomes secondary to the question of how to service the debt. As borrowing costs rise and fiscal space shrinks, developing countries are finding that the cost of finance is not merely financial. It is measured in postponed investments, constrained budgets, and development goals drifting further from reach. UNCTAD

Getting out of this trap requires two things simultaneously: credible domestic fiscal adjustment to signal solvency, and meaningful international debt restructuring to create the breathing room in which that adjustment becomes possible. The two are complementary. Neither works without the other.

The IMF’s Debt Sustainability Framework for low-income countries provides a structured lens through which borrowing decisions can be assessed — classifying economies by debt-carrying capacity and setting indicative thresholds accordingly. The framework requires regular debt sustainability analyses over a 10-year horizon, assessing vulnerability to economic and policy shocks. It’s a tool, not a solution. But countries that use it honestly, factoring in realistic growth projections and commodity price volatility, have a better starting point than those that borrow against optimistic assumptions. International Monetary Fund

The Counterargument: Is Fiscal Austerity the Wrong Medicine?

Not everyone agrees that the standard toolkit — revenue mobilisation, expenditure discipline, fiscal rules — is adequate or even appropriate. A substantial body of development economics holds that premature fiscal consolidation in low-income countries suppresses growth and undermines the very tax base that consolidation is meant to protect.

The argument, most forcefully made by economists at UNCTAD and supported by heterodox voices at the UN Development Programme, runs as follows: when a developing country with 10% tax-to-GDP and high unemployment cuts spending to reduce its deficit, it cuts into the multiplier. Public investment in roads, teachers, and health workers generates private sector activity. Remove the investment, and the private sector doesn’t fill the gap — it contracts. The result is a lower GDP base, lower tax revenues, and a higher debt ratio than before the cuts.

This view is not without evidence. The post-2010 austerity experience in several low-income African economies — where IMF-mandated fiscal consolidation was followed not by recovery but by prolonged stagnation — gave the critique real empirical weight.

The resolution, as the IMF itself has increasingly acknowledged, is sequencing and composition. Consolidation that preserves public investment while cutting regressive subsidies is qualitatively different from consolidation that slashes health and education to protect debt service payments. The former can coexist with growth. The latter is a poverty trap in policy form.

Second-Order Effects: What Happens When Fiscal Policy Loses Coherence

The consequences of failed fiscal management in developing nations extend well beyond the finance ministry.

When governments can’t control their fiscal policy, they often turn to monetary policy as a substitute — printing money to cover deficits. The result, in economies with limited financial depth and commodity-linked exchange rates, is inflation that destroys real wages and erodes household savings. Countries like Zimbabwe, Argentina, and Zambia have lived through versions of this spiral at different points in the past 25 years. The pattern is consistent: fiscal indiscipline precedes monetary chaos.

There’s also an institutional feedback loop that’s less often discussed. When fiscal policy lacks credibility, investors price in a risk premium on government bonds. That higher borrowing cost makes the next year’s budget harder to balance. The deficit widens. The premium rises. Without a credible institutional anchor — an independent fiscal council, a legislated debt ceiling, a transparent medium-term budget framework — this loop is almost impossible to break.

The World Bank helps countries design stronger institutions, including fiscal rules and independent fiscal councils, to build policy credibility and long-term stability. It also supports structural reforms for private sector–led growth and investments that expand economic output. The emphasis on institutions reflects a hard-won insight: instruments without institutions are fragile. Tax reform without a capable revenue authority collapses under elite resistance. Expenditure ceilings without independent oversight become suggestions. The governance framework matters as much as the fiscal target. World Bank Group

The Way Forward

There’s no single lever that controls fiscal policy in developing nations. That’s the uncomfortable truth that aid conditionality programmes and IMF letters of intent have sometimes obscured. What works is a coherent package: revenue systems that bring the informal sector gradually into the fiscal compact; expenditure frameworks that prioritise investment over recurrent costs; debt management strategies grounded in realistic projections; and institutions with enough independence to enforce the rules when political pressure mounts.

The countries that have improved their fiscal positions over the past two decades — Rwanda, Georgia, Ethiopia before its recent instability — did so through sustained, unglamorous administrative reform. They didn’t find a fiscal magic trick. They built revenue authorities, published budgets, reduced exemptions, and stuck to medium-term spending paths across election cycles.

That’s the model. It’s slow, technically demanding, and politically costly. It also works.

The question now isn’t whether these tools exist. It’s whether the governments that need them most have the capacity — and the insulation from short-term political incentives — to deploy them before the next debt ceiling becomes the last one.