The International Monetary Fund (IMF) defines fiscal space as “room in a government’s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy.” Loosely, it is the gap between what a government spends and the point at which it struggles to finance that spending or service its debt. Developing countries are routinely urged to conserve fiscal space in uncertain times, building buffers against future shocks. But governments can also create future fiscal space by investing in prevention and in economic transformation that yields high returns. The climate adaptation literature is full of microeconomic examples of a stitch in time saving nine: mangrove restoration, drought-resistant seeds, urban green space, early-warning systems, dual-use public buildings. Similarly, the economics of the clean energy transition offer significant opportunities for growth. The list of present-day expenditures that head off much higher future costs grows as climate and disaster shocks become more frequent.
Whether incremental spending adds to fiscal space or subtracts from it is therefore largely a matter of judgment about the impact of the spending. Such judgment also has to anticipate how others will react. Identical expenditures in two countries can have opposite implications for fiscal space depending on how much confidence lenders place in the government’s ability to identify and execute the investment and to respond to unanticipated shocks.
To help policymakers make sound judgments on how their spending decisions might impact fiscal space, a model is needed to rigorously quantify the implications for fiscal space of a range of decisions. There are two parts to such a decision: first, whether the marginal returns to a proposed public investment are high enough to justify the spending; second, whether the macroeconomic conjuncture of public debt, revenues, and GDP can accommodate higher levels of debt-financed public investment. One of us has previously addressed the first issue on marginal returns. That work finds the returns appear to be high, compared with the cost of capital, in most developing countries, even those with relatively weak institutions and limited complementary human capital. In this paper, we turn to the question of macroeconomic or fiscal sustainability. This is a rather loose term that we try to put on an empirical footing by creating a model that aggregates a number of readily observable, publicly available indices. Campos, Cysne, and Castro (2026) have built such a model and applied it to countries in Latin America and the Caribbean. This paper adapts that framework to extend coverage to 144 emerging market and developing economies (EMDEs).
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