Policy makers in small states can improve long-term growth prospects by building fiscal space, fostering effective economic diversification, and improving resilience to climate change. Small states are diverse in their economic features, but they share attributes that make them especially vulnerable to shocks, including dependence on imports of essential goods, highly concentrated economies, elevated levels of debt, reliance on external financing, and susceptibility to natural disasters and climate change. Now facing spillovers from the Russian Federation’s invasion of Ukraine and the global monetary tightening cycle, small states are expected to have weak recoveries with large and possibly permanent losses to the level of output. Small states’ economies were hit particularly hard by COVID-19, largely due to prolonged disruptions to global tourism. Given EMDEs’ limited fiscal space, the international community will need to significantly increase international cooperation, official financing and grants, and leverage private sector financing for adequate investment to materialize. Policies to boost investment growth need to be tailored to country circumstances, but include comprehensive fiscal and structural reforms, including repurposing of expenditure on inefficient subsidies. Weak investment growth is a concern because it dampens potential growth, is associated with weak trade, and makes achieving the development and climate-related goals more difficult. Each of these factors has been decreasingly supportive of investment growth since the 2007-09 global financial crisis. An empirical analysis covering 2000-21 finds that periods of strong investment growth were associated with strong real output growth, robust real credit growth, terms of trade improvements, growth in capital inflows, and investment climate reform spurts. This subdued outlook follows a decade-long, geographically widespread investment growth slowdown before the COVID-19 pandemic. Investment growth in emerging market and developing economies (EMDEs) is expected to remain below its average rate of the past two decades through the medium term. A more pronounced weakness in major economies, further increases in global interest rates, higher and persistent inflation, fragility, and increased frequency and intensity of adverse weather events could further slow growth across the region, exacerbating poverty and leading to debt distress in some countries. The regional outlook for 2023-24 is for only a modest pickup in growth and a slow rise in per capita incomes, dimming prospects for a rapid reversal of recent increases in poverty.

Fiscal space needed to protect the poor has been depleted in many countries, while rising borrowing costs and muted growth prospects have sharply worsened debt dynamics. Global demand for many nonenergy commodities softened, adversely affecting the region’s exporters of industrial metals. Soaring food and energy prices, stemming partly from the war in Ukraine, triggered sharp cost-of-living increases across the region, leading to millions more people falling into food insecurity and poverty. Growth in Sub-Saharan Africa slowed to an estimated 3.4 percent in 2022, as weakening external demand, high inflation, and tightening global financial conditions dampened regional activity.

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