Understanding the weakness of small states
Smaller states are particularly vulnerable to a variety of shocks, from natural disasters to ongoing COVID-19 epidemics and man-made events such as the Ukraine war. Pushings are inconsistent and repeatedly affect small states because of their peculiarities. They have an economic base combined with a small population and a geographically centralized economy, which makes them particularly vulnerable to collisions. They tend to be geographically isolated, which creates the challenge of consolidating resources to respond to shocks. In addition, their growth trajectory depends on a few sectors (indivisible) or large neighboring countries. These dynamics highlight the central importance of strengthening financial resilience in small states as they move towards development and poverty alleviation.
Svatini, a landlocked country in South Africa, reflects these challenges in Africa. Increasingly, like many other small states around the world, Eswatini is struggling to cope with the effects of compounding shocks that increase inflation, cut budgets and current accounts, stifle GDP growth, and increase debt and fiscal deficits. A quiet walk through time (Figure 1): In 2015/16, The drought in El Ni নিনo has left one-third of the population severely food insecure, forced the government to spend 19 percent of its annual expenditure (equivalent to 7 percent of GDP) and pushed inflation to 7.8 percent. Inside 2018/19, Drought gripped the South African region, particularly South Africa, which was driven by South African Customs Union (SACU) tariffs on which the eSwatini (GoeS) government relied for revenue, forcing GoeS to raise additional debt. Inside 2020, The global COVID-19 epidemic hit, for which GoeS has collected a significant response package, estimated at $ 67 million, or 1.5 percent of its GDP. Today, in 2022As the war in Ukraine continues, Svatini is under pressure from current accounts, reserves, fiscal and inflation. Each of these compound shocks depletes budget resources and diverts civilian employees’ time and attention from service delivery toward crisis response. Strengthening financial resilience should be a priority to reduce the poverty rate from a stagnant 28 percent. And there it is.
Figure 1. Effect of repetition of compounding shocks on esvatini
Source: Author.
The wind of financially resilient change
Emerging from the El Nino drought, GoeS decided it was time to change. In March 2020, GoeS requested assistance from the World Bank to conduct a disaster risk financing diagnostics. Diagnostic Svatini has assessed the financial impact of the collision, the existing legal and regulatory framework for disaster risk management and response, and the method of financing for disaster response. The World Bank has mobilized a team from the disaster protection program and mobilized resources. The timing was (unfortunately) perfect – with the start of the diagnostics, COVID-19 hit the African region and the team monitored GoeS ‘ability to finance the shock response in real time.
The leaked information confirms that, like other small states, Esbatino faces challenges in financing disaster response. Of particular importance in Esbatini, is a particularly severe problem for the (limited) financial space-drought. Drought in Svatini means drought in South Africa, which experience has shown less SACU revenue. Since revenue from SACU generates about half of GoeS revenue, drought increases both costs. And Reduce revenue উপাদান a component of a financial crisis. This happened in 2016 when the dynamics pushed GoeS to increase its debt to GDP growth from 13.9 percent in 2014 to 24.9 percent in 2016. In addition, although Eswatini’s currency is associated with the South African Round, high inflation is triggered by rising food prices. Central Bank of Eswatini raises the policy rate above the policy rate of the South African Reserve Bank in January 2017, exacerbating the weakness of the currency peg. The Covid-19 epidemic again led to a sharp rise in debt from 33.9 percent in 2018 to 43 percent of GDP in 2021.
Shock exposure in the absence of financing materials
Combined with this intense financial exposure of the shocks, GoeS currently has no financing tools to finance the shock response and instead relies entirely on budget rescheduling and ex-debt – a full funding gap. The lack of financing capacity to respond to the shocks was exposed during the COVID-19 crisis when GoeS had to seek funding from outside sources to respond quickly. The World Bank team conducted a Monte Carlo statistical simulation exercise as part of the diagnostics to measure the indicative financial benefits of developing a more comprehensive risk-leveling mechanism for financing shock response. Two financing strategies were compared (Figure 2):
- Base strategy. Virtual stagnation where GoeS will initially rely on the প্র 25 million of ex-budget rescheduling needed to finance the shock response, and for the shocks that were more expensive it was assumed that they would rely on ex-sovereign debt.
- Strategy b. Here an international best practice risk-leveling strategy was created consisting of three components – a reserve fund, a contingency line of credit and a sovereign insurance transfer product. Under this strategy, the reserve fund will first be used to finance the response to minor shocks. For a more serious push, reserve funds would be depleted and GoeS could draw on an ancillary line of credit. Ultimately, for the ultimate push where the credit line also ends, the payment response from a sovereign insurance product will finance the effort. This method of combining multiple instruments is called risk layering and has been shown to be the most effective way for governments to finance shock response.
The results show that significant cost savings are possible for smaller states like Esbatini to benefit from risk-leveling strategies: $ 2 million to $ 6 million for frequent events (i.e., 1-in-5-year to 1-10-year events) and more serious. Up to $ 26 million for the event. This analysis was certainly indicative, and more technical work would be required to justify the adoption of risk financing instruments. However, it does provide important data points for smaller states in the African region on the benefits of adopting a comprehensive risk-leveling financing strategy.
Figure 2. Proposed risk-leveling strategies for esbatini
Source: World Bank, 2022- Esbatini Disaster Risk Finance Diagnostic.
Lessons for small states
So, what can we learn from the Esbatini case to strengthen resilience in small states? Immediately comes to the head of the three. First, small states need to be serious about improving their financial resilience – compound shocks will continue to unfold, and in this space small states will find themselves in a perpetual cycle of crumbling, manic shock response without paying attention. Second, it is important to adopt a national disaster risk monetary strategy to force the scarcity of resources to prioritize in response to the shock. Esbati does not currently have such a strategy (although they are in the process of being developed) and so when a push occurs, multiple stakeholders support their sector to prioritize financial resources, which means no sector is prioritized. Finally, developing strong risk-leveling strategies can cut off significant financial gains for smaller states when it comes to disaster response financing. Multiple monetary instruments can ensure that the government has sufficient liquidity to respond quickly and therefore avoid the fate that small states may suffer if they are affected by shocks (inflation, deficit growth, slowdown in economic growth).