Impacts of climate change including disasters triggered by natural hazards are causing significant economic and social challenges in Asia and the Pacific, with developing countries the hardest hit. There is an urgent need for good fiscal policy to prepare robust adaptation strategies.
Climate-related disasters in Asia and the Pacific have affected 800 million people and caused losses of $400 billion in recent years, with developing countries the hardest hit.
While progress was made at the 2023 United Nations Climate Change Conference or Conference of the Parties (COP28), data shows that adaptation to climate change is and will continue to be crucial to the lives and economies of Asia and the Pacific.
Climate adaptation refers to economic and social adjustments to the current and future effects of climate change. It is meant to minimize the losses and maximize the opportunities from climate change. Low-income countries, which are the most vulnerable, urgently need stronger and better-financed adaptation strategies.
The investments needed for this adaptation are substantial, so they cannot be a simple add-on to fiscal policy―especially given that countries in Asia and the Pacific are finding their fiscal space squeezed by economic challenges, including higher borrowing costs. Despite this, there are ways that fiscal policy can be used to prioritize adaptation to climate change. We should start with these three actions:
Improve fiscal risk assessment. Identify, assess, and disclose the impact of climate and disaster risks on fiscal sustainability through four main impact channels: macroeconomic shocks including sectoral shocks, commodity shocks, infrastructure disruption, and financial sector risks; liabilities such as reconstruction costs, state-owned enterprises, and public–private partnership liabilities; adaptation needs, including infrastructure sectoral resilience; and public services, such as poverty reduction, public health, and education.
For instance, the Philippines publishes an annual fiscal risk statement that includes a section on the impact of climate disasters and refers to ongoing funding and management initiatives to address these impacts. Policy makers should conduct multi-hazard climate and disaster risk assessments to analyze the average annual losses from disasters, including those magnified by climate change. These will provide inputs for estimating the costs and benefits of investing in resilience and adaptation, inform investment decisions, and provide guidance on how to mitigate risk (through engineering design) or transfer risk (through insurance).
Strengthen fiscal risk management. This can be done by improving risk assignment (identifying who is responsible for the risk and its management) and targeted investment, ensuring effective handling of climate and disaster-related risks through preparedness, reduction, and risk transfer.
For example, Bangladesh, Indonesia, and Nepal have developed climate budgeting systems to help tag climate-related investments. Policy makers should integrate climate risk management into their public investment management systems to identify, align, and prioritize investment in climate action.
Overall, policy makers should consider this broad range of instruments to build more climate-adapted economies, but how can they select the best options for their countries?
Optimize resource allocation, finance, and investment. This allows fiscal policies to mobilize more domestic resources and leverage private finance for investment in climate action. It includes well-known tools, such as carbon taxes to generate revenue to support investment in low-carbon and climate-resilient activities, the phasing out of fossil fuel subsidies, and the redesign of sovereign funds. For instance, Mongolia is considering allocating a portion of its fund to invest in green bonds.
These actions can be complemented by innovative ways to create fiscal space, such as resilient bonds to mobilize finance for investment in climate actions; special purpose vehicles to pool funds from multiple sources to support private investment in adaptation, including de-risking private investment in climate action and providing concessional capital; and debt-for-climate or debt-for-nature instruments to enable investment in climate actions.
For example, in Ecuador, a debt-for-nature conversion (a $656 million sustainability-linked loan) helped support the effective management of 60,000 square kilometers of marine reserve in the Galapagos, generating $459 million in conservation savings and $1.1 billion in fiscal savings to invest in adaptation.
Another example is the Philippines, which mobilized resources and promoted smart actions leading to the development of a targeted financing mechanism, the People’s Survival Fund, to provide grants in order to mainstream adaptation from the national government to local government units and build resilience at all levels of the economy and society.
Overall, policy makers should consider this broad range of instruments to build more climate-adapted economies, but how can they select the best options for their countries? All countries need to adapt, and their benefits will be the highest if adaptation is holistically integrated into countries’ development plans.
In order to implement a structured approach, policy makers should fund or support projects that not only target specific issues but also provide wider benefits to many people. This includes putting money into things like better infrastructure, systems that give early warnings for disasters, and new technologies. They should also remove roadblocks to private investment in adaptation by eliminating harmful subsidies, setting proper carbon prices, and sharing knowledge.
In addition, fair redistribution policies should be designed with compensation plans for communities forced to relocate due to rising sea levels, to ensure everyone benefits from adaptation efforts.
Once areas of intervention have been defined at the country level, cost-benefit analysis methods can be applied to adaptation programs. Attention should be given to the distributional impacts to maximize the impact of spending while balancing efficiency and equity according to societal preferences and risk aversion.
Such a method requires strong knowledge of adaptation solutions, available good-quality data, and support from development finance institutions.
This blog post is based on an episode of the ADBI Webinar Series on the Economics of Climate Change. A version of this blog post was originally featured in Asia Pathways, the blog of the Asian Development Bank Institute.