Three Tools for Taking on Climate-Induced Fiscal Risk

Climate-related weather disasters have taken a toll on infrastructure in Asia. Photo: ADB
Climate-related weather disasters have taken a toll on infrastructure in Asia. Photo: ADB

By Sandeep Bhattacharya, Brent Edelman

Policymakers in the Asia and the Pacific have powerful tools available to identify funding gaps, optimize resource allocation, and enhance resilience against the looming fiscal challenges of climate change.

The fiscal risks of climate change facing countries in Asia and the Pacific are immense. Climate-related weather disasters and public spending on the climate change mitigation and adaptation investments needed to avoid worst case climate scenarios and protect livelihoods are placing a significant strain on public finances. 

When taken together, these fiscal risks have the potential to impact governments’ sovereign debt creditworthiness and are already making it more expensive to borrow for countries most vulnerable to climate change. 

As climate change poses a growing fiscal risk to Asia and the Pacific, policymakers need to better analyze the challenges, devise practical solutions, and attract private funding to strengthen climate-resilient fiscal management, according to the report Fiscal Risks of Climate Change: Sources and Practical Solutions

 Public finances will come under increasing pressure from the impact of extreme weather events alongside higher adaptation and mitigation costs. Policymakers can optimize public and private resources, identify climate financing gaps, and monitor investments in low-carbon, climate-resilient infrastructure to better manage looming fiscal threats.

Governments in Asia and the Pacific are already taking wide-ranging measures to proactively address these risks. Countries are analyzing the impact of climate change risks on their macroeconomic frameworks, their finance sectors, and the sustainability of their public finances, as well as the suitability of disaster risk financing instruments depending on their economic conditions.

Governments are building fiscal buffers to account for these risks, including contingent disaster financing, disaster insurance, and catastrophe-linked bonds for relief, recovery, and reconstruction after disaster occurs. 

Many countries in the region are also working to mitigate the fiscal risks of climate change by ensuring that strategic plans and fiscal frameworks align with climate targets and objectives and strengthening public financial management practices more broadly. 

When taken together, these steps shore up public finances and send a strong signal to private investors looking to finance climate change mitigation and adaptation projects.

Policymakers in Asia and the Pacific have access to a broad suite of analytical tools that they can use to better assess the fiscal risks posed by climate change and to develop ways to mitigate these risks.

Here are three important resources that policymakers can use to address these issues: 

The IMF’s Climate Macroeconomic Assessment Program looks at climate risk and preparedness, national strategy, mitigation, risk management, adaptation, the macroeconomic implications of climate change, and public financial management practices.  Findings from a program conducted in Samoa in 2021 indicate that economic damage caused by disasters has averaged 30% of GDP per disaster over the past four decades.  

The assessment in Samoa also found that while Samoa’s national strategy documents reflect its strong commitment to climate resilience-building and its disaster management planning is well developed, having consolidated information on the costing and funding gaps of adaptation plans at the national level could further facilitate discussions with potential investors in adaptation measures.

ADB’s country diagnostics tool kit is another key resource for assessing the enabling environment for disaster risk financing that can help governments in Asia and the Pacific identify and plan disaster risk financing instruments suitable to the local market and disaster risk landscape.  

In Fiji, for example, modeling predicts severe losses as a result of tropical storms, earthquakes, and tsunamis, with a 50% chance of losses exceeding $670 million and a 10% chance of losses exceeding $1.34 billion in the next 50 years. The diagnostics tool kit recommends that the government develop a comprehensive register of all government-owned infrastructure and other assets, improve underwriting standards to accept more catastrophic risk, and consider catastrophe bonds as an additional disaster risk financing instrument.  

The International Monetary Fund developed a climate module for its Public Investment Management Assessment, which assesses the extent to which public investment management institutions critical for developing climate-smart infrastructure are prepared to manage these public investments. It provides practical policy and regulatory reforms to increase efficiencies.  

Nepal recently used the assessment to strengthen alignment between its nationally determined contributions and sector investment plans regarding renewable power capacity, electric vehicle and rail networks, and its national policy to maintain current levels of forest cover.  

Our research found that  policymakers in Asia and the Pacific have access to a broad suite of analytical tools that they can use to better assess the fiscal risks posed by climate change and to develop ways to mitigate these risks.

Many countries in the region already have experience utilizing these tools, which can be tailored for each country’s situation, and are generating important lessons learned that other countries can consider.