Review Nepal News

Tools and principles for creating fiscal space for climate adaptation
  Kathmandu      February 06 2024

By Declan Magee and Agnes Surry

COP28 finished with new initiatives for promoting climate adaptation, some hope, and many questions. Similarly, the climate emergency continues to present many uncertainties. One certainty is that adaptation to climate change is and will continue to be necessary. UNEP’s Emissions Gap Report 2023 projects the increase in greenhouse gas emissions by 2030 to be 3%, based on current policies, while it was 16% at the time of the Paris Agreement’s adoption in 2015 (UNEP 2023a). While this is good news, the 2030 greenhouse gas emissions still need to decrease by 28% and 42% to achieve 2°C and 1.5°C global average temperature increases, respectively. Current plans reflected in the nationally determined contributions are putting us on a path toward 2.4°C–2.6°C by the end of the century. Therefore, even if mitigation actions intensify, the global climate is very likely to continue to change.

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. Evidence shows that economic development reduces climate vulnerability, and reducing climate vulnerability facilitates economic development. Indeed, emerging and low-income countries are, in general, more exposed to climate risks than advanced ones, suggesting that while adaptation to climate change is important for all countries, it is particularly needed in emerging and developing ones. Additionally, higher incomes are associated with higher adaptive capacity.

Despite this relationship showing a positive correlation between reduced climate vulnerability and economic development, the Adaptation Gap Report 2023 (UNEP 2023b) highlights that progress on adaptation is slowing across finance, planning, and implementation. Instead, it should be accelerating rapidly on those three fronts. The report also states that adaptation finance needs in developing countries are 10–18 times greater than current international public adaptation finance flows—at least 50% higher than previously estimated. From 2015 to 2022, in Asia and the Pacific, losses from climate-related natural disasters rose to reach $400 billion, with 800 million people affected. In such a context, domestic resources mobilization and fiscal policies to bridge the adaptation finance gap and build economies and societies that are climate resilient are critical.

Against this background, fiscal policies include a broad range of tools and actions, from government spending to directly prioritize adaptation programs, to taxes, which incentivize key stakeholders in supporting adaptation strategies. However, fiscal space in Asia and the Pacific is constrained as many countries are facing more challenging borrowing conditions.

Climate change has to be mainstreamed into the core of fiscal policymaking

The size of the investments needed is such that adaptation to climate change cannot be a simple add-on to fiscal policy. To create fiscal space, climate change has to be mainstreamed through three main actions (Asian Development Bank 2023):

Improving fiscal risk assessment involves identifying, assessing, and disclosing the impact of climate and disaster risks on fiscal sustainability through four main impact channels: (i) macroeconomic shocks (sectoral shocks, commodity shocks, infrastructure disruption, and financial sector risks), (ii) implicit/explicit liabilities (reconstruction costs, state-owned enterprises, and public–private partnership liabilities), (iii)  adaptation needs (infrastructure resilience and sectoral resilience), and (iv) public services (poverty, 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).

Strengthening fiscal risk management can be used to improve risk assignment, which is key to identifying who is responsible for the risk and management, and ensure targeted investment is implemented to better manage climate and disaster-related fiscal risks through better preparedness, risk reduction, and risk transfer. For instance, 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.

Optimizing resource allocation, finance, and investment allows fiscal policies to mobilize more domestic resources and leverage private finance for investment in climate action. This 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 subsidies that support fossil fuels, 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 in 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.

How should policy makers prioritize their actions?

Overall, policy makers should consider this broad range of instruments to build more climate-adapted economies, but how can they select the best options tailored 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 consider three main areas of intervention (International Monetary Fund 2022).

Investing in or subsidizing adaptations that have positive externalities. Being selective is important, and such a prioritization is justified by the fact that private actors under-invest in these adaptation solutions because the benefits generated take time to materialize and affect a broad range of stakeholders. Infrastructure investment, early warning systems, and research and development supporting new adaptation technologies are relevant examples.

Removing barriers to private investment. This type of action includes removing financial and nonfinancial barriers to private investment, such as counterproductive subsidies, creating carbon pricing frameworks, and supporting knowledge production and dissemination, as well as capacity development for climate risk and adaptation solutions.

Designing redistribution policies. This action is critical to deal with equity issues arising from climate change or from adaptation policy itself. For instance, a sound and fair compensation plan should be implemented to offset a population leaving an area vulnerable to sea level rise following the development of a new local urban plan.

Once areas of intervention have been defined at the country level, cost-benefit analysis methods can be applied to adaptation programs, with strong attention 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 development finance institutions and think tanks like the Asian Development Bank Institute and Asian Development Bank to support policy makers in their endeavors.