Climate change presents a serious economic challenge to government finances, and has the potential to push some countries toward sovereign debt crises, a new study by the Bruegel think tank has found.
The study, Sovereigns on thinning ice: debt sustainability, climate impacts and adaptation, assessed whether governments have the capability to sustain rising public debt levels as they confront the growing economic impacts of climate change, stress-testing sovereign debt under a number of climate change scenarios developed by the Intergovernmental Panel on Climate Change (IPCC).
GDP impact
As it reveals, many countries face serious long-term debt sustainability risks under high climate impact scenarios – GDP losses could average 28% globally between 2030 and 2100.
Expected costs would increase by up to 3% of GDP under high climate impact, or 0.25% under a low impact situation in a middle-of-the-road narrative, with considerable variation evident between countries.
Under the worst-case climate pathway, countries would need to implement fiscal adjustments ranging from 1.8% (in the case of Italy) to 2.6% (in India) of GDP just to stabilise debt.
‘Sustaining public debt on a stable trajectory is possible with additional fiscal effort that can be challenging to achieve under extreme climate scenarios and high damage functions,’ the report notes. ‘However, climate damages imply a significant reduction in public spending. A constant spending policy requires excessively large deficits and unsustainable debts.’
The study also examines the role that adaptation investments could have, suggesting that while public financing of reactive climate adaptation would break even economically, it would not be sufficient to restore debt sustainability in heavily impacted and highly indebted countries.
Facing a trade-off
Many global governments are likely to face a trade-off – whether to hold spending steady, leading to unsustainable debt increases, or to implement strict fiscal adjustments that could severely impact public services.
‘Across narrative scenarios and damage functions, we provide robust evidence that there is no safe way for governments to navigate a world in which major economic risks from climate change cannot be ruled out,’ the report states. ‘Our results corroborate the adage that there can be no public finance sustainability without environmental sustainability. Governments will find themselves walking on ice that is thinning over time.’ Read more here.
