Climate change presents a critical challenge to sovereign debt sustainability, particularly for countries vulnerable to extreme weather events and rising adaptation costs. The study "Sovereigns on Thinning Ice: Debt Sustainability, Climate Impacts, and Adaptation" highlights the interplay between fiscal risks, climate shocks, and debt dynamics. The study emphasises that climate risks—if unaddressed—can exacerbate fiscal vulnerabilities, pushing debt-to-GDP ratios to unsustainable levels in climate-exposed economies.
The study employs a novel methodology integrating Debt Sustainability Analysis (DSA) with Integrated Assessment Models (IAMs), specifically the RICE50+ model. The latter incorporates regional socio-economic pathways (SSPs) and climate scenarios (RCPs) to predict growth and fiscal effects.
Key findings suggest that:
- Under moderate climate scenarios (SSP2-RCP4.5), fiscal efforts required for stabilisation remain manageable, demanding an additional fiscal adjustment of approximately 0.2% of GDP annually.
- Severe scenarios (SSP3-RCP7.0) necessitate significant adjustments, with some countries like Italy requiring up to 1% of GDP annually for debt stabilisation.
Adaptation measures are considered essential, but they require significant public financing. The analysis shows that although contributions from the private sector can help reduce some adaptation costs, public sector investments are crucial to facing environmental impacts. Policymakers must carefully balance the need to maintain debt sustainability with the necessity of public spending to address climate risks effectively.
