The climate emergency has become a wider focus of policy discussions around debt, as extreme climatic events and environmental hazards increase both the cost of borrowing and the risk of debt crises in countries in the global south that are often already bearing large external debt stocks. Similarly, unsustainable debt levels can mean less fiscal space and opportunities to face the challenges of adaptation and mitigation, as well as to recover from loss and damage after a climate disaster.

The overlap of the climate emergency and the Covid-19 health, social and economic crisis, poses enormous challenges for countries in the global south, aggravated by the unfurling debt crisis that many developing countries are facing. With increased debt vulnerabilities, fiscal pressures and the economic downturn, the capacity for many countries to invest in climate change mitigation and adaptation, as well as to face unexpected shocks such as those triggered by the climate emergency, the capacity is weakened even further. Furthermore, climate crisis can exacerbate debt vulnerabilities by increasing both debt levels and costs.

Alongside the costs of changes to the ecosystem, the human losses and impacts on the cultural heritage and livelihoods, material and monetary losses caused by the climate crisis are particularly acute after a catastrophe, which can be a driver of weakened debt sustainability. Both the World Bank (WB) and International Monetary Fund (IMF) have recognised that climate disasters can cause a significant deterioration of debt sustainability in the affected countries.

Special attention should be paid to Small Island Developing States (SIDS), which, while contributing less than 1 per cent to the world’s greenhouse gas emissions, are amongst the most vulnerable countries to climate catastrophic events. Additionally, SIDS are amongst the countries that are most affected by increasing debt vulnerabilities. Furthermore, borrowing costs are higher for SIDS than for other developing countries with similar income levels and in general they have less access to concessional finance. Recent cases such as Vanuatu, Grenada or Dominica show how climate extreme events have triggered further debt unsustainability, a situation that has been worsened by the economic impacts of the Covid-19 pandemic.

The economic downturn is hitting those economies that are dependent on tourism particularly hard, amongst which SIDS are the most vulnerable. The collapse in government revenue, when external debt payment levels were already high, has led these countries to increase their reliance on non-concessional loans, which worsens their debt vulnerabilities. Even when facing debt distress, some SIDS are not eligible for the Debt Service Suspension Initiative (DSSI) implemented by the G20 governments in the context of the Covid-19 crisis. As the United Nations (UN) Secretary General António Guterres has stated, the debt and climate crisis constitute “piling injustice upon injustice” for SIDS.

As the experience in many SIDS and other impoverished countries shows, debt and climate crises have a feedback effect. The deterioration of the physical and economic situation in an over indebted country after a climate-related disaster not only makes it more difficult to face existing debt repayments in the immediate aftermath of the crisis, it also worsens the economic prospects for increasing revenues in the future, in order to be able to achieve debt sustainability. Furthermore, when the reconstruction and recovery is financed with more loans, it can be like throwing fuel onto the fire.

Report by Eurodad