Scaling up climate adaptation finance during periods of growing public debt, inflation and natural disasters

In 2021, economic losses from natural catastrophes were USD 270 billion. Poor physical climate risk assessment limits the scaling up of adaptation finance, which is still lagging behind mitigation finance in emerging markets and developing economies (EMDEs) but also high-income countries.

Physical climate risk pricing and portfolio risk assessment is still at an early stage. Most analyses are focused on firm level shocks, but they neglect the asset-level dimension of risks, which in turn leads to a severe underestimation of losses. Risk assessment and estimation of the transition investments needed should be incorporated into corporate valuation and sovereign debt sustainability analysis.

Adapting to physical climate risks requires massive investments. Because of high upfront costs, risks and the long-time horizons of infrastructure projects, adaptation finance faces larger hurdles than mitigation investments. Climate vulnerable countries are sometimes in a vicious circle of debt and climate change.

Limited fiscal space and debt sustainability challenges frequently prevent them from adapting to climate change. Innovations in adaptation technologies are still slow and still primarily rely on public funding.

Financing could consist of multiple layers. Public finance should play a central role, followed by the international climate finance pledges, such as the adoption of the Glasgow Climate Pact. Private finance is also key, with blended finance arrangements by development finance institutions and multilateral development banks, in addition to the issuance of sustainable debt instruments such as ‘pay-for-success’.

Finally, there is a crucial need to develop climate-aligned debt restructuring accompanied by substantial debt relief in some countries, as well as countercyclical financing instruments such as the IMF Catastrophe Containment and Relief Trust. This would allow EMDEs to have systems in place for the quick release of finance when disaster strikes.

Irene Monasterolo is Professor of Climate Finance at the EDHEC Business School and EDHEC-Risk Climate Impact Institute. Marie Brière is Head of Investor Intelligence & Academic Partnerships at Amundi Institute; Affiliate researcher at Paris Dauphine University-PSL and Senior Affiliate Researcher at the Université Libre de Bruxelles. Kevin Gallagher is Director at Boston University Global Development Policy Center. Charlotte Gardes-Landolfini is Climate change and financial stability expert, IMF. Nicola Ranger leads the Resilience and International Development Programme Oxford University.