Unlocking the flow of finance for climate adaptation: estimates of ‘Fiscal Space’ in climate-vulnerable developing countries

Abstract

ABSTRACT We study the availability of fiscal space in climate-vulnerable developing countries. These countries require urgent climate adaptation and transition investments. However, their governments describe being bypassed for international financial support due to ‘limited fiscal space.’ We suspect that many governments are not close to a point of long-term insolvency but are unable to maneuver fiscally because of what has been called a ‘financial death trap.’ We apply a measure of fiscal space based on an endogenous debt limit reflective of a country’s record of fiscal adjustment consistent with long-term solvency. We find that for many countries, the distance between the endogenous debt limit and forecast public debt ratios – i.e. fiscal space – is fairly ample. Our findings imply that climate-vulnerable countries should be afforded a second look by international financial institutions using a long-term lens, of which this measure of fiscal space is an example. By illuminating the difference between long-term insolvency and short-term liquidity crises, the endogenous debt limit measure could be part of a multi-pronged strategy to unlock greater flows of adaptation finance. It could lower the cost of capital or be useful in the efficient allocation of adaptation financing among countries given current shortfalls. Actions to obviate the financial death trap are also warranted. Climate ambitions will be derailed if otherwise solvent and able governments are unable to access finance for urgent climate adaptation investments.