The climate crisis poses a set of unique challenges to fiscal policy and debt sustainability. Rapid industrial transitions are unlikely to be achieved without direct financial assistance from governments, and the speed and scale of public financial resources required may strain government budgets and create fiscal challenges over the short, medium and long-term. Disaster response will require unplanned public spending on relief, exacerbating public deficits and increasing the debt burden. Destroyed infrastructure will diminish productivity and the tax base, amplifying fiscal imbalances. Yet debt-constrained countries that forego investment and suffer damages may face higher costs in the long-run. Effective approaches are needed to plan and efficiently manage needs and risks in the face of constrained fiscal space.

Emerging approaches to fiscal policy and debt sustainability are shifting the focus from debt reduction and balanced budgets to an expanded set of social, economic and environmental goals and indicators. Ministries of Finance have started integrating new tools to understand future damages, planning investments to mitigate impacts, and assessing the potential of financial instruments to manage climate risks and mobilize additional financing.  

A key challenge is that definitions and approaches to debt sustainability may need to be expanded. A second challenge is how to incorporate climate-related physical and transitions risks into Debt Sustainability Analyses (DSA). A third lies in identifying and using innovative financing instruments and approaches to maintain debt sustainability through climate mitigation and adaptation measures.  

This includes:

• Supporting the development and application of bespoke quantitative and qualitative methodological toolkits that integrate the costs and benefits of fiscal policy levers, and integrate climate factors into debt sustainability analyses ;
   
• Building capacity for the contextualization and use of these analytical tools, together with other C3A hubs, Ministries of Finance, and affiliated institutes and universities in diverse countries ;
   
• Supporting peer-to-peer knowledge exchange including specific approaches, best practices, learning outcomes, policy challenges, and solutions.  

Map the landscape of climate-related macro-financial fiscal risks and opportunities that could impact the government's budgetary position. 

Green and sustainability-linked bonds, debt for climate swaps, catastrophe resilient contracts have emerged as instruments to support sovereign borrowers in managing their risks. They come with their own political economy constraints. The hub will provide tools to assess if and when these instruments are useful.  

Improve understanding of environmental taxation and subsidies reform to accelerate the transition and budget’s resilience.