Gaps and Fiscal Adjustment for Debt Stability in Climate-Vulnerable Developing Countries: How Large and by How Much?

Abstract We explore the extent of the fiscal resource gap described by climate-vulnerable developing countries which have called for debt flexibility. We compute indices of fiscal sustainability, defined as the difference between an economy’s current tax rate and the “sustainable” tax rate, or the rate which, if constant, would enable the debt-to-GDP ratio at time n to be equal to the debt-to-GDP ratio at time 0, given current policy rules. We estimate short- and medium-term gap indices for 2010 to 2020, and a “climate change gap” (CCG) which incorporates countries’ reported climate change needs for the period 2021–2030. Estimated short- and medium-term gaps capture the 2020 disruption to fiscal sustainability, while CCGs indicate a highly diverse picture: one-third of the sample have CCGs ranging from 10 to 99 % of GDP, another third have CCGs from −8.6 to −0.3 %. Negative CCGs, which imply that immediate adjustments in taxes or spending are not required for fiscal policy sustainability, are surprising but come with a crucial caveat: CCGs are likely to be significantly understated because of data gaps, especially regarding adaptation requirements. This highlights the urgent need for finance and technical assistance dedicated to building national capacities for determining and costing climate change needs.