## 1. Cost of Sea-Level Rise (in percentage of GDP)

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### Key summary findings and projections
- Climate hazards already affecting Palau: warming, sea-level rise, ocean acidification, and heavy rainfall events.
- IMF staff estimate: sea-level rise can cost as much as 4 percent of GDP annually in 2040 without adaptation.
- Optimal combined adaptation (protection + planned retreat) would cut overall cost (including adaptation costs) by 75 percent to approximately 1 percent of annual GDP by mid-century.
- Palau’s 2015 Intended National Determined Contribution (INDC) targets:
  - reduce energy sector emissions 22 percent below 2005 levels,
  - increase renewable energy share to 45 percent,
  - improve energy efficiency by 35 percent by 2025 (conditional on international financing).
- Near-term renewable increase: introduction of a new solar farm expected to raise renewable generation share to 20 percent.
- Sea-level rise projections:
  - By 2030: an additional 8 to 18 cm relative to 1986–2005 average.
  - Under SSP2-4.5 by 2070: increase of 23 to 48 cm above 1986–2005 level.
- Temperature projection: median projection of temperature in 2050 is 1.1 °C higher than in 1985-2014 under SSP2-4.5.

### Climate impacts and vulnerabilities
- Temperature and precipitation
  - Warming trend since the 1950s expected to continue even with strong mitigation.
  - No significant trend in annual total precipitation; future scenarios show a small and uncertain increase.
  - Palau has the largest average annual total precipitation of all countries but very limited storage capacity, increasing drought susceptibility.
- Coral bleaching and biodiversity
  - Increased sea-water temperature and ocean acidification will intensify coral bleaching risks, harming biodiversity, fisheries, and tourism.
  - Historical strong El Niño events (1998, 2016) contributed to massive coral bleaching; such events are more likely with rising temperatures.
- Tropical cyclones
  - Available data unsuitable to robustly assess historical cyclone trends for Palau.
  - Climate models project a reduction in future cyclone formation around Palau with low confidence; globally, cyclones expected to be stronger.

### Adaptation to sea-level rise — CIAM model approach and scenarios
- Model and scope
  - Model used: Coastal Impact and Adaptation Model (CIAM); divides global coastline into more than 12,000 segments and further by elevation; each segment contains data on capital, population, and wetland coverage.
  - CIAM does not consider increased river flood risks.
  - Loss of life monetized using the Value of Statistical Life; wetland loss monetized using willingness to pay for biodiversity preservation.
- Adaptation scenarios modeled
  - No-adaptation: costs = value of abandoned capital + demolition costs + value of inundated land + monetized disutility of reactive migration.
  - Full-protection: invest in seawalls/barriers; cost = protection costs + expected storm costs; capital and population retained but periodic storm losses possible.
  - Planned retreat: avoid new coastal capital, allow existing capital to depreciate, relocate inland when major retrofitting is required; cost = residual capital loss + value of inundated land + monetized disutility of migration.
  - Other strategies: varying degrees of protection vs. speed of retreat; optimal strategy chosen per coastal segment by net present value of discounted costs and benefits.
- Modeling caveats
  - Parameters (e.g., seawall costs) taken from literature; coarse segmentation implies need for more granular coastal modeling and asset mapping for precision.
  - CIAM provides systematic long-term planning insights despite uncertainties.

### Economic costs, drivers, and optimal tendencies
- Example cost estimates
  - No-adaptation: as high as 4 percent of GDP in 2040 (assuming SSP2-4.5 / present trends).
  - Optimal combined protection and planned retreat (CIAM): costs approximately equal to 1 percent of GDP annually throughout the century.
  - Hypothetical full-coastline protection scenario: investment of approximately 2 percent of GDP in 2040 and an upfront investment of up to 5 percent of GDP during the present decade.
- Main cost components in no-adaptation
  - Loss of land due to inundation.
  - Forced relocation (reactive migration).
  - Storm damages.
- Optimal adaptation tendencies
  - Protection tends to be optimal where large existing capital and high population density exist.
  - Retreat tends to be optimal where capital and population density are low.
- Robustness
  - Analysis relies on median sea-level projection for present-trend emissions, but planned retreat remains optimal also with faster sea-level rise in modeled alternatives.
  - Faster-than-consensus Antarctic and Greenland melting considered unlikely this century but cannot be excluded.
  - Lincke and Hinkel (2018) find planned retreat remains optimal under a range of alternatives, including very fast SLR scenarios.

### Policy implications and recommendations on sea-level adaptation
- Integrate adaptation into development planning to allocate scarce government resources efficiently and address distributional effects.
- Adopt a balanced mix of protection and planned retreat; long-term planning combining both reduces overall costs substantially.
- Use Cost-Benefit Analysis (CBA) and cost-effectiveness analysis as decision frameworks:
  - Standard CBA rule: finance only programs with NPV > 0 and rank competing programs by NPV.
  - In the sea-level example, planned retreat shows highest NPV; compensation (relocation subsidies) can be more efficient than expensive full protection when protection has negative NPV.
- Address equity-efficiency trade-offs explicitly; planned retreat has small fiscal costs but shifts burdens to asset owners in inundated areas.
- Prioritize adaptation policies with positive externalities and remove market imperfections hindering private adaptation.
- For infrastructure, apply the “additionality principle”: count only costs attributable to climate change, excluding normal development and resilience to normal weather shocks.

### Adaptation in other sectors and cost guidance
- World Bank estimates incremental costs to make new infrastructure climate-resilient in Palau: approximately 2 percent (except roads).
  - Roads would require a 30 percent cost premium; high road upgrade costs suggest reactive adaptation may be optimal for roads.
- IMF staff using World Bank data: adaptation costs to present pluvial and coastal flood risks would be well below 1 percent of GDP, annually, from 2021 to 2040.
- Droughts unlikely to become more frequent/intense, but current risks warrant actions: increase water storage capacity and reduce distribution losses.
- Efficient water pricing covering long-run marginal cost encourages conservation and reduces supply-side needs.

### Integrating climate into Public Financial Management (Green PFM)
- Green PFM: adapt existing PFM practices to support climate-sensitive policies; preferred approach for small states with capacity constraints.
- Palau’s PFM Roadmap under formulation provides a five-year opportunity to integrate climate considerations into reforms; sequencing should reflect capacity and prioritize entry points with most value.

### Entry points to integrate climate into PFM (four priorities)
- Entry point 1 — Budget Decision Making
  - Require line ministries/agencies to prepare a short analysis (qualitative initially) on climate impacts of proposed policy and links to mitigation/adaptation.
  - Sequence: start with major new decisions and pilot selected ministries; evolve from qualitative to quantitative as capacity grows.
- Entry point 2 — Identification, Management and Reporting of Fiscal Risks
  - Identify and prioritize fiscal risks (including pandemic-related debt, pension liabilities, SOE risks, climate/natural disaster risks); begin with qualitative identification and evolve sophistication.
  - Output could feed a fiscal risk statement published alongside budget documents.
- Entry point 3 — Infrastructure Project Selection and Costing
  - Strengthen public investment management by systematically including climate-resilient requirements in project costings (e.g., cyclone-resilient materials, land acquisition for less exposed locations).
- Entry point 4 — Reporting on Climate Funding
  - Identify funding received for climate initiatives and government resources devoted to climate initiatives; publish in budget papers with narrative on priorities.
  - Next step: report funds actually spent on climate initiatives depending on FMIS capabilities and include climate spending in annual performance statements.

### Climate finance access and institutional requirements
- Robust PFM and PIM systems are necessary but not sufficient to access large multilateral climate finance; Palau’s access to global climate finance has been limited.
- Strengthen financial reporting, internal controls, and audit to improve access; explore partnerships with international institutions, regional accredited entities, and bilateral partners.

### Mitigation, energy profile, and decarbonization pathways
- Key metrics
  - CO2 emissions per capita: 60 tonnes in 2022.
  - Emissions intensity of output: 5.7 tonnes of CO2 per USD$1000.
  - Palau’s global share of emissions: less than 0.01 percent.
  - Main sectoral contributor: transport.
- Energy infrastructure and targets
  - Dependence on imported fossil fuels; two main diesel generating plants produce the majority of electricity.
  - Baseline renewable generation: less than 7 percent of power sector.
  - A 2-megawatt solar farm set to come online this year expected to increase renewable share to 20 percent.
  - PPUC plans an additional solar farm to reach the 45 percent renewable generation target; further grid investments needed.
  - INDC conditional targets by 2025: 22 percent energy emissions reduction vs. 2005, 45 percent renewable share, 35 percent energy efficiency improvement.
  - Government goal: generate 100 percent of electricity from renewable energy sources by 2035.
- Constraints and options
  - Limited land mass (tenth smallest in Oceania) necessitates strategic ground-mounted PV placement and rooftop PV; floating solar is an emerging option.
  - Policy levers: net metering and feed-in tariffs exist; interconnection standards and green public procurement recommended.

### Decarbonizing transport and sectoral policy instruments
- Feebate schemes: sliding fees/subsidies on new vehicle or vessel purchases to incentivize cleaner choices without increasing average consumer prices.
- Encourage transition to EVs or low-carbon alternatives (biofuels) for vehicles; maritime options include synthetic gasoline from renewable hydrogen/biomass, hydrogen speedboats, or battery-powered hydro foiling boats.

### Carbon pricing: instruments, impacts and illustrative scenario
- Existing carbon instrument: carbon tax on imported liquid petroleum-based products; rate recently reduced from $0.05 per gallon to $0.02 per gallon.
- CPAT findings and requirements
  - To reach a mid-century net-zero aligned pathway by 2030 through pricing alone, Palau would need an additional economy-wide carbon price of over $200/tCO2; an even higher rate would be needed to reach its current NDC.
- CPAT illustrative scenario and impacts
  - A $5/tonne of CO2 economy-wide carbon tax imposed in 2025 that linearly increases to $25/tonne by 2030 could:
    - reduce GHGs,
    - raise significant revenues of over 10 percent of GDP,
    - increase fuel prices by about 5 percent.
  - Energy price changes (Average Effective Carbon Rates in 2030):
    - Gasoline $/lit: BAU 1.23 → BAU+ Average Effective Carbon Rate 1.29 (5% change).
    - Diesel $/lit: BAU 1.25 → BAU+ Average Effective Carbon Rate 1.32 (5% change).
- Distributional measures
  - Carbon pricing can adversely affect low-income households; revenue recycling (e.g., cash transfers) can make pricing progressive.
  - Example: 80 percent of Canadian households receive more back in transfers than they pay in additional costs.
  - Tourists would contribute to revenues but would not receive transfers; competitiveness and growth implications should be considered.

### Leakage risks, transition costs, and financing
- Leakage risks
  - Leakage is “not of much concern” for firms producing non-traded goods/services and for firms where energy is a small share of costs (examples: electricity generation, domestic distribution, restaurants, financial and other services).
  - Primary concern: energy‑intensive, trade‑exposed firms; tourism could be exposed as Palau competes with countries not facing the tax increase.
  - Empirical evidence on leakage is mixed but tends to be small in the industrial sector.
  - Tourism leakage is explicitly noted as “under-studied.”
- Transition costs and financing needs
  - Initial capital cost estimate to achieve 100% renewable energy by 2050: “over 179 million USD,” described as “more than 80 percent of Palau’s GDP.”
  - Domestic actions and funds:
    - “The Palau Social Security Administration (SSA) … transferred $60 million into climate transition investments that reduce carbon emissions” in 2021.
    - “The   A’s goal is to cut indirect contributions to global carbon emissions by half relative to BAU.”
    - “In the same year, the CTF signed into the Principles for Responsible Investment (PRI) … which includes environmental, social, and governance (ESG) into their investment analysis.”
  - Given significant capital needs and small population, seeking additional grants, soft loans, independent power producers (IPPs), and climate finance is imperative.

### Modeling and assessment tools referenced
- CIAM (Coastal Impacts and Adaptation Model): global optimization model for CBA of adaptation to sea-level rise using more than 12,000 coastal segments; evaluates strategies by maximizing net present value across protection, retreat, and other options.
- CPAT (Climate Policy Assessment Tool): projects fuel use and CO2 emissions by major energy sector for 200 countries; baseline uses GDP projections, income and price elasticities, technological change assumptions, and international energy price assumptions; caveats include abstraction from broader mitigation dynamics and general equilibrium feedbacks.

*Source: 1plwea2023002 - 1. Cost of Sea-Level Rise (in percentage of GDP), November 13, 2023, INTERNATIONAL MONETARY FUND.*

### 1. Cost of Sea-Level Rise (in percentage of GDP) _____________________________________ 10

### 1. Cost of Sea-Level Rise (in percentage of GDP)

### Key summary findings
- Warming, sea-level rise, ocean acidification, and heavy rainfall events already affect Palau and will likely intensify in the future.
- IMF staff estimates sea-level rise can cost as much as 4 percent of GDP annually in 2040 without adaptation.
- An adaptation strategy that combines protection and planned retreat of areas at risk of inundation would cut the overall cost of sea-level rise (including adaptation costs) by 75 percent to approximately 1 percent of annual GDP by mid-century.
- Palau’s 2015 Intended National Determined Contribution (INDC) aims to reduce energy sector emissions 22 percent below 2005 levels, increase renewable energy share to 45 percent and improve energy efficiency by 35 percent by 2025, conditional on international financing.
- With the introduction of a new solar farm, Palau is expected to increase its renewable generation share to 20 percent in the near future.
- By 2030, sea-level could increase by an additional 8 to 18 cm relative to its average 1986–2005 level.
- If emissions follow present trends (SSP2-4.5) sea-level is projected to increase by 23 to 48 cm above its 1986–2005 level by 2070.
- The median projections of temperature in 2050 is 1.1 °C higher than in 1985-2014 under continuation of present trends (SSP2-4.5).

### Climate impacts and vulnerabilities
- Temperature and precipitation:
  - The warming trend observed since the 1950s is expected to continue even with strong mitigation efforts globally.
  - There is no significant trend in annual total precipitation; future scenarios indicate a small and uncertain increase in precipitation.
  - Palau receives the largest average annual total precipitation of all countries but has very limited storage capacity, making it susceptible to drought impacts despite high annual rainfall.
- Coral bleaching and biodiversity:
  - Risk of coral bleaching will intensify due to increased sea-water temperature and ocean acidification, with negative effects on biodiversity, fisheries, and tourism.
  - Historical strong El Niño events (1998, 2016) contributed to massive coral bleaching and are more likely with increasing temperatures.
- Tropical cyclones:
  - Available data is not suitable to robustly assess historical trends in tropical cyclones for Palau.
  - Climate models project a reduction in future tropical cyclone formation around Palau but with low confidence; globally, future cyclones are expected to be stronger.

### Adaptation to sea-level rise — model approach (CIAM)
- Model used:
  - The IMF uses the Coastal Impact and Adaptation Model (CIAM) to estimate economic costs and benefits of adaptation to sea-level rise.
  - CIAM divides global coastline into more than 12,000 segments and further by elevation; each segment contains data on capital, population, and wetland coverage.
- Scenarios and strategies modeled:
  - No-adaptation: population and capital remain until inundation forces abandonment; costs equal value of abandoned capital, demolition costs, value of inundated land, plus monetized disutility of reactive migration.
  - Full-protection: invest in seawalls/barriers to avoid inundation; cost equals protection costs plus expected storm costs; capital and population retained but periodic storm losses can occur.
  - Planned retreat: avoid building new coastal capital, allow existing capital to depreciate and relocate infrastructure inland when major retrofitting is required; cost equals residual capital loss, value of inundated land, and monetized disutility of migration.
  - Other strategies: varying degrees of protection vs. speed of retreat; optimal strategy chosen per coastal segment via net present value of discounted costs and benefits.
- Modeling scope and caveats:
  - CIAM does not consider increased river flood risks (not a concern in Palau).
  - Loss of life is monetized using the Value of Statistical Life; loss of wetland monetized using willingness to pay for biodiversity preservation.
  - Model parameters (e.g., costs of seawalls) are taken from the literature.
  - More granular coastal modeling and asset mapping would improve precision, but CIAM provides systematic insights for long-term planning.

### Economic costs and principal drivers
- Estimated costs (examples from analysis):
  - No-adaptation scenario: cost as high as 4 percent of GDP in 2040 (assuming SSP2-4.5 / present trends).
  - With combined protection and planned retreat: overall cost cut by 75 percent to approximately 1 percent of annual GDP by mid-century (including adaptation costs).
- Main cost components in no-adaptation:
  - Loss of land due to inundation.
  - Forced relocation (reactive migration).
  - Storm damages.
- Optimal adaptation tendencies:
  - Protection tends to be optimal in areas with large existing capital and high population density.
  - Retreat tends to be optimal in areas with low capital and population density.

### Policy implications and recommendations
- Integrate adaptation into development planning:
  - Adaptation must be an integral part of development planning to allocate scarce government resources efficiently and consider distributional effects.
  - Prioritize adaptation policies with positive externalities and remove market imperfections that hinder private adaptation.
- Adopt a balanced mix of protection and planned retreat:
  - Long-term planning combining protection and planned retreat substantially reduces overall costs of sea-level rise.
- Use “green PFM” to support climate-sensitive policies:
  - Consider integrating climate considerations into Public Financial Management (PFM) systems via budget decision making, fiscal risks management, project selection processes, and climate reporting—commensurate with authorities’ capacity and only after basic PFM elements are functional.
- Pursue mitigation and complementary policies:
  - Continue investments in renewable infrastructure and grid renewal to meet conditional INDC targets.
  - Complementary policies (feebates in transport, interconnection standards, green public procurement) can strengthen mitigation progress.
- Consider carbon pricing and revenue recycling:
  - A moderate carbon tax could reduce GHGs, encourage renewables, and raise revenues; revenue recycling can help political acceptability and protect vulnerable communities.

*Source: 1plwea2023002 - 1. Cost of Sea-Level Rise (in percentage of GDP), November 13, 2023, INTERNATIONAL MONETARY FUND.*

### 21.      Adaptation to sea-level rise with protective barriers can be highly effective but

### 21.      Adaptation to sea-level rise with protective barriers can be highly effective but

### Sea-level rise adaptation: main findings
- Protecting main urban areas in Palau against sea-level rise is estimated to be highly cost-effective (World Bank, 2016).
- With protection in place, the cost of sea-level rise is estimated to equal to 1 percent of GDP, annually, in 2040 (World Bank, 2016).
- CIAM model analysis assuming optimal adaptation finds costs approximately equal to 1 percent of GDP, annually, throughout the century (Panel b, Box 1).
- Under the CIAM optimal strategy, planned retreat is chosen as the optimal protection strategy.
- A hypothetical scenario in which all the coastline is protected would require:
  - an investment of approximately 2 percent of GDP in 2040, and
  - an upfront investment of up to 5 percent of GDP during the present decade (Panel c, Box 1).

### Scenarios analyzed (Box 1)
- Three scenarios estimated by IMF staff using the CIAM model (Diaz, 2016):
  - No Planned Adaptation – society reacts by relocating, no protection built, capital losses are large.
  - Full Protection – society builds protection anticipating sea-level rise without relocating people or assets.
  - Efficient Adaptation – society plans a mix of protection and retreat by comparing costs and benefits and choosing the strategy with the largest net present value.

### Uncertainty and robustness
- Analysis relies on the median projection of sea-level rise for an emission scenario along present trends, but planned retreat remains the optimal strategy also with faster sea-level rise.
- Higher emissions do not have a large impact on sea-level rise at least until mid-century; there is substantial uncertainty on the speed of sea-level rise for any given emission trajectory.
- Faster-than-consensus melting of the Antarctic and Greenland ice sheets is considered unlikely this century but cannot be excluded.
- Lincke and Hinkel (2018), using a model similar to CIAM, find planned retreat remains optimal under a range of alternative modeling options, including a scenario of very fast sea-level rise.
- Due to the coarse nature of the model and large uncertainties in protection costs and avoided damages, scenario estimates should not be interpreted as exact point estimates; high-resolution, case-by-case analysis is needed.

### Cost-benefit analysis (CBA) and decision framework
- CBA provides a standard framework to estimate social costs and benefits and to identify trade-offs and most attractive policy options (Bellon and Massetti, 2022a).
- Best practices can be drawn from the Netherlands’ long-standing tradition of using CBA and Cost-Effectiveness analysis for flood risk management and water governance.
- Limitations of CBA under uncertainty exist; cost-effectiveness analysis can be an alternative if outcomes are considered too uncertain.
- According to standard CBA rules:
  - Only programs with NPV greater than zero should be financed.
  - Competing programs should be ranked using CBA and financed in order of highest ranking.
- In the sea-level rise example, planned retreat is the strategy with the highest net present value.
- Compensation (e.g., relocation subsidies) might be more efficient than expensive full protection to achieve society’s equity preferences when protection has negative NPV.

### Equity-efficiency trade-offs
- Adaptation involves efficiency-equity trade-offs that can be measured with economic tools like CBA but evaluated by policymakers reflecting societal equity preferences.
- Large protection investments can be effective but very expensive, potentially requiring cuts to other public spending or higher fiscal revenues; donor funding could alternatively be used for other development goals.
- Planned retreat has small fiscal costs but requires long-term land use planning and shifts the burden to populations owning assets in inundated areas.
- Full compensation of residual damages may be theoretically possible but not feasible or desirable in practice.

### Adaptation in other sectors: costs and guidance
- World Bank estimates:
  - Incremental cost of making new infrastructure resilient to climate change in Palau is approximately 2 percent (except roads).
  - Roads would require a 30 percent cost premium.
- High cost of upgrading roads suggests reactive adaptation is optimal for roads—after worst outcomes become clear (World Bank, 2016, Table 13, p. 47).
- IMF staff estimates using World Bank data indicate adaptation costs to present pluvial and coastal flood risks would be well below 1 percent of GDP, annually, from 2021 to 2040 (Aligishiev, Bellon, and Massetti, 2022).
- Droughts are unlikely to become more frequent or intense in Palau, but present risks warrant corrective actions such as increasing water storage capacity and avoiding water distribution losses.
- Efficient water pricing schemes that cover the long-run marginal cost of water supply encourage conservation and can reduce supply-side intervention needs (Olmstead and Stavins, 2009).
- When estimating adaptation investment needs, apply the “additionality principle”: count only costs attributable to climate change (exclude normal development and resilience to normal weather shocks).

### Efficient adaptation principles and policy priorities
- Start from core principles for effective and efficient adaptation policy; integrate climate change in macro-fiscal planning (Gonguet et al. 2021; Bellon and Massetti, 2022a,b; Aligishiev, Bellon, and Massetti, 2022; Sakrak et al. 2022).
- Adaptation is most effective when an integral part of development planning and when government prioritizes:
  - Concentrating efforts and resources in key areas.
  - Collecting information on effectiveness of spending and distributional impacts across groups.
- Government role:
  - Prioritize adaptation policies with positive externalities.
  - Remove market imperfections and policy failures that hinder efficient private adaptation.
  - Ensure a just transition, including support mechanisms when retreat is preferred.

### Market imperfections relevant to adaptation (Box 2)
- Adaptations with large positive externalities and public goods (e.g., information, emergency preparedness plans, seawalls, basic research) are underprovided by markets.
- Network dependencies (dikes, water networks, transportation) can cause underprovision of private adaptation; government coordination may be required.
- Extent of cooperation needed depends on spillover scope; local, national, or international coordination may be warranted.
- Broader market imperfections (poor business environment, inefficient credit markets) hamper private adaptation investments.
- Moral hazard may reduce private investment if relief is expected from central government; regulations (zoning, building codes, mandatory evacuations, mandatory insurance) can mitigate moral hazard.
- Governments should also consider correcting distortions from their own policies (e.g., subsidized water use worsening water scarcity, trade barriers preventing efficient reallocation).

### Integrating climate into public financial management (PFM)
- “Green PFM” adapts existing PFM practices to support climate-sensitive policies; it is an enabler of integrated government climate strategy.
- For small developing states with capacity constraints, integrating climate-sensitive practices into existing PFM systems is preferred over creating entirely new systems—prioritize entry points with most value given thin capacity.
- Palau’s PFM Roadmap under formulation presents an opportunity to integrate climate considerations into PFM reforms over the next five years; the Roadmap will respond to PEFA assessment results and fiscal challenges including pandemic-related public debt increases, elevated fiscal risks from pension liabilities and SOEs, and large climate change adaptation needs.

*Source: IMF staff summary of chapter content (1plwea2023002).*

### 38.      Adoption of Green PFM requires countries to consider entry points that are reflective

### 1plwea2023002 - 38.      Adoption of Green PFM requires countries to consider entry points that are reflective

### Entry points to integrate climate into Public Financial Management (PFM)
- Four initial priority entry point opportunities for incorporating climate considerations into PFM systems that could be led by the Ministry of Finance in collaboration with other relevant entities:
  - Entry point 1 – Incorporating climate considerations into Budget Decision Making
    - PEFA assessment: Palau’s budget preparation process is sound.
    - Proposal: require line ministries and agencies to prepare a short analysis (qualitative statement, at least initially) on the climate impacts of proposed policy, including connection to mitigation or adaptation.
    - Sequencing: focus first on major new decisions before all new decisions; evolve from qualitative to quantitative impact assessments as data and capacity improve.
    - Pilot/target: begin with selected ministries and programs to avoid overwhelming initial rollout.
    - Example: Turks and Caicos implemented this approach with support from CARTTAC.
  - Entry point 2 – Incorporating climate considerations into the Identification, Management and Reporting of Fiscal Risks
    - PEFA assessment: limited practices in fiscal risk analysis, management and reporting.
    - Context: elevated fiscal risks since the onset of the pandemic including from SOEs and higher levels of debt, plus climate and natural disaster risks.
    - Proposal: identify the range of fiscal risks, prioritize which risks require more analysis based on likelihood and impact, begin qualitative identification and evolve sophistication over time.
    - Output: information could form the basis of a fiscal risk statement to be published alongside the budget documents.
  - Entry point 3 – Strengthening climate considerations in infrastructure project selection and costing
    - PEFA assessment: relative weakness in public investment management (project appraisal and costing).
    - Observation: project appraisal criteria include climate considerations but costing guidance/methodologies need to incorporate climate-resilient requirements (e.g., cyclone resilient materials, land acquisition for less exposed locations).
    - Proposal: systematically include these factors in proposal development and project costings to inform allocation and prioritization.
  - Entry point 4 – Enhancing Reporting on Climate Funding
    - Current reporting: Palau has an established performance reporting framework; backlog of audited annual financial statements primarily due to pandemic delays; budget execution reports are timely and regular.
    - Proposal: identify funding received for climate initiatives and government resources devoted to climate initiatives; publish in budget papers with narrative on climate priorities and policy rationale (Box 4 reference: Cook Islands approach).
    - Next step: report on funds actually spent on climate initiatives depending on new FMIS capabilities; include climate spending and intended impacts in annual performance statements.

*Source: IMF staff assessment as presented in the text.*

### Climate finance access and PFM/PIM
- Robust PFM and PIM systems are necessary but not sufficient to access climate finance from large multilateral funds.
- Palau’s access to global climate finance (e.g., Green Climate Fund) has been limited to date.
- Requirements for access reinforce robust PFM and PIM processes, particularly financial reporting, internal controls, and audit.
- Recommendation: continue strengthening these practices and explore diverse channels to access finance, including partnerships with international institutions, regional accredited entities, and bilateral partners.

### Climate change mitigation — emissions and energy profile
- Key metrics and observations:
  - CO2 emissions per capita: 60 tonnes in 2022.
  - Emissions intensity of output: 5.7 tonnes of CO2 per USD$1000.
  - Global share: Palau produces less than 0.01 percent of global emissions.
  - Main sectoral contributor: transport (largest contributor to Palau’s GHG emissions).
- Energy dependence and infrastructure:
  - Palau is dependent on imported fossil fuels; two main diesel generating plants produce the majority of electricity.
  - Renewable energy generation: less than 7 percent of total share of the power sector (baseline).
  - A 2-megawatt solar farm is set to come online this year and is expected to boost renewable power share to 20 percent.
  - PPUC plans an additional solar farm to reach the 45 percent renewable generation target, but further grid investments will be needed.
  - Palau’s renewable/energy targets and goals:
    - By 2025, the 2015 INDC aims to reduce energy sector emissions 22 percent below 2005 levels, increase renewable energy share to 45 percent and improve energy efficiency by 35 percent. These targets are conditional on international financing.
    - Government goal: generate 100 percent of electricity from renewable energy sources by 2035.
- Constraints and opportunities:
  - Land mass: Palau has the tenth smallest country land mass in Oceania, requiring strategic placement of ground-mounted PV arrays and investments in rooftop PV.
  - Emerging options: possibility of floating solar (pilot stage in other countries).
  - Policy levers: net metering and feed-in tariffs already established; interconnection standards and a green public procurement strategy recommended to expedite transition.

### Decarbonizing transport and sectoral policies
- Strategies:
  - Apply a feebate scheme to new vehicle or vessel purchases (sliding fees/subsidies: fees for dirty vehicles/vessels, subsidies for clean ones) to incentivize transition without increasing average consumer prices.
  - Encourage transition of vehicle fleet to electric vehicles (EVs) or low carbon alternatives such as biofuels.
  - Maritime transition: shift from high-power outboard gasoline engines to synthetic gasoline alternatives (from renewable hydrogen and biomass), hydrogen speedboats, or battery-powered hydro foiling boats.

### Carbon pricing: potential, impacts and revenue recycling
- Existing carbon instrument:
  - Palau has a carbon tax on imported liquid petroleum-based products.
  - The tax was recently reduced from $0.05 per gallon to $0.02 per gallon.
- Effective rates and CPAT findings:
  - As of 2022, the effective carbon rate on diesel and gasoline is high compared to some island states (Figures referenced).
  - CPAT finds that to reach the mid-century net-zero aligned pathway by 2030 through pricing alone, Palau would need an additional economy-wide carbon price of over $200/tCO2, and an even higher rate to reach its current NDC.
- Policy scenario example (CPAT illustrative scenario):
  - A $5/tonne of CO2 economy-wide carbon tax imposed in 2025 that linearly increases to $25/tonne by 2030 could:
    - Reduce GHGs (Figure 10 referenced).
    - Raise significant revenues of over 10 percent of GDP.
    - Increase fuel prices by about 5 percent.
  - Table of energy price changes for the Average Effective Carbon Rates in 2030:
    - Gasoline $/lit: BAU 1.23 → BAU+ Average Effective Carbon Rate 1.29 (5% change).
    - Diesel $/lit: BAU 1.25 → BAU+ Average Effective Carbon Rate 1.32 (5% change).
- Distributional considerations and revenue recycling:
  - Carbon pricing can adversely affect low-income households.
  - Revenue recycling can make pricing progressive (example cited: 80 percent of Canadian households receive more back in transfers than they pay in additional costs).
  - Recommendation: identify vulnerable households and use revenues to provide cash transfers; phase in pricing to improve political acceptability.
  - Note: tourists would contribute to carbon pricing revenues but would not receive transfers; implications for competitiveness and growth should be considered when setting pricing levels.

*Italicized source attribution provided by the pipeline.*

### 47.      Carbon taxes can increase costs for tourists and can raise concerns around activity

### 47.      Carbon taxes can increase costs for tourists and can raise concerns around activity moving abroad (i.e., “carbon leakage”)

### Leakage risks and sectoral exposure
- Leakage is “not of much concern” for firms producing non-traded goods and services (examples given: electricity generation, domestic distribution, and restaurants) and for firms “where energy makes up a small share of total costs” (examples given: financial, and other services).
- The primary concern is energy‑intensive, trade‑exposed firms, which “could include tourism as Palau would compete against countries that do not face this tax increase.”
- Empirical evidence: Studies have found mixed evidence of leakage but “it tends to be small in the industrial sector (see Keen et al. 2021).”
- Tourism leakage is explicitly noted as “under-studied.”

### Policy options to address leakage (relevant to Palau)
- Establishing international coordination on climate mitigation “since this removes the cost advantage of traveling to another location.”
- Applying the carbon price to emissions above a threshold level; this “would still increase the marginal incentive to reduce emissions so long as the threshold is low enough to be impactful.”

### Transition costs and financing needs
- Initial capital cost estimates for achieving 100% renewable energy by 2050 amount to “over 179 million USD,” described as “more than 80 percent of Palau’s GDP.”
- Domestic institutional actions:
  - “The Palau Social Security Administration (SSA) … transferred $60 million into climate transition investments that reduce carbon emissions” in 2021.
  - “The   A’s goal is to cut indirect contributions to global carbon emissions by half relative to BAU.” (text preserved exactly as in source)
  - “In the same year, the CTF signed into the Principles for Responsible Investment (PRI) … which includes environmental, social, and governance (ESG) into their investment analysis.”
- Given the significant capital costs and Palau’s small population, the report states that “seeking additional grants, soft loans, independent power producers (IPPs), and climate finance will be imperative to strengthen mitigation efforts.”

### International mitigation trends and spillover channels
- Strengthened mitigation policies by trading partners may affect Palau through three channels:
  - (i) Increased international fuel prices, which could increase the cost of diesel generation;
  - (ii) Increased cost of transport, which would put pressure on Palau’s terms of trade as the cost of imports rises;
  - (iii) More expensive travel, which could disproportionately impact Palau’s tourism sector given its remoteness and reliance on highly polluting transport vessels by air and sea.
- The report notes: “However, the extent of these impacts remains uncertain.”

### Modeling and assessment tools referenced
- Coastal Impacts and Adaptation Model (CIAM)
  - CIAM is “a global optimization model for cost-benefit analysis of adaptation to sea-level rise (SLR)” that uses coastal characteristics from more than 12,000 coastal segments and develops economic, population, and SLR scenarios.
  - CIAM evaluates alternative adaptation strategies (full protection, partial protection, minimal/progressive retreat) by maximizing net present value across strategies using costs such as protection cost, retreat cost, inundation cost, wetland loss cost, and flood cost.
- Climate Policy Assessment Tool (CPAT)
  - CPAT provides country-by-country projections of fuel use and CO2 emissions by major energy sector for 200 countries.
  - Baseline projections use: GDP projections; assumptions about income elasticity and own-price elasticity for electricity and other fuels; assumptions about the rate of technological change affecting energy efficiency; and future international energy prices.
  - Impacts of carbon pricing in CPAT depend on: (i) proportionate impact on future fuel prices across sectors; (ii) a simplified model of fuel switching in power generation; and (iii) own-price elasticities for electricity and fuels (fuel price elasticities are “typically between -0.5 and -0.8”).
  - Caveats: CPAT abstracts from additional mitigation beyond currently observed fuel use and prices; may not capture dramatic price-driven technological shifts; does not explicitly model general equilibrium feedbacks or changes in international fuel prices from simultaneous reforms in large countries.

*Source: 1plwea2023002 - 47.      Carbon taxes can increase costs for tourists and can raise concerns around activity*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1plwea2023002.pdf_