## ch3 - introduction of carbon taxes, establishment of emissions trading systems, and feebates

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### Introduction and scope
- Transition to a post-pandemic era presents an opportunity to address climate change as a threat to long-term growth and prosperity.
- Chapter scope:
  - Takes stock of main climate change challenges in LAC and explores a menu of policy options recognizing country- and sector-specific circumstances.
  - Addresses:
    - What are the main climate change challenges in LAC? (Section II)
    - What are the policy options in LAC to tackle climate change, including mitigation (Section III.1) and adaptation (Section III.2)?
    - What are the financing requirements to reach LAC’s climate goals? (Section IV)

### Climate risks: physical and transition
- Physical risks (key findings):
  - High vulnerability to higher temperatures, weather-related natural disasters, sea-level rise, coastal erosion, and loss of biodiversity.
  - High reliance on climate-sensitive sectors such as tourism and agriculture.
  - Physical risks can adversely affect aggregate supply (destruction of physical capital, dislocation of labor markets, disruption of supply chains) and aggregate demand (reductions in consumption and investment, disruption of trade flows), threatening growth, employment, fiscal sustainability, and financial stability.
- Transition risks (key findings):
  - Structural changes required to achieve climate sustainability goals can cause economic dislocations if not managed properly.
  - Potential repercussions include sectoral shifts in employment, comparative advantage, and trade patterns with effects on growth, fiscal positions, inflation, external positions, and financial systems.

### Opportunities from mitigation and adaptation
- Mitigation co-benefits:
  - Short-run domestic environmental and health benefits, including reductions in air pollution mortality and morbidity, and in road fatalities.
  - Direct economic savings (e.g., reduced road damage and traffic congestion).
- Investment and innovation gains:
  - Investment in green technologies and infrastructure could help boost growth and generate new jobs (IMF October World Economic Outlook (WEO) 2020).
  - Green innovation in the energy sector could generate positive spillovers and reduce energy security risks.
- Agricultural and resource opportunities:
  - Sustainable farming can release fiscal resources used for subsidies, increase external resilience, contribute to food security, and increase domestic income sources.
  - Shift away from livestock could free up land for plant-based proteins or reforestation.
  - LAC countries with natural endowments of metals (copper, nickel, cobalt, lithium) could benefit from demand for low greenhouse-gas technologies.
- Resilience investments:
  - Investing in resilient infrastructure could yield significant growth and fiscal benefits over time for countries vulnerable to climate disasters.

### Regional emissions and sectoral composition (key statistics)
- LAC’s share of global net GHG emissions (including impact of land use practices): 8.4 percent.
- LAC per capita net GHG emissions: 6.4 metric tons CO2-eq.
- LAC gross GHG emissions per capita (excluding land use practices): 5.2 metric tons CO2-equivalent.
- World average gross GHG emissions per capita (for comparison in text): 6.3 metric tons CO2-equivalent.
- The region’s higher net (relative to gross) emissions reflect a positive contribution from land use practices largely due to deforestation.
- The three largest emitters in the region together contributed 5.4 percent to global net GHG emissions in 2018.
- Countries heavily dependent on fossil-fuel exports (Bolivia, Colombia, Ecuador, Guyana, Suriname, Trinidad and Tobago, and Venezuela) represent a total of 1.7 percent of global net GHG emissions.
- Energy sector share of GHG emissions in LAC: 43 percent of GHG emissions, compared to the world average of 74 percent.
- Net GHG emissions from agriculture and change in land use and forestry combined: 45 percent of total in LAC, compared to the world average of 14 percent.
- Electricity production in the Caribbean: non-renewable sources comprise 88 percent of electricity generation, in contrast to about 40 percent in the rest of LAC.

### Vulnerability and disaster impacts (key statistics)
- LAC as a whole is below the world average on the ND-GAIN vulnerability index, but there are pockets of high vulnerability, notably the Caribbean.
- Damages from natural disasters in the Caribbean are estimated at 2.5 percent of GDP annually.
- Estimated annual average damages in Central America: 0.8 percent of GDP.
- Expected climate impacts include higher temperatures, sea-level rise, changes in precipitation, lower agricultural production, reduced availability and quality of water resources, loss of forested areas and biodiversity, and adverse health effects.

### Policy approach and priorities
- Broad mitigation toolkit recommended:
  - Price-based instruments: introduction of carbon taxes, establishment of emissions trading systems, and feebates.
  - Non-price-based measures: public investment in low-GHG technologies and infrastructure, fiscal incentives, direct current public spending to make low-carbon energy sources more abundant and affordable, and supportive regulations.
- Nature-based Solutions (NbS) important given large share of emissions from change in land-use practices.
- Policy mixes should account for extensive renewable energy use, societal preferences, and political economy; countries should adopt nationally articulated strategies.
- Adaptation priority:
  - Building resilience to natural disasters is region-wide but a priority for Caribbean and Central American economies.
  - Comprehensive medium-term adaptation approach focused on:
    - investing in structural (or physical) resilience,
    - boosting financial resilience,
    - enhancing post-disaster resilience.
- Mitigation and adaptation require significant upfront financing, including international and private-sector support.

### Policy instruments: features, trade-offs, and current use
- Carbon taxes:
  - Levied on the supply of fossil fuels in proportion to their carbon content.
  - Efficient by allowing least-cost reductions, but may need to be set at high levels to achieve desired reductions in some countries; politically and socially challenging.
- Fossil fuel subsidy removal:
  - Increases relative price of energy products, reduces consumption, encourages shift to low-carbon alternatives; politically and socially difficult—design, phasing, and communications must protect most vulnerable.
- Emissions Trading Systems (ETS):
  - Auction or allocate permits that are traded; can provide carbon removal credits to incentivize carbon capture.
  - Application across forestry and agriculture requires well-defined property rights and good measures of CH4 and N2O emissions.
- Feebates:
  - Tax/subsidize activities with above/below average emissions intensity; help achieve cuts without net tax burden or fiscal cost; narrower sectoral reach and require periodic schedule adjustments.
- Current use in LAC:
  - Only four LAC countries have carbon taxes in place: Argentina, Chile, Colombia, and Mexico.
  - Implemented carbon tax rates are in the range of US$1-10 per ton CO2-eq.
  - Carbon taxes in these countries cover only a portion of GHG emissions: 20-24   percent.
  - Environmental taxes collected 1.1 percent of GDP on average in 2018 in LAC, compared with 2.2 percent of GDP on average in the OECD.
  - Explicit fossil fuel subsidies particularly large in oil producing economies, exceeding 1 percent of GDP in some cases.
  - ETS and feebates not actively used regionwide; Brazil conducted voluntary ETS simulations since 2013 and feebates are under consideration in Costa Rica.

### Non-price-based mitigation and institutional considerations
- Public investment examples:
  - Electrification of public bus fleets; installation of solar panels and wind turbines; investment in sustainable farming methods.
  - Benefits: lower cost of switching to sustainable practices; contribute to sustainable and inclusive post-pandemic recovery; contain negative supply shocks.
- Fiscal incentives and direct public spending:
  - Subsidies and direct public funding for R&D; subsidies and price guarantees for low-carbon sectors; address market failures and generate private sector spillovers.
- Supportive regulations and NbS:
  - Emission, technological, product, and land/forest management standards.
  - NbS: protect, manage, restore ecosystems; provide carbon capture, address food and water security, reduce disaster risk, increase biodiversity, foster green jobs.
- Institutional and political economy considerations:
  - Maintain macroeconomic and financial stability; establish clear property and intellectual property rights; strengthen competition, transparency, financial inclusion.
  - Incorporate climate-related risks into macro-financial and fiscal frameworks; assign roles to public policy institutions; fiscal institutions lead and central banks incorporate climate risks into financial risk assessments and monetary policy design.
  - Transition creates winners and losers; recommended compensatory measures include cash transfers, active labor market policies, and strengthening social safety nets early.

### Price-Based Mitigation Policies in LAC: CPAT scenarios and modeling specifics
- Modeling approach:
  - Uses Carbon Pricing Assessment Tool (CPAT) developed by IMF and World Bank (model and data last updated October 6, 2021).
  - Two-stage simulation:
    1. Gradual and complete removal of existing fossil fuel subsidies between 2022 and 2025.
    2. In addition to subsidy removal, gradual introduction of carbon taxes of $25/ton, $50/ton and $75/ton from 2022 to 2030.
- Carbon tax specifics:
  - Carbon taxes mentioned are 2030 targets. The starting carbon tax in 2022 is assumed to be 1/3 of the 2030 target. Carbon taxes rise linearly to reach the 2030 target. After 2030, carbon taxes keep rising with the same trend.
  - Carbon taxes are levied on each unit of GHG emission from fuel combustion.
  - Example: combustion of one liter of gasoline emits 2.4kg of CO2. A $50/ton carbon tax will translate to $0.12/liter levy for gasoline.
- Revenue recycling:
  - Fiscal revenue from carbon pricing policies assumed recycled back via universal cash transfers to households.
- BAU to 2030:
  - Under Business-As-Usual (BAU), greenhouse gas emissions excluding LULUCF will increase slightly for most countries by 2030 due to continued economic growth increasing fossil-fuel consumption and reduced energy intensity from efficiency improvements and rising international petroleum prices.

### CPAT model findings: emissions, prices, fiscal revenues, welfare, distribution
- Emissions:
  - Phasing out fossil fuel subsidies would substantially reduce emissions in countries with large subsidies.
  - Further gradual introduction of $25/ton, $50/ton and $75/ton carbon taxes by 2030 would reduce NDC gaps for many LAC countries.
  - Some countries, including Colombia, Jamaica, and some other Caribbean economies, would remain far from their NDC goals.
  - Analysis focuses further on a $50/ton carbon tax scenario.
- Price impacts (with subsidy removal and a $50/ton carbon tax):
  - gasoline prices would increase by 10–30 percent by 2030 in many countries.
  - natural gas prices would rise by around 30 percent.
  - coal prices would double or triple.
- Fiscal revenues:
  - Countries can raise significant fiscal revenues between 0.5 percent and 4.5 percent of GDP.
  - Recycling revenues through cash transfers could offset much of the negative growth effect of subsidy removal and carbon taxes.
  - An upfront green investment push could compensate effects on activity.
- Wider welfare and distributional effects:
  - Non-GDP benefits: lower air pollution mortality and morbidity; reduced road fatalities; direct economic savings from reduced road damages and traffic congestion; fewer extreme weather phenomena associated with climate change (assuming global cooperation).
  - Distributional impacts:
    - Differential impacts across households due to differential energy intensity of consumption, varying purchasing power, and differential exposure of labor to carbon-intensive sectors.
    - Channels: direct consumption impact from higher energy prices; indirect effects via Input-Output linkages; income/employment losses for workers in affected sectors.
    - Compensatory policies: using carbon tax and subsidy-removal revenues for universal cash transfers can make the overall policy package highly progressive.
    - Model estimates suggest universal cash transfers could fully offset adverse impact on household consumption in the first six to seven deciles of per capita household consumption in Argentina, Brazil, Colombia, and Mexico.
    - Absent compensatory policies, consumption impact could be relatively large and somewhat regressive.
    - Governments could alternatively leverage existing social safety nets to target the most vulnerable and allocate part of revenues to green public investment.

### CPAT additional modeling notes and key scenarios
- Scenarios and assumptions:
  - Analysis includes removal of explicit fossil fuel subsidies only in base analysis.
  - A gradual and complete removal of fossil fuel subsidies (both explicit and implicit) by 2025—including introducing optimal carbon taxes to eliminate implicit subsidies—could:
    - reduce regional carbon dioxide emissions by 24 percent below baseline levels in 2025,
    - raise revenues by 1.7 percent of regional GDP,
    - prevent 35,000 local air pollution deaths annually.
  - Fossil fuel subsidies in illustrative scenarios are phased out over 3 years (2022–25) and the carbon tax is assumed to rise linearly from $17 to $50/ton between 2022–30.
- Caveats:
  - Economic models of climate change have high model and data uncertainty; results are indicative rather than precise.
  - Empirical evidence on GDP impacts of carbon taxes is inconclusive; CPAT results align with CGE models showing negative effects, but some empirical studies point to roughly no effect on GDP or employment growth.

### Country and sectoral specifics: Brazil case study (key figures and findings)
- Employment and income impacts:
  - Simulations suggest aggregate impact of an increase in carbon price on income would be limited, affecting less than 1 percent of employed persons in Argentina, Brazil, and Mexico.
  - In Brazil the impact would remain small across all income deciles; larger in coal and oil sectors.
  - Price elasticity of energy products assumed: -0.25 (as in IMF (2020)).
- Green transition offsets:
  - IEA (2021) estimates for global green transition: 14 million green jobs and 30 million green and related jobs by 2030; translates to 1.2 million green jobs and 2.6 million green and related jobs by 2030 in LAC based on LAC’s share in the global economy.
  - IMF WEO, 2020 style policy package estimated to increase employment by around 1 percent of the labor force in 10 years. Package specifics include a 10-year green public investment program starting at 1 percent of GDP and linearly declining to zero, 80 percent subsidy rate on renewables production, carbon tax starting at $8-18 per ton growing by 7 percent annually, compensatory transfers equal to ¼ of carbon tax revenues, and debt finance in a low-for-long interest rate, low inflation context.
- Agriculture and livestock transition:
  - Panel data estimation suggests an emissions intensity ratio of six-to-one between livestock and plant-based agriculture in Latin America.
  - For a given GHG reduction in agriculture, estimated average gross employment/labor income loss in livestock would be higher in countries with higher initial livestock employment; Brazil’s livestock accounts for 3.9 percent of employment (compared with 1.2 percent in Argentina).
  - CPAT scenario implies a decline in livestock by about 3 percent by 2030 in Brazil and Argentina, with resources repurposed to plant-based production and increased forestry (afforestation).
- Green commodity exports (annual average during 2016–19) — Brazil:
  - Copper: Percent of GDP: 0.120; Percent of Exports: 0.915.
  - Nickel: Percent of GDP: 0.000; Percent of Exports: 0.004.
  - Cobalt: Percent of GDP: 0.000; Percent of Exports: 0.001.
- Historical precedent:
  - Brazil’s National Alcohol Program (Proálcool) launched in 1975 cited as positive example for renewable investment and low-skilled job creation.

### Adaptation, disaster insurance, and resilience financing
- Insurance coverage and layering (simulated costs and calibration):
  - Simulated annual cost of illustrative insurance coverage would initially be in the range of 0.5-2 percent of GDP per year.
  - As structures become more resilient, insurance requirements for same coverage would decline in the long run to about one-fourth of the current level.
  - Simulations calibrated to achieve coverage of 99 percent of disaster loss and include risk of tropical cyclones and earthquakes.
  - Saving fund size calibrated to cover fiscal cost of natural disasters in 95 percent of events; access to CCRIF and issuance of CAT bonds added to reach coverage of 99 percent.
- Near-term fiscal costs and transitional financing gap:
  - Large upfront costs relative to fiscal capacity; benefits accrue over medium/long term.
  - Example: Dominica total cost of building resilience estimated at US$2.8 billion (about 500 percent of GDP) and would require over a decade to fully execute.
  - For ECCU countries, additional cost of resilience could increase public debt by 4-20 percentage points of GDP by 2030, translating into additional financing gaps of 0.4 to 1.5 percent of GDP relative to historical levels.
  - For countries with public investment rate of 5 percent, increasing resilience to 80 percent (with resilient capital 25 percent more expensive) would imply a fiscal deterioration of 1 percent of GDP each year.
- Insurance market constraints and instruments:
  - CCRIF improved regional coverage but many countries still have low coverage due to high upfront costs, payout concerns, and competing needs.
  - Catastrophe bonds underused because of complexity, high setup costs, and capacity/regulatory constraints.
  - Reinsurance dynamics: In the ECCU, estimated 60-75 percent of insurance premiums are ceded to reinsurance; ceded share higher for property insurance.
  - Reinsurance costs increased by 20–40 percent in 2018 for countries hit by disasters the preceding year in the Caribbean, and 10–20 percent for other countries.
- Private sector adaptation barriers and policy options:
  - Barriers: credit constraints (high interest rates, limited collateral), limited affordable insurance, bank credit skewed away from vulnerable sectors.
  - Policy options: technical support, climate risk information dissemination; regulatory and fiscal incentives; partial public credit guarantee schemes; alternative collateral frameworks; risk pooling among private insurers with public guarantees for excess liability.
- Financial system resilience and supervisory actions:
  - Current direct financial sector exposure limited due to insurance gaps and limited lender credit exposure to vulnerable sectors; scaling up local financial services for adaptation would increase direct exposures.
  - Indirect risks: macroeconomic amplification, (re)insurance pricing and counterparty risks, sovereign exposure.
  - Recommendations: incorporate physical climate risks into supervisory frameworks; implement reporting structures for granular monitoring; strengthen oversight of inter-institutional exposures; adopt regulatory measures for climate risk-aware lending, exposure diversification, prudential buffers, and ex-post asset recovery; integrate physical climate risk scenarios into crisis management plans.

### Preparing fossil-fuel exporters and transition risks
- Assessment of preparedness:
  - Venezuela and Guyana among least prepared; Bolivia moderately prepared; Brazil, Colombia, Mexico relatively better prepared (World Bank 2020).
- Policy measures:
  - Improve export competitiveness and lower trade costs; foster green innovation; use enabling policies for countries with green commodity reserves; design fiscal policies for mitigation/adaptation emphasizing social and political acceptability and effectiveness.

### Financing mitigation and adaptation: scale and instruments
- Global investment needs to reach net zero by 2050: US$1.475–1.8 trillion annually in new investment in green energy generation, transmission, and storage (Energy Transitions Commission).
- Estimated annual investment needs for LAC based on share of global GDP:
  - Climate mitigation: US$75–92 billion.
  - Adaptation: US$14–17 billion.
  - Combined estimate to reach NDC goals and strengthen structural resilience: US$90–110 billion per year for the LAC region (around 1.7–2.1 percent of the region’s 2019 GDP).
- Resource mobilization:
  - Most resources will need to come from external private or public sources; for most vulnerable countries, highly concessional terms, including grants, will be essential.
- Private funding opportunities and risks:
  - Sustainable debt market reached US$2.3 trillion with net new issuance of US$760 billion in 2020; LAC issuance represented 2.5 percent or US$19 billion of net new issuance.
  - Green bonds cumulative global issuance just over US$1 trillion by end-2020; LAC green bond issuance was US$7.6 billion in 2020.
  - ESG equity funds estimated size varies from US$3.5 to US$10 trillion or more; ESG equity investment in LAC is a small share.
  - Risk of greenwashing; need transparent, verifiable standards for green financing.
- State-contingent and official instruments:
  - Catastrophe bonds and hurricane clauses underused but potentially important.
  - Loan guarantees, “debt-for-nature” swaps, compensation payments to preserve tropical forests (financing for NbS).
  - Advanced economies’ pledge of US$100 billion a year in climate finance to developing economies is critical.
  - MDBs and national development banks provided substantial shares of climate financing in LAC (25 percent and 53 percent of total financing, respectively, per ECLAC 2020).
  - IMF exploring a Resilience and Sustainability Trust (RST) financed by rechanneling SDRs; RST objectives include support for policy reforms, cheaper financing at longer maturities, and targeting low-income, small states, and vulnerable middle-income countries.

### Conclusions: strategic takeaways and policy recommendations
- Regional overview:
  - LAC is diverse in climate-related risks; net GHG emissions in line with economic size and population, with clean energy mix counterbalanced by large emissions from agriculture, land use, and forestry.
  - Climate change is macro-critical for LAC, especially Caribbean and Central America; exacerbates poverty and inequality.
- Mitigation policy recommendations:
  - Use a broad range of mitigation tools: carbon taxes, fossil fuel subsidy removal, ETS, feebates, public investment, fiscal incentives, and supportive regulations.
  - Leverage NbS given LAC’s natural resources.
  - Design policy mixes tailored to country circumstances, balance carbon pricing with green investment push, and secure public support through consultation, sequencing, and social protection.
- Adaptation recommendations:
  - Prioritize structural resilience, financial resilience (layered insurance), and post-disaster resilience—especially in the Caribbean and Central America.
  - Address transitional financing gap through international support and incentivizing private adaptation investment while strengthening financial system resilience.
- Financing recommendations:
  - Significant upfront financing required; external financing (official and private) essential.
  - Develop transparent standards to mitigate greenwashing; use state-contingent instruments such as catastrophe bonds.
  - Leverage MDBs, national development banks, and potential IMF RST for concessional finance and policy support.

_Italic: Chapter prepared by Anna Ivanova (lead), Sònia Muñoz (co-lead), Leo Bonato, Serhan Cevik, Ding Ding, Emilio Fernandez-Corugedo, Alejandro Guerson, Chao He, Janne Hukka, Diane C. Kostroch, Huidan Lin, Constant Lonkeng, Joana Pereira, Chris Walker (all WHD), Andres Gonzalez (ICD), and Emanuele Massetti (FAD) under the supervision of Jorge Roldós; benefited from contributions and assistance as noted in the chapter._

### introduction of carbon taxes, establishment of emissions trading systems, and feebates) and non-priced-based mitigation 

### ch3 - introduction of carbon taxes, establishment of emissions trading systems, and feebates) and non-priced-based mitigation

### Introduction and scope
- The transition to a post-pandemic era provides an opportunity to address climate change as a threat to long-term growth and prosperity.
- The chapter takes stock of the main climate change challenges in LAC and explores a menu of policy options to address them, recognizing that the appropriate policies depend on country- and sector-specific circumstances and require in-depth analysis beyond the chapter’s scope.
- The chapter addresses the following questions:
  - What are the main climate change challenges in LAC? (Section II)
  - What are the policy options in LAC to tackle climate change (Section III), including mitigation (Section III.1) and adaptation (Section III.2)?
  - What are the financing requirements to reach LAC’s climate goals? (Section IV)

### Climate risks: physical and transition
- Physical risks
  - High vulnerability to climate-related phenomena: higher temperatures, weather-related natural disasters, sea-level rise, coastal erosion, and loss of biodiversity.
  - High reliance on climate-sensitive sectors such as tourism and agriculture.
  - Physical risks can adversely affect aggregate supply (destruction of physical capital, dislocation of labor markets, disruption of supply chains) and aggregate demand (reductions in consumption and investment, disruption of trade flows), threatening growth, employment, fiscal sustainability, and financial stability.
- Transition risks
  - Structural changes required to achieve climate sustainability goals (reducing reliance on high-GHG activities and improving land-use practices) can cause economic dislocations if not managed properly.
  - Potential repercussions include sectoral shifts in employment, comparative advantage, and trade patterns with effects on growth, fiscal positions, inflation, external positions, and financial systems.

### Opportunities from mitigation and adaptation
- Mitigation co-benefits
  - Short-run domestic environmental and health benefits, including reductions in air pollution mortality and morbidity, and in road fatalities.
  - Direct economic savings (e.g., reduced road damage and traffic congestion).
- Investment and innovation gains
  - Investment in green technologies and infrastructure could help boost growth and generate new jobs (IMF October World Economic Outlook (WEO) 2020).
  - Green innovation in the energy sector could generate positive spillovers and reduce energy security risks.
- Agricultural and resource opportunities
  - Sustainable farming can release fiscal resources currently used for subsidies, increase external resilience through sustainable produce, contribute to food security, and increase domestic income sources.
  - A shift away from livestock agriculture could free up land for plant-based proteins or reforestation.
  - LAC countries with natural endowments of metals (copper, nickel, cobalt, lithium) could benefit from demand for low greenhouse-gas technologies.
- Resilience investments
  - Investing in resilient infrastructure could yield significant growth and fiscal benefits over time for countries vulnerable to climate disasters.

### Policy approach and priorities
- A broad range of mitigation tools is likely needed in LAC, including price-based instruments (introduction of carbon taxes, establishment of emissions trading systems, and feebates) and non-price-based mitigation policies (public investment in low-GHG emissions technologies and infrastructure, fiscal incentives, and direct current public spending to make low-carbon energy sources more abundant and affordable, as well as supportive regulations).
- Given the large share of emissions from change in land-use practices, cost-effective Nature-based Solutions (NbS) can play an important role in LAC.
- Policy mixes should account for extensive use of renewable energy in the region, societal preferences, and political economy considerations; countries should adopt the policy mixes that best suit their circumstances, ideally articulated as national strategies.
- On adaptation, building resilience to natural disasters is important region-wide but is a priority for Caribbean and Central American economies that are highly vulnerable to climate change impacts.
- A comprehensive medium-term adaptation approach focused on:
  - investing in structural (or physical) resilience,
  - boosting financial resilience, and
  - enhancing post-disaster resilience
  would yield significant long-run benefits for countries in the Caribbean and Central America.
- Mitigation and adaptation policies in LAC will require significant upfront financing, including support from the international community and the private sector.

### Regional emissions and sectoral composition (key statistics)
- LAC’s share of global net GHG emissions (including impact of land use practices) is 8.4 percent.
- LAC per capita net GHG emissions: 6.4 metric tons CO2-eq.
- LAC gross GHG emissions per capita (excluding land use practices): 5.2 metric tons CO2-equivalent.
- World average gross GHG emissions per capita (for comparison in text): 6.3 metric tons CO2-equivalent.
- The region’s higher net (relative to gross) emissions reflect a positive contribution from land use practices largely due to deforestation.
- The three largest emitters in the region together contributed 5.4 percent to global net GHG emissions in 2018.
- Countries heavily dependent on fossil-fuel exports (Bolivia, Colombia, Ecuador, Guyana, Suriname, Trinidad and Tobago, and Venezuela) represent a total of 1.7 percent of global net GHG emissions.
- Energy sector share of GHG emissions in LAC: 43 percent of GHG emissions, compared to the world average of 74 percent.
- Net GHG emissions from agriculture and change in land use and forestry combined: 45 percent of total in LAC, compared to the world average of 14 percent.
- Electricity production in the Caribbean: non-renewable sources comprise 88 percent of electricity generation, in contrast to about 40 percent in the rest of LAC.

### Vulnerability and disaster impacts (key statistics)
- LAC as a whole is below the world average on the ND-GAIN vulnerability index, but there are pockets of high vulnerability, notably the Caribbean.
- Damages from natural disasters in the Caribbean are estimated at 2.5 percent of GDP annually.
- Estimated annual average damages in Central America: 0.8 percent of GDP.
- Expected climate impacts include higher temperatures, sea-level rise, changes in precipitation, lower agricultural production, reduced availability and quality of water resources, loss of forested areas and biodiversity, and adverse health effects.

### Distributional and structural policy considerations
- Maximizing opportunities and minimizing risks requires improving flexibility and adaptability:
  - Policies to support reallocation of labor and capital across sectors.
  - Investing in basic skills and human capital.
  - Improving transparency and economic governance to encourage investment in technology and know-how.
  - Creating fiscal space to manage the climate transition.
- Large upfront financing needs imply an important role for international support and private-sector investment.

*Italic: Chapter prepared by Anna Ivanova (lead), Sònia Muñoz (co-lead), Leo Bonato, Serhan Cevik, Ding Ding, Emilio Fernandez-Corugedo, Alejandro Guerson, Chao He, Janne Hukka, Diane C. Kostroch, Huidan Lin, Constant Lonkeng, Joana Pereira, Chris Walker (all WHD), Andres Gonzalez (ICD), and Emanuele Massetti (FAD) under the supervision of Jorge Roldós; benefited from contributions and assistance as noted in the chapter.*

### 1.  ND-GAIN Index of Vulnerability to Climate Change, 2018

### ND-GAIN Index of Vulnerability to Climate Change, 2018

### ND-GAIN index: scope and construction
- Assesses the vulnerability of a country to climate change risks by considering:
  - exposure to climate-related hazards,
  - sensitivity to the hazards’ impacts, and
  - adaptive capacity to cope with or adapt to these impacts.
- Covers six life-supporting sectors: food, water, health, ecosystem services, human habitat, and infrastructure.
- Raw data are scaled to a range from zero to one and the arithmetic average is used to construct each index.
- Regional average is weighted by annual population as of 2018.
- Data labels use International Organization for Standardization (ISO) country codes.

### Weather-related natural disasters: sample and measures (1980–2020)
- Weather-related natural disasters included: climatological (includes drought, wildfire), hydrological (includes flood, landslide), and meteorological (storm, extreme temperature).
- Sample covers countries that report at least one weather-related natural disaster incurring positive damage (countries that report the occurrence but with zero damage are excluded).
- Groups of WHD, Pacific and rest of the world are exclusive.
- For each group a simple average is taken across country and year, after:
  - damage is scaled by GDP annually, and
  - disaster frequency is scaled by 2018 land area annually.

### Climate strategies and commitments in Latin America and the Caribbean (LAC)
- All LAC countries have submitted and ratified their Nationally Determined Contributions (NDCs) commitments under the Paris Accords of 2016.
- Nine LAC countries are supporting the goal of carbon neutrality by 2050.
- 14 LAC countries have committed to generating at least 70 percent of their electricity from renewable sources by 2030.
- Many LAC countries have committed to implement the Kigali Amendments to phase out hydrofluorocarbons.
- Governments have used policy measures to expand renewables and support mitigation/adaptation, including:
  - catalyzing financing for renewable energy projects,
  - offering dedicated credit lines, currency hedges, and guarantees,
  - providing grants and subsidized loans,
  - introducing tax incentives for low-carbon industries, renewable energy, and R&D,
  - promoting renewables through feed-in tariffs (FITs).
- Note on FITs: Argentina, Brazil, and Ecuador had established FIT schemes, but they are no longer active for various implementation and design reasons.

### Policy options and instruments for mitigation in LAC
- Policy instruments are grouped as:
  - price-based mitigation policies (PBMP): e.g., carbon pricing, fossil fuel subsidy reduction;
  - non-price-based instruments: e.g., regulation, fiscal incentives, and green public investment.
- Important considerations in choosing policy mixes: efficiency, equity, political and social feasibility.
- Illustrative mitigation instruments described: carbon tax, fossil fuel subsidy removal, emissions trading systems (ETS), feebates.

Policy instrument features and trade-offs:
- Carbon taxes:
  - Levied on the supply of fossil fuels in proportion to their carbon content.
  - Efficient because they allow firms and households to find least-cost ways of reducing energy use and shifting to cleaner alternatives.
  - May need to be set at high levels to achieve desired emissions reductions in countries with already low carbon content in energy generation and already high fuel prices, which may be politically and socially challenging.
- Fossil fuel subsidy removal:
  - Increases the relative price of energy products, reducing consumption and encouraging a shift towards low-carbon alternatives.
  - Critical for emissions reduction but politically and socially difficult in some countries; design, phasing, and communications must protect the most vulnerable.
- ETS:
  - Auction or allocate emission permits that are traded; can provide carbon removal credits to incentivize carbon capture.
  - Can be applied across energy, agriculture and forestry, but implementation in forestry and agriculture requires well-defined property rights and good measures of agricultural emissions (methane CH4 and nitrous oxide N2O).
- Feebates:
  - Tax (subsidize) activities/products with above (below) average emissions intensity or carbon storage baseline.
  - Help achieve cuts in emissions without adding a net tax burden on industry or a fiscal cost.
  - Typically have narrower sectoral reach than carbon taxes and require periodic schedule adjustments.

### Integrated Assessment Model (IAM) simulations and implications
- Under a Business-As-Usual (BAU) scenario IAM simulations suggest:
  - LAC’s CO2e emissions from energy and industrial processes are expected to more than double by 2030.
  - CO2 emissions per unit of output are expected to decline, but not sufficiently to stabilize total emissions given continued GDP per capita growth.
  - GHG emissions from agriculture, forestry and other land uses are expected to decline under the assumption that the reduction of deforestation continues following recent trends.
- Long-run potential:
  - IAMs suggest substantial potential for net negative emissions in LAC after mid-century, relying on afforestation or biomass electricity with carbon capture and sequestration.
  - Given forestry and biodiversity endowments, LAC has potential to reduce net emissions cost-effectively; it may be more cost-effective globally to compensate LAC countries for utilizing their lower-cost mitigation potential.

### Current use of price-based mitigation policies in LAC (empirical findings)
- Only four LAC countries have carbon taxes in place: Argentina, Chile, Colombia, and Mexico.
- Where implemented, carbon tax rates are in the range of US$1-10 per ton CO2-eq.
- Carbon taxes in these countries cover only a portion of GHG emissions: 20-24   percent.
- Many LAC countries have environmental taxes (including on energy, fuels and transport), but:
  - These taxes collected 1.1 percent of GDP on average in 2018 in LAC,
  - Compared with 2.2 percent of GDP on average in the OECD.
  - These environmental taxes are not directly linked to the carbon content of products and thus are less effective incentives for emissions reduction.
- Explicit fossil fuel subsidies are particularly large in oil producing economies in LAC, exceeding 1 percent of GDP in some cases.
- Implicit subsidies that reflect price deviations from efficient fuel prices, including environmental costs, are also large in some countries, particularly in the Caribbean.
- ETS and feebates are not actively used regionwide; Brazil has conducted voluntary ETS simulations since 2013 and feebates are under consideration in Costa Rica.

### Adaptation policy pillars and recommendations for vulnerable LAC countries
- Three pillars to prepare for climate-related disasters:
  - structural resilience,
  - financial resilience,
  - post-disaster resilience.
- Highlights and recommendations:
  - Scale up investment in structural resilience (e.g., infrastructure that withstands climate hazards).
  - Develop a comprehensive layered insurance framework to manage disaster risks.
  - Encourage deeper private sector contribution to adaptation financing.
  - Facilitate the transition of commodity (fuel and non-fuel) exporters to low-carbon economies through tailored policies and support.

_Italic: Sources: EM-DAT database; IMF, World Economic Outlook database; Notre Dame Global Adaptation Initiatives (ND-GAIN) database; and IMF staff calculations._

### 2.  Total Fossil Fuel Subsidies by Type, 2019

### 2.  Total Fossil Fuel Subsidies by Type, 2019

### Data sources and notes
- Sources: World Bank, Carbon Pricing Dashboard (June 2021); and IMF staff calculations.
- Note: Data labels use International Organization for Standardization (ISO) country codes. LAC = Latin America and the Caribbean.
- Fossil fuel subsidies include the following products: gasoline, diesel, kerosine, LPG, natural gas, coal, electricity.
- “Other local factors” comprise road congestion, damage, and accidents.

### Non-price-based mitigation (Non-PBMP) tools and public investment
- Public investment in low-carbon technologies and infrastructure (examples in text):
  - electrification of public bus fleets
  - installation of solar panels and wind turbines
  - investment in more sustainable farming methods
- Benefits:
  - could lower the cost of switching to sustainable practices
  - directly contributes to a sustainable and inclusive post-pandemic recovery
  - early investments in renewable energy sources can contain negative supply shocks
- Fiscal incentives and direct public spending:
  - subsidies and direct public funding for R&D
  - subsidies and price guarantees for low-carbon sectors and activities
  - can address market failures: knowledge spillovers, network externalities, economies of scale
  - potential to generate positive spillovers to the private sector
- Government-financed educational programs:
  - disseminate knowledge about low-carbon technologies
  - example: agricultural extension programs to promote climate-smart farming practices

### Supportive regulations and Nature-based Solutions (NbS)
- Supportive regulations could include:
  - emission standards for industries, buildings, transport and products
  - technological standards to enhance fuel and energy efficiency
  - product standards to phase out polluting products and encourage low-carbon products
  - land and forest management standards
- Trade-offs of regulations:
  - politically easier to adopt
  - less cost-effective than price-based measures
  - raise no revenue to compensate the vulnerable
  - involve uncertain costs for the consumer
  - effective regulations require predictability, impartiality, accessibility, and robust anti-corruption safeguards
- NbS (Nature-based Solutions):
  - aim at protecting, managing, and restoring ecosystems
  - can address both mitigation and adaptation challenges
  - potential benefits: carbon capture and sequestration, limit sharp rise in carbon prices, address food and water security, reduce natural disaster risk, increase biodiversity, foster green jobs
  - LAC has abundance of natural resources and ecosystems suited to NbS using a mix of regulations, incentives, feebates, and ETS

### Institutional and political economy considerations
- Conducive business environment needed to implement mitigation policies and benefit from technological diffusion:
  - maintain macroeconomic and financial stability
  - establish clear property rights and protect intellectual property rights
  - strengthen competition, improve transparency, and foster financial inclusion
  - incorporate climate-related risks and policies into macro-financial and fiscal frameworks
  - assign roles and responsibilities to public policy institutions, with fiscal institutions taking the lead and central banks incorporating climate risks in financial risk assessments and monetary policy design
- Political economy:
  - transition will create winners and losers; e.g., workers in traditional energy sectors may not benefit from new green jobs
  - governments could use cash transfers to compensate households for consumption losses and active labor market policies to support displaced workers
  - strengthening social safety nets early is recommended to foster trust and public support
  - reforms should be phased in gradually, objectives clearly articulated, tradeoffs explained, and social impact accounted for ex-ante
  - synchronous international cooperation reduces political cost and carbon leakage risk

### Price-Based Mitigation Policies in LAC: illustrative CPAT scenarios
- Modeling approach:
  - Uses Carbon Pricing Assessment Tool (CPAT) developed by IMF and World Bank (model and data last updated October 6, 2021)
  - Two-stage simulation:
    1. Gradual and complete removal of existing fossil fuel subsidies between 2022 and 2025
    2. In addition to subsidy removal, gradual introduction of carbon taxes of $25/ton, $50/ton and $75/ton from 2022 to 2030
- Carbon tax specifics:
  - Carbon taxes mentioned are 2030 targets. The starting carbon tax in 2022 is assumed to be 1/3 of the 2030 target. Carbon taxes rise linearly to reach the 2030 target. After 2030, carbon taxes keep rising with the same trend.
  - Carbon taxes are levied on each unit of GHG emission from fuel combustion.
  - Example: combustion of one liter of gasoline emits 2.4kg of CO2. A $50/ton carbon tax will translate to $0.12/liter levy for gasoline.
- Revenue recycling:
  - Fiscal revenue from carbon pricing policies assumed recycled back via universal cash transfers to households.
- BAU to 2030:
  - Under Business-As-Usual (BAU), greenhouse gas emissions excluding LULUCF will increase slightly for most countries by 2030 due to offsetting effects:
    - continued economic growth increasing fossil-fuel consumption (increases emissions)
    - reduced energy intensity from efficiency improvements and rising international petroleum prices (reduces emissions)

### Model findings: emissions, prices, and fiscal revenues
- Emissions:
  - Phasing out fossil fuel subsidies would substantially reduce emissions in countries with large subsidies.
  - Further gradual introduction of $25/ton, $50/ton and $75/ton carbon taxes by 2030 would reduce NDC gaps for many LAC countries.
  - Some countries, including Colombia, Jamaica, and some other Caribbean economies, would remain far from their NDC goals.
  - The analysis focuses further on a $50/ton carbon tax scenario.
- Price impacts (with subsidy removal and a $50/ton carbon tax):
  - gasoline prices would increase by 10–30 percent by 2030 in many countries
  - natural gas prices would rise by around 30 percent
  - coal prices would double or triple
  - price impacts differ across countries depending on initial price levels and carbon content of products
- Fiscal revenues:
  - Countries can raise significant fiscal revenues between 0.5 percent and 4.5 percent of GDP
  - While subsidy removal and carbon taxes have generally negative estimated impacts on growth, recycling revenues through cash transfers could offset much of the negative growth effect
  - An upfront green investment push could compensate effects on activity

### Wider welfare and distributional effects
- Non-GDP benefits:
  - lower air pollution mortality and morbidity
  - reduced road fatalities
  - direct economic savings from reduced road damages and traffic congestion
  - fewer extreme weather phenomena associated with climate change (assuming global cooperation)
  - Previous studies suggest net welfare effects of such policies will be positive for most countries
- Distributional impacts:
  - Increase in price of carbon has differential impacts across households due to:
    - differential energy intensity of household consumption
    - varying purchasing power
    - differential exposure of labor to carbon-intensive sectors
  - Channels of impact:
    - direct adverse impact on household consumption from higher energy prices
    - indirect effects through higher prices of other products via Input-Output linkages
    - income/employment losses for workers in negatively affected sectors
  - Country variation:
    - impact depends on initial energy mix, size of simulated carbon price adjustment, and strength of upstream linkages with energy sectors
  - Compensatory policies:
    - using carbon tax and subsidy-removal revenues for universal cash transfers can make the overall policy package highly progressive
    - model estimates suggest universal cash transfers could fully offset adverse impact on household consumption in the first six to seven deciles of per capita household consumption in Argentina, Brazil, Colombia, and Mexico
    - absent compensatory policies, consumption impact could be relatively large and somewhat regressive
    - governments could alternatively leverage existing social safety nets to target the most vulnerable and allocate part of revenues to green public investment

### Additional modeling notes and caveats
- The analysis focuses on selected fiscal policy options using CPAT; other instruments are beyond scope.
- Economic models of climate change have high model and data uncertainty; results are indicative rather than precise.
- The analysis in this section includes removal of explicit fossil fuel subsidies only. A gradual and complete removal of fossil fuel subsidies (both explicit and implicit) by 2025—including introducing optimal carbon taxes to eliminate implicit subsidies—could:
  - reduce regional carbon dioxide emissions by 24 percent below baseline levels in 2025
  - raise revenues by 1.7 percent of regional GDP
  - prevent 35,000 local air pollution deaths annually
- The fossil fuel subsidies in the illustrative scenarios are phased out over 3 years (2022–25) and the carbon tax is assumed to rise linearly from $17 to $50/ton between 2022–30.
- Empirical evidence on GDP impacts of carbon taxes is inconclusive; CPAT results align with CGE models showing negative effects, but some empirical studies point to roughly no effect on GDP or employment growth.

*Source: IMF staff calculations and analyses as presented in "2.  Total Fossil Fuel Subsidies by Type, 2019" (ch3).*

### 1.  Brazil

### Brazil

### Impact of carbon pricing on income and employment in energy sectors
- Simulations using sectoral microeconomic data suggest the aggregate impact of an increase in the price of carbon on income would be limited, affecting less than 1 percent of employed persons in Argentina, Brazil, and Mexico.
- In Brazil the analysis suggests:
  - The impact would remain small across all income deciles.
  - The impact is larger in sectors with higher carbon intensity: coal and oil in Brazil.
- Assumptions underlying the simulations:
  - Price elasticity of energy products of -0.25 (as in IMF (2020)): a 100 percent increase in the price of energy products reduces real demand by 25 percent, leading to an equivalent reduction of labor income or employment under unchanged labor productivity.
- Regional disparities:
  - Important within-country regional disparities are likely due to high geographic concentration of energy activities.

### Potential offsets from green transition and policy package
- Job gains in cleaner energy sectors could offset income/job losses in carbon-intensive sectors.
- IEA (2021) estimate used for LAC: 14 million green jobs and 30 million green and related jobs could be created by 2030 globally during the green transition; this translates into 1.2 million green jobs and 2.6 million green and related jobs by 2030 in LAC, based on LAC’s share in the global economy.
- IMF WEO, 2020 style policy package (summarized results):
  - A public green investment push starting with 1 percent of GDP and declining over 10 years, combined with renewables production subsidies, a pre-announced gradual increase in carbon taxes, compensatory transfers to households, and supportive macroeconomic policies, is estimated to increase employment by around 1 percent of the labor force in 10 years.
  - Policy-package specifics (from IMF WEO, 2020): 10-year green public investment program starting at 1 percent of GDP and linearly declining to zero over 10 years; 80 percent subsidy rate on renewables production; carbon tax starting at $8-18 per ton of CO2 (depending on the country) and growing by 7 percent annually; compensatory transfers to households equal to ¼ of carbon tax revenues; debt finance for the first decade in a low-for-long interest rate, low inflation context.
- Financing constraint:
  - The green investment push will require substantial financing (Section IV); carbon tax/fossil fuel subsidy removal revenues could only partially cover it.

### Agriculture and livestock transition implications for Brazil
- Emissions intensity:
  - Panel data estimation suggests an emissions intensity ratio of six-to-one between livestock and plant-based agriculture in Latin America.
- Simulated adjustment to low GHG emissions in agriculture:
  - For a given GHG emissions reduction in agriculture, the estimated average gross employment/labor income loss in livestock would be higher in countries with a higher initial level of employment in livestock; Brazil’s livestock accounts for 3.9 percent of employment (compared with 1.2 percent in Argentina).
  - The scenario assumes required emission reduction in agriculture comes entirely from livestock, implying a decline in livestock by about 3 percent by 2030 in Brazil and Argentina (based on CPAT simulations).
  - The simulation also assumes resources previously used for livestock, including labor, are repurposed for plant-based production (which may require some government transitory support), and forestry activity will increase proportionally with the required emissions reduction (afforestation).
- Policy support:
  - Governments could support adversely affected livestock farmers by facilitating their transition towards plant-based agriculture; land released from livestock agriculture can contribute to afforestation.
- Distributional outcome:
  - Simulations suggest the estimated net income impact of the adjustment to low GHG emissions on farmers would be more uniformly distributed across income deciles compared to the progressive impact of carbon tax in the energy sectors.

### Green commodities export context for Brazil
- Table excerpt (Annual average during 2016–19): exports of certain “green” commodities where Brazil appears
  - Copper: Brazil — Percent of GDP: 0.120; Percent of Exports: 0.915
  - Nickel: Brazil — Percent of GDP: 0.000; Percent of Exports: 0.004
  - Cobalt: Brazil — Percent of GDP: 0.000; Percent of Exports: 0.001

### Example of employment creation from green investment in Brazil
- Historical precedent:
  - Brazil’s National Alcohol Program launched in 1975 is cited as an example of the positive impact of an investment push for renewable energy sources on the creation of low-skilled jobs.

*Source: ch3 - 1.  Brazil (IMF staff calculations and chapter content).*

### 1.  Disaster Insurance Coverage and Layering

### 1.  Disaster Insurance Coverage and Layering

### Annual fiscal cost of illustrative insurance coverage
- Simulated annual cost of the illustrative insurance coverage would initially be in the range of 0.5-2 percent of GDP per year.
- As structures become more resilient, insurance requirements for the same coverage would decline in the long run to about one-fourth of the current level.
- Simulations are calibrated to achieve coverage of 99 percent of disaster loss and include risk of tropical cyclones and earthquakes.
- The saving fund size in the simulations has been calibrated to cover the fiscal cost of natural disasters in 95 percent of the events; access to CCRIF and issuance of CAT bonds is added to reach coverage of 99 percent.
- Simulations incorporate impacts on output, tax revenue, grants and other non-tax revenue, recurrent expenditure, and capital expenditure, and consider re-prioritization of expenditures (reconstruction largely replaces pre-existing projects).

### Near-term fiscal costs and the transitional financing gap
- Building structural resilience involves very large upfront costs relative to fiscal capacity; returns accrue over the medium and long term.
- Example: For Dominica, the total cost of building resilience is estimated at US$2.8 billion (about 500 percent of GDP) and would require over a decade to fully execute.
- For countries with a public investment rate of 5 percent, increasing resilience to 80 percent (with resilient capital 25 percent more expensive) would imply a fiscal deterioration of 1 percent of GDP each year (as noted in IMF (2019c)).
- For ECCU countries, the additional cost of resilience could increase public debt by 4-20 percentage points of GDP by 2030, translating into additional financing gaps of 0.4 to 1.5 percent of GDP relative to historical levels.
- Near-term fiscal costs of structural and financial resilience open a transitional financing gap since benefits accrue over medium/long term.

### Insurance market coverage, instruments, and constraints
- CCRIF has been valuable for improving regional insurance coverage, but coverage remains low for many countries due to:
  - High upfront costs of insurance products.
  - Concerns that significant damages may not trigger payouts.
  - Competing developmental needs.
- Use of innovative state-contingent instruments such as catastrophe bonds has remained limited because of complexity, high setup costs, and capacity/regulatory constraints.
- Reinsurance dynamics: In the ECCU, an estimated 60-75 percent of insurance premiums are ceded to reinsurance; ceded share is even higher for property insurance.
- Reinsurance cost example: In 2018, reinsurance costs increased by 20–40 percent for countries hit by disasters the preceding year in the Caribbean, and 10–20 percent for other countries.

### Private sector investment in adaptation: barriers and policy options
- Role: Private sector investment in adaptation is important but constrained by credit constraints and limited access to affordable insurance.
- Credit constraints:
  - High interest rates and shortages of qualifying collateral (mostly limited to fixed assets).
  - Bank credit composition skewed away from sectors most vulnerable to physical disaster risks (e.g., tourism and agriculture).
- Limited access to affordable insurance:
  - High property insurance costs due to susceptibility to natural disasters.
  - Small primary insurance market reliant on overseas reinsurance -> high regional pass-through of reinsurance pricing.
- Policy options to foster private sector adaptation investment:
  - Technical support, climate risk information dissemination, and services to evaluate adaptation options.
  - Regulatory and fiscal incentives (e.g., targeted taxes, subsidies, service pricing) to improve risk-return profile.
  - Introduce or scale up partial public credit guarantee schemes; support alternative collateral frameworks (e.g., machinery or inventory).
  - Facilitate risk pooling among private insurers, e.g., through a public guarantee for excess liability from natural disasters.

### Financial system resilience and supervisory actions
- Current direct financial sector exposure to natural disasters has been limited due to insurance coverage gaps and limited lender credit exposure to vulnerable sectors; primary insurers’ reliance on reinsurance and lenders’ reliance on insured property collateral have mitigated losses.
- Scaling up local financial services for adaptation would increase direct physical risk exposures, particularly if reinsurers reduce coverage.
- Indirect financial sector risks to consider:
  - Macroeconomic amplification from impacts on sectors such as tourism or agriculture.
  - (Re)insurance pricing and counterparty risks, including systemic tail risk of reinsurer exit from the market.
  - Sovereign exposure risks where public sector linkages to local financial systems are significant.
- Strengthening supervision, reporting, and regulatory frameworks:
  - Incorporate physical climate risks into supervisory frameworks.
  - Implement reporting structures for granular monitoring of risk transmission channels and strengthen oversight of inter-institutional exposures.
  - Adopt regulatory measures to support climate risk-aware lending, exposure diversification, prudential risk buffers, and ex-post asset recovery.
  - Integrate physical climate risk scenarios into authorities’ financial system crisis management plans.

### Preparing for transition risks and low-carbon scenarios
- Fossil-fuel exporters in the region need timely and targeted policies to prepare for a low-carbon environment and mitigate macroeconomic consequences.
- Assessment examples: Venezuela and Guyana are among the least prepared; Bolivia moderately prepared; Brazil, Colombia, Mexico relatively better prepared for low-carbon transition (World Bank 2020).
- Policy measures:
  - Improve export competitiveness and lower trade costs to reduce over-dependence on fossil-fuel revenues.
  - Foster innovation in green technologies to create spillovers, jobs, and reduce energy security risks.
  - Use enabling policies to help countries with “green” commodity reserves (e.g., lithium) benefit from the transition.
  - Design fiscal policies for mitigation/adaptation with emphasis on social and political acceptability and effectiveness (e.g., targeted use of revenues, international carbon price floors, supporting technology policies).

### Financing climate mitigation and adaptation in LAC
- Global investment needs to reach net zero by 2050: US$1.475–1.8 trillion annually in new investment in green energy generation, transmission, and storage (Energy Transitions Commission).
- Estimated annual investment needs for LAC based on share of global GDP:
  - Climate mitigation: US$75–92 billion.
  - Adaptation: US$14–17 billion.
  - Combined estimate to reach NDC goals and strengthen structural resilience: US$90–110 billion per year for the LAC region (around 1.7–2.1 percent of the region’s 2019 GDP).
- Most required resources will need to come from external private or public sources; for the most vulnerable LAC countries, financing on highly concessional terms, including grants, will be essential.
- Private funding opportunities:
  - Sustainable debt market reached US$2.3 trillion with net new issuance of US$760 billion in 2020; LAC issuance represented 2.5 percent or US$19 billion of net new issuance.
  - Green bonds cumulative global issuance just over US$1 trillion by end-2020; LAC green bond issuance was US$7.6 billion in 2020.
  - ESG equity funds: estimated size varies from US$3.5 to US$10 trillion or more; ESG equity investment in LAC is a small share of the total market.
  - Risk: greenwashing; need transparent, verifiable standards for green financing.
- State-contingent instruments:
  - Catastrophe bonds and hurricane clauses are underused but potentially important for state-contingent financing and managing debt-service payments during disasters.
  - Other mechanisms: loan guarantees for sustainable energy projects, “debt-for-nature” swaps, compensation payments to preserve tropical forests (financing for NbS).
- Role of bilateral and multilateral institutions:
  - Advanced economies’ pledge of US$100 billion a year in climate finance to developing economies is critical.
  - MDBs and overseas development agencies have been important in kickstarting renewable deployment via risk mitigation, dedicated long-term credit lines, and technical assistance.
  - In LAC, MDBs and national development banks provided substantial shares of climate financing (25 percent and 53 percent of total financing, respectively, per ECLAC 2020).
- IMF initiatives:
  - The IMF is exploring a Resilience and Sustainability Trust (RST) financed by rechanneling SDRs from strong external position countries to vulnerable countries.
  - RST objectives: support policy reforms for economic resilience and sustainability, provide financing at cheaper rates and longer maturities than traditional IMF lending, and target low-income countries, small states, and vulnerable middle-income countries.

*Source: ch3 - 1.  Disaster Insurance Coverage and Layering*

### Conclusions

### Conclusions

### Regional overview and macro-criticality
- LAC is one of the most diverse regions in the world with respect to climate-related risks, with some countries facing mitigation challenges and others an urgent need for adaptation to natural disasters.
- The region’s net GHG emissions are in line with its economic size and population, with a relatively clean energy mix counterbalanced by large emissions from agriculture, land use, and forestry.
- Climate change is macro-critical for LAC: severe and frequent weather-related natural disasters and global warming represent considerable macroeconomic shocks, particularly in the Caribbean and Central America.
- Many economies depend on climate-sensitive activities such as tourism and agriculture, which contribute significantly to output, employment, and FX earnings.
- Climate change exacerbates poverty and inequality, disproportionately affecting lower-income groups and potentially increasing migration.

### Mitigation: tools, scenarios, and economic effects
- Price-based mitigation instruments available to LAC policymakers:
  - Carbon taxes.
  - Removal of fossil fuel subsidies.
  - Ramping up ETS.
  - Establishing a system of feebates.
- Non-price-based mitigation measures:
  - Public investment in low-carbon technologies and infrastructure.
  - Fiscal incentives and direct public spending to make low-carbon energy sources more abundant and affordable.
  - Supportive regulations encouraging emission reductions, shifts to low-carbon activities, and protection/enhancement of natural carbon sinks.
- Nature-based solutions (NbS) present important cost-effective opportunities given LAC’s abundance of natural resources and ecosystems.
- Policy design recommendations:
  - Countries should adopt policy mixes tailored to their circumstances, accounting for extensive renewable energy use, societal preferences, and political economy considerations.
  - A broad range of mitigation tools is likely needed; balancing carbon pricing with a green investment push could have positive long-run effects on activity and employment.
  - Advanced public consultation, careful sequencing and communication, and a conducive business environment are essential to secure public support, sufficient financing, and benefit from global technological diffusion.
- Illustrative scenario finding:
  - An increase in the price of carbon could help close NDC gaps in many LAC countries, although some countries would remain far from their NDC goals.
  - Revenues from carbon-pricing policies could compensate a large portion of the population and, with targeted cash transfers, additional resources could be invested in green infrastructure and to support the labor market transition.

### Adaptation: priorities for the Caribbean and Central America, and resilience frameworks
- Building resilience to natural disasters is a priority for Caribbean and Central American economies due to high vulnerability.
- Recommended comprehensive medium-term approach:
  - Invest in structural resilience to yield significant long-run macroeconomic benefits and support macroeconomic sustainability.
  - Boost financial resilience through a comprehensive layered insurance framework to ensure financing for reconstruction while safeguarding public finances.
- Financing trade-offs and private sector role:
  - Upfront fiscal costs of structural and financial resilience create a transitional financing gap.
  - Deeper private sector contributions to adaptation investment could ease public finance burdens and can be facilitated by incentives and improved access to financial services.
  - Efforts to boost private adaptation investment should be accompanied by strengthening the climate risk resilience of the financial system via fortifying supervision and bolstering reporting and regulatory frameworks.
- Fossil-fuel exporters need timely and targeted policies to prepare for a low-carbon environment and mitigate adverse macroeconomic consequences.

### Financing mitigation and adaptation; international support and instruments
- Mitigation and adaptation policies in LAC will require significant upfront financing and importantly support from the international community.
- External financing—from both official and private sectors—will be essential given limits to domestic resource mobilization.
- Private sector instruments and risks:
  - Rapidly developing markets for sustainability-linked debt and equity could support climate efforts, but actions are needed to avoid "greenwashing".
  - State-contingent instruments such as catastrophe bonds can play an important role.
- Official sector support:
  - Bilateral and multilateral support will be essential in financing LAC’s mitigation and adaptation efforts.

### Box highlights and sectoral specifics

- Box 1 (Macro-criticality):
  - Weather-related natural disasters cause growth declines when they strike, with growth recovering the following year but fiscal deficits and debt levels rising and remaining higher thereafter.
  - Fossil-fuel industry decline poses risks to producer countries via job losses, lower tax revenues, and potential FX and exchange rate pressures.
  - Transition costs also arise from reductions in non-energy emissions, including opportunity costs from policies to reduce deforestation.

- Box 2 (Brazil’s Sugarcane-based Ethanol Program):
  - Renewables (mostly ethanol) represent 20 percent of energy use in transport in Brazil; in the motor fuels market, the share of ethanol use rises to about 40 percent.
  - Brazil’s Proálcool program launched in late 1975; Brazilian production of ethanol "quintupled" from mid to late 1970s and "tripled" in the following 6 years (Brookings, 2006).
  - Brazil’s NDC foresees a 10% reduction in greenhouse gas emissions from transport by 2028 and an 18% share for sustainable biofuels in the country’s overall energy mix by 2030.
  - RenovaBio was launched in 2016, establishing annual carbon intensity reduction targets and a framework for "decarbonization credit" market mechanisms.

- Box 3 (Agricultural Mitigation Policies):
  - LAC: 45 percent of total net GHG emissions come from agriculture and change in land use and forestry, compared to the world average of 14 percent.
  - FAO estimates livestock is responsible for about 15 percent of annual global GHGs.
  - Demand for emission-intensive agricultural products is estimated to increase by 50 percent by 2050 relative to 2013.
  - Reducing food loss and waste accounts for about 10 percent of food systems’ GHG emissions and could provide mitigation potential.
  - Anaerobic digestion systems could reduce CH4 emissions and reductions could reach as high as 90 percent (U.S. EPA, 2013).
  - Historical Brazil deforestation reduction: From 2004-2012 Brazil reduced deforestation by an average 5 percent per year, amounting to a decline in the national deforestation rate of 84 percent; returning to 2012 developments would allow reversal of recent trends and reach zero deforestation by 2030.

- Box 4 (Political Economy Considerations):
  - National mitigation strategies affect many sectors and vested interests and require coordination, consultation, and buy-in across authorities, politicians, and civil society.
  - Climate policies should be phased, clearly anchored to improve predictability, and their social impact accounted for ex-ante to secure public support.
  - Advanced public consultation, international cooperation, careful communication, and strengthening social safety nets early on (or before reform implementation) can help secure household support.
  - Sequencing example: countries with high fossil fuel subsidies could phase out subsidies first and then hike carbon taxes, or increase carbon taxes gradually in parallel to subsidy removal.
  - Compensatory measures (cash transfers, training for displaced workers) should eventually be folded into broader social safety nets and standard labor market transition mechanisms.

*Source: ch3 - Conclusions*

### Box 5. Implications of Climate Risks for Financial Stability

### Box 5. Implications of Climate Risks for Financial Stability

### Nature of climate-related financial risks
- Physical risks:
  - Damage from extreme weather events and long-term degradation of capital and land that can affect financial firms through loan portfolios.
  - Physical risks are particularly high in tourism-dependent economies in the Caribbean.
- Transition risks:
  - May arise from implementation of a carbon tax or other tax on fossil fuels, or from the adoption of specific green mandates.
  - Firms with carbon-intensive product portfolios may shoulder many of these costs, affecting the financial institutions that support them.
  - Financial institutions supporting commodity exporters in South America may be especially exposed to transition risks.

### Evidence from stress tests and country analyses
- European Central Bank (ECB) stress test:
  - Showed that European financial institutions are subject to significant physical risks from climate change, with default probabilities rising 1–2 percent over the next 30 years in a “hot house world” scenario in which temperatures continue to rise unabated.
- Norway (Norges Bank) analysis:
  - Indicates that transition risks are salient in Norway, where carbon taxes are among the world’s highest at US$45 a ton and oil is an important revenue source.
- Canada:
  - Banks are expected to consider climate risks in assessing possible loans, potentially assigning higher risk weightings for loans to firms in oil, gas, and other fossil-fuel related industries.
- Colombia (Sever and Perez-Archila, forthcoming) stress tests for transition to a low-carbon economy:
  - Sectors most important in transmission of risk to the banking system: agriculture, manufacturing, electricity, wholesale and retail trade, and transportation.
  - A sudden increase in the carbon tax of US$70 per ton (from the current level of US$5 per ton) results in sizeable, but potentially manageable, risks for the banking system, with at-risk bank loans as large as 13.6 percent of total outstanding corporate loans.
  - Lower rates of increase in the carbon tax carry lower transition risks to the financial system, suggesting that an incremental strategy of increasing the carbon tax towards the target of US$75 per ton over a span of several years may be advisable (as suggested in IMF WEO 2020).

### Actions already taken by financial authorities
- Incorporation of physical and transition risks into financial stability monitoring through:
  - Stress-testing the financial system for climate risks.
  - Posting guidelines for managing risks from climate change.
  - Strengthening climate-related disclosure requirements.

### Policy recommendations to build financial system resilience (Latin America focus)
- Strengthen supervision, reporting, and regulatory frameworks to build resilience to climate risks.
- Incorporate climate risks in existing supervisory frameworks.
- Develop reporting structures that allow for more granular monitoring of various risk transmission channels.
- Strengthen oversight of exposures between institutions.
- Implement regulatory measures to support:
  - Climate risk-aware lending practices.
  - Exposure diversification.
  - Prudential risk buffers.
  - Ex-post asset recovery.
- Integrate climate risk scenarios into authorities’ general financial system crisis management plans.

*This box was prepared by Chris Walker and Serhan Cevik.*

### Annex Figure 4 .2)   .

### Annex Figure 4.2. Spatial Distribution of Estimated Gross Income Loss in Energy Sectors and Net Income Gain/Loss in Agriculture from Climate Policies

### Overview and context
- The figures present spatial distributions of estimated gross income loss in energy sectors and net income gain/loss in agriculture induced by climate policies for Brazil and Argentina.
- Note 4: "Energy sector firms adjust to reduced demand for energy by either lowering wages or cutting jobs (or a combination of the two). As such, the numbers in Figure 12 represent income loss, which is the total impact."
- Note 5: "It is assumed in CPAT that emissions in agriculture grow at the same rate as energy CO2 emissions."
- Note 6: "It should be noted that, because the starting level of livestock and plant-based agriculture is different across countries (e.g., livestock accounts for 3.9 and 1.2 of total employment in Brazil and Argentina respectively, against 1.3 and 2 percent for plant-based agriculture), the percentage increase in plant-based agriculture induced by the decline in livestock needs not be the same across countries (base effect)."

### Key numeric facts and parameters shown or described
- Livestock accounts for "3.9" and "1.2" of total employment in Brazil and Argentina respectively.
- Plant-based agriculture accounts for "1.3" and "2 percent" of total employment in Brazil and Argentina respectively.
- Resilient public investment is assumed to be costlier with "a premium of 25 percent over non-resilient investment".
- Given a fixed physical amount of public investment, countries are assumed to allocate "80 percent" of investment in resilient capital.
- The public investment transformation parameter satisfies "0< a_Gd <1" (notation preserved as in source).

### Structure of impacts (as described in the surrounding text)
- Energy sector impacts:
  - Estimated gross negative impact (income loss) in energy sectors is mapped spatially for Brazil and Argentina.
  - Income loss numbers reflect combined effects of wage reductions and job cuts by energy sector firms (total impact).
- Agriculture impacts:
  - Net impact in agriculture (net income gain/loss) is mapped spatially for Brazil and Argentina.
  - CPAT assumption: agricultural emissions grow at the same rate as energy CO2 emissions, linking policy impacts across sectors.
  - Base effects: differing initial shares of livestock and plant-based agriculture across countries imply heterogeneous percentage changes (example figures given above).

### Modeling assumptions and mechanisms referenced in the chapter (relevant for interpreting Figure 4.2)
- The broader model includes interactions across households, firms, government, and external sector; climate policies affect energy demand and agricultural responses as part of general equilibrium adjustments.
- Energy sector firm behavior: lower wages and/or employment reductions translate into income loss metrics reported.
- Agriculture response: shifts between livestock and plant-based agriculture can occur; percentage changes vary due to initial sector shares (base effect).
- CPAT behavioural assumption: emissions in agriculture grow at the same rate as energy CO2 emissions.

### Implications for interpreting spatial distributions
- Spatially heterogeneous outcomes are expected because:
  - Initial sectoral composition differs across regions and countries (base effects).
  - Energy-sector gross negative impacts translate into localized income losses through labor and wage channels.
  - Agricultural net impacts reflect both direct emissions assumptions (CPAT) and local economic structure (livestock vs plant-based shares).

*Sources: IMF, Carbon Pricing Assessment Tool; and IMF staff calculations.*

### References

### ch3 - References

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### Natural disasters, resilience, and insurance
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### Fiscal policy, macroeconomics, and labor impacts
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### Institutions, indices, and technical contributions
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### Governance, institutions, and country experiences
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### Methods, modeling techniques, and theory
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- Metcalf, G.E. and J.H. Stock. 2020. “Measuring the Macroeconomic Impact of Carbon Taxes.” AEA Papers and Proceedings, Vol. 110, pp. 101-106. 

*References listed in ch3 - References*

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_Source: https://www.imf.org/-/media/files/publications/reo/whd/2021/english/ch3.pdf_