## EXECUTIVE SUMMARY (Content unit: _110416)

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### Impact of natural disasters on small developing states
- Annual cost of disasters for small states is nearly 2 percent of GDP—more than four times that for larger countries.
- About 9 percent of disasters in small states involve damage of more than 30 percent of GDP, compared to less than 1 percent for larger states.
- According to EM-DAT (1950–2014), the economic cost of the average natural disaster was nearly 13 percent of GDP for small states compared to less than 1 percent of GDP for larger states.
- The average natural disaster affects 10 percent of the population in small states, compared to 1 percent for other countries.
- Absolute average damages: nearly $850 million for large states, under $90 million for small states.
- A disaster-level storm is 23 times more damaging in proportional GDP terms for small states than for large states.
- Greater exposure and tail-risk for small states are associated with:
  - lower investment,
  - lower GDP per capita,
  - higher poverty,
  - a more volatile revenue base.

### Climate change vulnerabilities and impacts
- One-third of small developing states are highly or extremely vulnerable to climate change in the lifetime of the current generation.
- Climate change is projected to:
  - exacerbate natural disasters,
  - produce gradual effects such as rising sea level (SLR).
- Projected impacts on small states include larger economic costs versus larger peers and adverse effects on agriculture, tourism, and fishing.
- Pressures on ecosystems could exacerbate poverty and emigration.

### Policy responses and resilience-building
- Domestic policies can reduce direct human and economic costs.
- Recommend a shift toward proactive, advance planning and integration of risk-reduction and preparedness into:
  - core PFM,
  - investment frameworks,
  - debt management frameworks.
- Assess risk to the financial sector and adopt crisis-management frameworks.
- Risk reduction efforts expected to:
  - improve the business climate,
  - encourage new investments,
  - help sustain stronger medium-term growth.
- Capacity-building support from the Fund and other development partners remains critical.

### Financing for risk reduction and disaster response
- Advance financing plans should combine:
  - fiscal buffers,
  - contingent financing plans,
  - risk transfer arrangements.
- Disaster financing is often identified “after the event”, leading to under-financing of larger disasters for small states.
- On climate change financing:
  - financing has been oriented toward mitigation rather than adaptation,
  - small states’ adjustment needs are under-funded by as much as $1 billion annually,
  - complex and administratively cumbersome eligibility procedures hamper access by small states with weak capacity.

### The Fund’s role and recommendations
- Small developing states are active users of the Fund’s emergency financing facilities and instruments (RCF and RFI).
- Small states benefitted much less than larger countries from the 2015-16 reforms to access under PRGT facilities and the RFI; current access limits constrain response to the most severe disasters.
- Proposed measures to strengthen the financial safety net:
  - increase RCF and RFI access limits for members facing severe disasters,
  - encourage more active use of Fund arrangements, including on a precautionary basis, to support resilience-building reforms and capacity building,
  - consider tailored assessments of macro-critical policies for climate change mitigation and adaptation to help countries qualify for global climate funding.

### Key actionable points (summary)
- Integrate disaster risk reduction and preparedness proactively into core fiscal and debt frameworks.
- Develop advance financing plans combining buffers, contingent financing, and risk-transfer instruments.
- Expand and tailor Fund access and policy-assessment tools to better meet small states’ post-disaster needs and to support access to global climate finance.
- Prioritize capacity building and streamline administrative procedures to improve small states’ access to climate adaptation funding.

*Source: EXECUTIVE SUMMARY, November 4, 2016.*

---

### Box 2 — Data on Natural Disasters (Coverage, frequency, costs, and transmission)

### Coverage and data limitations
- EM-DAT database:
  - Covers 13,000 natural disasters for 1950-2014 (date, location, type, human and economic cost).
  - Inclusion criteria: (i) 10 or more people reported killed; (ii) 100 or more people reported affected; (iii) declaration of a state of emergency; or (iv) call for international assistance.
- Reporting gaps and biases:
  - Human impact reported for about 90 percent of disasters.
  - Economic damage reported for only 32 percent of disasters (36 percent for small states).
  - Economic damage estimates more available for storms; rarely available for epidemics.
  - Richer countries tend to have better economic damage records.
  - PDNAs provide separate property damage and income loss estimates but for a limited number of disasters.

### Frequency and cost for small states (EM-DAT and adjusted estimates)
- Small states (1950-2014):
  - Experienced 460 disasters as a consolidated group — average of 7 disasters per year within the group.
  - Eight countries with similar combined land area experienced 66 disasters (roughly one each year).
  - Ranked by frequency relative to land area: 21 of 33 small states are in the global top-50.
- Costs and relative impact:
  - Over last 25 years, annual damage averaged 1.8 percent of GDP for small states vs 0.4 percent of GDP for other countries.
  - Data for 1950–2014 show annual average cost of 1.2 percent of GDP (likely under-recording).
  - EM-DAT suggests about 9 percent of disasters impacting small states create damages ≥30 percent of GDP (vs <1 percent for larger states).
  - Adjusting for under-reporting, Acevedo (2016) suggests Caribbean damages could be 1.6 to 3.6 times larger than EM-DAT reports.

### Macroeconomic transmission channels and empirical findings
- Three-stage cycle:
  - Stage 1: direct losses to infrastructure and property.
  - Stage 2: indirect losses from foregone output and disruptions.
  - Stage 3: recovery and rebuilding — temporary boost and opportunity to upgrade infrastructure (possible leakage if external contractors used).
- Heterogeneity by disaster type:
  - Earthquakes: large up-front damage and heavy rebuilding costs.
  - Droughts: drawn-out damages and costs.
  - Same-magnitude events can have divergent outcomes (example: 2010 Chile vs Haiti earthquakes).
- Empirical findings:
  - Short-term: clear temporary negative impact on growth.
  - Reconstruction: can produce positive growth effects for small disasters.
  - Medium-term: significant negative impacts mainly for large shocks.
  - Long-run: mixed evidence; Pacific islands trend growth 1980–2014 estimated 0.7 percentage point lower than without natural disasters.
  - Fiscal: weakened tax bases, higher spending, higher revenue volatility, increases in public indebtedness in disaster-prone small states.
  - External: trade balances worsen; disaster episodes can increase aid, remittances, and insurance-related inflows.
  - Distributional: disasters disproportionately affect the poor; larger impact on life expectancy for women and girls.
- Role of institutions:
  - Better institutions, diversification, fiscal space, and financial buffers improve mobilization and coping capacity.

*Source: Box 2. Data on Natural Disasters (excerpt).*

---

### Climate Change: Projected Impacts, Scenarios, and Vulnerabilities

### Projected channels and quantitative projections
- Tropical storms:
  - By 2100, tropical storms making landfall could inflict damages up to 77 percent higher than today.
  - Damage could be up to 42 percent higher even when storms do not make landfall.
  - Estimates based on high CO2 scenario (higher sea surface temperatures → more intense storms).
- Sea-level rise (SLR) projections:
  - SLR of 50cm by the 2050s expected based on existing carbon emissions.
  - SLR could reach 70cm with 2°C global warming (central Paris Agreement goal).
  - SLR could exceed 1m with 4°C global warming.
  - SLR near the tropics could be 10-15 percent higher.
  - Maldives at risk of disappearing with SLR of 1m; other small states at significant risk include Dominica, Grenada, Kiribati, Marshall Islands, St. Vincent and the Grenadines, Tuvalu.
- Extreme temperatures:
  - Global mean temperature is now about 0.8°C higher than pre-industrial levels.
  - Stabilizing CO2-equivalent concentrations at 450, 550, and 650 ppm projects mean warming of 2, 3, and 4°C respectively.
  - Absent mitigation/adaptation, global mean temperature increase could reach about 3-4°C or more by end of century.
- Water stress:
  - SLR causes saltwater contamination of freshwater aquifers.
  - Under a 2°C scenario (2040s), water runoff for drinking/irrigation could decline by as much as 30 percent in Latin America and the Caribbean and 50 percent in sub-Saharan Africa.

### Projected economic costs and sectoral risks
- Economic costs for small states projected at 15 percent of GDP or more in some studies.
  - Caribbean: one-meter SLR by 2080 projected losses/damages ~8 percent of projected GDP.
  - Pacific islands: SLR between 1 and 1.7 meters projected impact between 3 and 15 percent of GDP.
- Broader persistent costs: reduced agricultural productivity, threatened tourism, stressed ecosystems, increased poverty, and emigration.
- Social impacts:
  - Climate change could push more than 100 million people into poverty by 2030.
  - Emigration from small states already twice that for larger countries and rising since early-2000s.

*Source: Box 2 and related sections.*

---

### Policy Responses and Risk Reduction Programs

### Main elements to mainstream into fiscal and other policy frameworks
- Identification and quantification of disaster/climate risks, likelihood, potential impacts, and vulnerabilities.
- Invest in risk reduction guided by risk assessments.
- Develop contingency plans where risks cannot be mitigated.
- Arrange contingency financing: self-insurance (reserves/contingency funds), contingent borrowing/grants, and risk-transfer arrangements (insurance/capital markets).

### Risk reduction measures and options (Box 33 highlights)
- Information and preparedness:
  - Public information campaigns, early warning systems, contingency planning, risk maps (flood zones, coastal erosion, landslides).
- Physical infrastructure and incentives:
  - Seawalls, bridge reinforcement, resilient construction, "building back better".
  - Incentives: subsidies for retrofitting, accelerated capital depreciation provisions, fiscal incentives for drought-resilient crops.
- Financial instruments:
  - Public insurance subsidies tailored by risk; promote private sector risk reduction investment.
- Public investment management:
  - Use Public Investment Management Assessment (PIMA) diagnostics and recommendations.
  - Accumulate fiscal buffers through a saving strategy consistent with medium-term fiscal objectives (example: rainy-day fund).
  - Integrate contingency allowances into multi-year budgets; unspent contingency funds may finance risk reduction the following year (examples: Mexico and Vietnam).
- Regional approaches and diversification:
  - Regional regulatory standards and administrative bodies (example: CDEMA).
  - Promote economic diversification and "blue economy" approaches (example: Seychelles).
- Social safety nets and contingency plans:
  - Scale up existing safety nets, prefer cash transfers/vouchers where markets can meet needs, use public works for recovery-support.
  - Minimize discretion; use clear triggers and rules for interventions.
  - Explore contingent financing with development partners for safety net programs.
- Legal and budgetary frameworks:
  - Organic budget law provisions to exceed spending limits upon disaster declarations.
  - Escape clauses in fiscal responsibility laws.
  - Annual budget flexibility provisions and contingency space.

### Implementation challenges and political economy
- Underinvestment persists despite high returns (example: $1 US federal investment in preparedness yields approximately $15 reduction in damage).
- Practical obstacles: inadequate contingency planning, coordination failures, lack of access to financing.
- Political obstacles: electoral incentives for post-disaster response over preventive investments; program ownership across administrations; preference to retain discretion.
- Financing hurdle: disaster risk reduction competes with other public service needs and buffer maintenance in small states.

*Source: Sections 33 and related policy text.*

---

### Financing Approaches, Risk-Layering, and Instruments

### World Bank risk-layered framework (Box 65)
- Core principle: choose instrument mix minimizing economic opportunity cost.
- Layering by event size and typical instruments:
  - Small disasters (5 percent or ≤ 20 years (≤ 3 percent of GDP)): self-insurance (reallocate spending, draw down deposits).
  - Moderate disasters (3.33 percent or 20-30 years (≤ 5 percent of GDP)): access external resources; contingent arrangements; risk transfer options.
  - Large disasters (1 percent or 30-100 years (≥ 5 percent of GDP)): insurance, reinsurance, contingent financing.
  - Very large/catastrophic events (0.5 percent or 100-200 years (≥ 5 percent of GDP); Below 0.5 percent or ≥ 200 years (≥ 5 percent of GDP)): catastrophe bonds, grants, humanitarian aid.

### Empirical findings on financing practice (24 disasters, 1995-2015)
- Smallest disasters: financing from internal resources.
- Medium disasters: domestic bank credit plus external grants/loans.
- Largest disasters: reliance on external resources and remittances; new external financing over three years covered less than half of estimated disaster losses.

### Domestic options and buffers
- Central bank financing should be strictly limited to avoid fiscal dominance.
- Domestic commercial bank borrowing useful for small-scale disasters but limited by liquidity.
- Government deposit buffers:
  - Some Pacific countries aim to maintain a deposit buffer equivalent to 3 months of recurrent spending.
  - Buffer drawdown has liquidity implications similar to borrowing.
- Dedicated contingency funds:
  - Useful for unpredictable expenditures; recommended governance and transparency features; should not substitute for predictable medium/long-term expenditures.

### External borrowing, contingent credit, and insurance
- Contingent lines of credit: bilateral/multilateral/commercial examples (compacts with the US; World Bank CAT DDO; Pandemic Emergency Financing Facility).
- IMF facilities (RCF and RFI) are rapid but not fully contingent; fiscal cost deferred until debt service.
- Insurance and risk transfer:
  - Traditional indemnity insurance penetration low; premium payments average 1 percent of GDP.
  - Parametric insurance: rapid payouts but costly with basis risk; regional pooling reduces costs.
  - CAT bonds: principal forgiven if parametric trigger met; Mexico issued a sovereign CAT bond (2012).
  - Regional pooling examples: CCRIF (Caribbean), Pacific Catastrophe Risk Insurance Pilot, African Risk Capacity.
  - Empirical examples: Grenada’s insurance covered about 4.5 percent of total damages (9.2 percent of GDP) in one large disaster.
- Fund’s role:
  - TA on debt management and optimal mix of debt and insurance instruments.
  - Support private insurance market development via FSAPs and FSSRs.

### Climate change financing context
- Estimated global climate financing: US$391 billion in 2014 (comprehensive source cited).
- Alternative broader estimate (including private investment in energy efficiency and domestic public financing): US$933 billion in 2014.
- Investment in fossil energy: US$1.6 trillion in 2014.
- Small states:
  - Climate finance for small developing states reached less than US$1 billion in 2014.
  - Multilateral development banks channeled $444 million to small states in 2014.
  - Bilateral donors: US$368 million in 2014.
  - Dedicated multilateral and bilateral climate funds: US$140 million in 2014.
  - Mitigation accounted for some 58 percent of climate finance to small states.
  - Small states face adaptation under-funding by as much as $1 billion annually.
  - World Bank estimated annual adaptation financing shortfall of about $800 million in 2010 for small states (66 percent Caribbean, 27 percent Pacific, 7 percent Africa and Indian Ocean).
- Challenges: fragmentation, complex eligibility, administrative capacity constraints, small project sizes (over half of SIDS projects < $200,000), SIDS projects represent 2 percent of global projects.

*Source: Excerpt from IMF content unit _110416 - 65.*

---

### IMF Role, Emergency Financing, and Proposed Access Reforms

### Current IMF instruments and usage
- RCF (Rapid Credit Facility) and RFI (Rapid Financing Instrument) provide rapid support; RCF is concessional via PRGT, RFI on GRA terms.
- RCF financing: zero interest, grace period 5½ years, final maturity 10 years.
- RFI repayable within 3¼ to 5 years.
- Annual access limits:
  - Increased from 50 to 75 percent of quota in July 2015; quotas doubled in 2016 which halved PRGT and RFI access limits to 37.5 percent of quota.
- Historical use:
  - Of 49 instances of disaster-related Fund lending since 2000, small states accounted for a little over one-third of instances.
  - Small states accounted for 60 percent of the number of disbursements of emergency financing facilities since 2000.
  - Of 53 natural disasters reported by EM-DAT for small states since 2000, the Fund provided assistance in 16 cases.

### Fund financing relative to disaster impact (documented ratios)
- For smaller disasters (costs <30 percent of GDP), Fund emergency financing was equivalent to 11.6 percent of disaster impact.
- For larger disasters (costs >30 percent of GDP), Fund emergency financing was equivalent to 2.4 percent of disaster impact.
- Examples exceeding normal access limits:
  - 2015 Dominica: Fund financing under RCF approved equivalent to 53.5 percent of current quota.
  - 2015 Vanuatu: Fund financing under RCF/RFI blends approved equivalent to 71.4 percent of current quota.

### Proposed augmented access window for severe disasters
- Proposal:
  - For severe disasters (damage ≥30 percent of GDP), annual access limit under RCF/RFI set at 60 percent of quota (current limit 37.5 percent).
  - Cumulative access limits remain unchanged at 75 percent of quota.
  - Damages measured as destruction of physical assets plus foregone output relative to pre-disaster GDP projections; Fund would draw on national and international assessments.
  - A letter of intent would document existing and planned disaster risk reduction practices (not conditionality; to allow Board assessment and identify capacity needs).
  - Access determined case-by-case based on balance of payments need, repayment capacity, and catalytic role of Fund financing.
- Rationale and implications:
  - Historically <1-in-10 disasters in small states result in damages ≥30 percent of GDP.
  - Over 2000-2015, eleven countries would have met proposed threshold (ten PRGT eligible; nine small states; nine sought Fund financing).
  - Augmented access window would be used rarely; projected additional PRGT demand modest — under most scenarios <5 percent of annual average PRGT lending capacity.
  - Even with 60 percent of quota access, Fund financing would remain a small share of total damages (example: 60 percent of quota ≈ 4 percent of overall damages per historical averages).

### Eligibility, moral hazard, and catalytic role
- Narrow targeting reduces moral hazard and facilities shopping.
- Fund financing intended to be catalytic: identify BoP needs, provide quick-disbursing funds, confirm sound macro framework to unlock other external grant support.
- The Fund could assist by assessing macro frameworks and catalyzing climate finance where appropriate.

*Source: Sections 76–93 (IMF staff paper excerpt).*

---

### Modeling Tools, Macroeconomic Baseline Adjustments, and Scenario Analysis

### DIG model and disaster modeling (Introduction)
- DIG features:
  - Dynamic LIDC-specific open-economy model capturing public investment-growth nexus, financing strategies, fiscal reaction rules, public capital productivity.
  - Applied to 14 countries and a custom economic union.
- Modeling disasters in DIG:
  - Capture three negative effects: loss of current output, loss of productive assets (capital stock), and productivity disruptions from damaged infrastructure.
  - Implement as: immediate productivity drop, percentage reduction in capital stocks, persistent productivity shock.
- Stylized example parameters:
  - Long-run growth rate: 4 percent per year.
  - International market borrowing rate: 9.55 percent per annum.
  - Disaster destroys 8 percent of current year output; wipes out 20 percent of capital stock (loss of 56.8 percent in terms of GDP); total loss 64.8 percent of GDP.
  - Productivity reductions in next three years: 5, 3, and 2 percent respectively.
  - Grants inflows offset public capital loss: 12 percent of GDP (5, 4, and 3 percent over first three years).
- Stylized example results:
  - Growth falls from 4 to -4 percent in disaster year; further falls to -5 percent the following period; reverts toward trend later with persistent level loss.
  - Tax rate hits ceiling of 15 percent.
  - Debt rises from close to 65 percent of GDP to over 90 percent of GDP.
- Potential DIG applications:
  - Ex ante resilience-building trade-offs.
  - Financial and insurance policy comparisons.
  - Organizing and financing post-disaster reconstruction.
  - Effects on investment and FDI (stochastic extensions needed to capture uncertainty-induced deterrence).

### Adjusting macro baselines and second-round effects
- Baselines should reflect first-round impacts and plausible government/household/corporate reactions where expectation of adoption is justified.
- Fiscal presentation options:
  - Adjust budget lines individually, or
  - Introduce a new “net disaster impact” line above-the-line after unadjusted balance (recommended for clarity).
- Scenario and stress testing guidance:
  - Include single large disaster scenarios (one-in-50 or one-in-100 year) in DSAs and reserve adequacy analyses.
  - Use stochastic (Monte Carlo) simulation to produce probability distributions of outcomes; caveats on data scarcity and resource intensity.
- Financial sector and reserve adequacy:
  - FSAPs and FSSRs can assess disaster risks; stress testing banks for disaster scenarios recommended.
  - Reserve adequacy tools (ARA-CC) can be tailored to account for disaster susceptibility.

*Source: Introduction and Annex IV–VI excerpts.*

---

### Case Study — Vanuatu (Cyclone Pam) and Operational Lessons

### Event and impacts
- Cyclone Pam (March 2015):
  - Damages amounted to more than 60 percent of GDP.
  - Almost 72 percent of the population affected (more than 188,000 inhabitants).
  - Major impact on tourism, transport infrastructure, and agricultural production.

### Financing and assistance
- IMF assistance under RCF and RFI: about USD23.8 million.
- Bilateral and multilateral partners committed more than USD210 million (28 percent of GDP).
- Grants received in 2015: about USD72 million.
- Sovereign insurance payout through PCRFI covered less than 1 percent of damages.

### Institutional and fiscal lessons
- Institutional arrangements: Ministry focused on climate change and NDMO central to coordination; advance attention needed to avoid bureaucratic obstacles in recovery committees.
- Domestic buffers limited:
  - Response Fund provides up to 1.5 percent of government budget for fiscal year (0.3 percent of GDP), insufficient for restoring basic services; recommend a permanent expedited response mechanism for average-size disasters.
- External buffers: need for actionable, predictable concessional disbursements and pre-approved drawdownable instruments; pursue greater donor contributions for sovereign insurance.
- Infrastructure maintenance: budget should include explicit allocation for disaster risk reduction and adaptation; maintain infrastructure as well as invest in new projects.
- Social safety nets: Vanuatu used ad hoc measures (temporary VAT/import duty suspension, deferred fees, subsidies, provident fund withdrawals); these provided relief but raised targeting and sustainability concerns.

### Monetary and financial sector response
- RBV actions:
  - Reduced monetary policy rate by about 340 basis points.
  - Cut statutory reserve deposit requirement from 7 to 5 percent.
- RBV provided liquidity support; banks waived retail loan repayments for 2–3 months; some corporate loan repayments delayed 6–12 months pending insurance payouts.
- Recommendation: ensure banks have adequate business continuity plans and resilient payments/cash systems.

*Source: Annex III — Vanuatu: Coping with the Damages of Cyclone Pam.*

---

### Key Statistics and Selected Numeric Points (preserved verbatim)
- Annual cost of disasters for small states: nearly 2 percent of GDP.
- Average natural disaster economic cost (EM-DAT 1950–2014): nearly 13 percent of GDP for small states; less than 1 percent for larger states.
- Average population affected: 10 percent in small states; 1 percent in other countries.
- Absolute average damages: nearly $850 million (large states); under $90 million (small states).
- Tail-risk: about 9 percent of disasters in small states create damages ≥30 percent of GDP.
- Climate projections:
  - Tropical storm damages by 2100: up to 77 percent higher than today; up to 42 percent higher even without landfall.
  - SLR: 50cm by 2050s from existing emissions; 70cm with 2°C; >1m with 4°C.
  - Global mean temperature now about 0.8°C higher than pre-industrial.
  - Stabilizing CO2-equivalent at 450, 550, 650 ppm → warming of 2, 3, 4°C respectively.
- DIG stylized disaster example:
  - Long-run growth: 4 percent per year.
  - Borrowing rate: 9.55 percent per annum.
  - Disaster: destroys 8 percent of current year output; wipes out 20 percent of capital stock (56.8 percent in terms of GDP); total loss 64.8 percent of GDP.
  - Persistent productivity reductions: 5, 3, 2 percent in next three years.
  - Grants offset public capital loss: 12 percent of GDP (5, 4, 3 percent first three years).
  - Simulated outcomes: growth falls to -4 percent then -5 percent; tax rate hits 15 percent; debt rises from ~65 percent to over 90 percent of GDP.
- IMF financing ratios:
  - For disasters <30 percent of GDP: Fund emergency financing ≡ 11.6 percent of disaster impact.
  - For disasters >30 percent of GDP: Fund emergency financing ≡ 2.4 percent of disaster impact.
- Access proposals:
  - Augmented annual access under RCF/RFI for damage ≥30 percent of GDP: 60 percent of quota (current annual limit 37.5 percent of quota; cumulative limit unchanged at 75 percent).
- Climate finance figures:
  - Global climate financing: US$391 billion in 2014 (comprehensive source cited).
  - Broader estimate including private/domestic public financing: US$933 billion in 2014.
  - Fossil energy investment: US$1.6 trillion in 2014.
  - Climate finance to small developing states in 2014: less than US$1 billion (MDBs $444 million; bilateral $368 million; dedicated funds $140 million).
  - Small states’ adaptation under-funding: as much as $1 billion annually; World Bank estimated annual adaptation shortfall about $800 million in 2010 for small states.
- Vanuatu (Cyclone Pam):
  - Damages >60 percent of GDP.
  - Almost 72 percent of population affected (more than 188,000).
  - IMF support ~USD23.8 million; bilateral/multilateral commitments >USD210 million (28 percent of GDP); grants ~USD72 million in 2015.

*Source: Extracted numeric entries and text from content unit _110416.*

---

*Source: IMF staff paper, content unit _110416 (excerpts and compiled sections).*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Impact of natural disasters on small developing states
- On average, the annual cost of disasters for small states is nearly 2 percent of GDP—more than four times that for larger countries.
- About 9 percent of disasters in small states involve damage of more than 30 percent of GDP, compared to less than 1 percent for larger states.
- According to EM-DAT (1950–2014), the economic cost of the average natural disaster was nearly 13 percent of GDP for small states compared to less than 1 percent of GDP for larger states.
- The average natural disaster affects 10 percent of the population in small states, compared to 1 percent for other countries.
- Though absolute average damages are larger in bigger countries, the absolute magnitude averaged nearly $850 million for large states, compared to under $90 million for small states.
- A disaster-level storm is 23 times more damaging in proportional GDP terms for small states than for large states.
- Greater exposure and tail-risk of extremely damaging disasters for small states are associated with:
  - lower investment,
  - lower GDP per capita,
  - higher poverty,
  - a more volatile revenue base.

### Climate change vulnerabilities and impacts
- One-third of small developing states are highly or extremely vulnerable to climate change in the lifetime of the current generation.
- Climate change is projected to affect small states disproportionately by:
  - exacerbating natural disasters,
  - producing more gradual effects such as rising sea level (SLR).
- Larger economic costs for small states are expected versus larger peers, with adverse impacts on key sectors: agriculture, tourism, fishing.
- Pressures on ecosystems could exacerbate poverty and emigration.

### Policy responses and resilience-building
- Well-designed domestic policies can reduce direct human and economic costs.
- A shift toward proactive, advance planning is recommended, with integration of risk-reduction and preparedness into:
  - core PFM (Public Financial Management),
  - investment frameworks,
  - debt management frameworks.
- Risk to the financial sector should be assessed and crisis-management frameworks adopted.
- Risk reduction efforts will:
  - improve the business climate,
  - encourage new investments,
  - help sustain stronger medium-term growth.
- Capacity-building support from the Fund and other development partners will remain critical.

### Financing for risk reduction and disaster response
- Advance planning should provide for a combination of:
  - fiscal buffers,
  - contingent financing plans,
  - risk transfer arrangements.
- In practice, disaster financing is often identified “after the event”, leading to under-financing of larger disasters for small states despite their relatively small cost by global standards.
- On climate change financing:
  - financing has been oriented toward mitigating greenhouse gas emissions rather than helping small states adapt,
  - small states’ adjustment needs are under-funded by as much as $1 billion annually,
  - complex and administratively cumbersome procedures for establishing eligibility are hampering access by small states with weak capacity.

### The Fund’s role and recommendations
- Small developing states are active users of the Fund’s emergency financing facilities and instruments (RCF and RFI), which have been important sources of rapid liquid support.
- Small states benefitted much less than larger countries from the 2015-16 reforms to access under PRGT facilities and the RFI, and find current access limits constraining relative to their large balance of payments needs for the most severe disasters.
- Proposed measures to strengthen the financial safety net:
  - increase RCF and RFI access limits for members facing severe disasters,
  - encourage more active use of Fund arrangements, including on a precautionary basis, as vehicles for resilience-building policy reforms and associated capacity building support,
  - consider tailored assessments of macro-critical policies for climate change mitigation and adaptation (carbon pricing and energy subsidies; fiscal, investment and debt management frameworks for climate-related spending) to help countries develop strong climate change policy frameworks and qualify for access to global climate funding.

### Key actionable points (summary)
- Integrate disaster risk reduction and preparedness proactively into core fiscal and debt frameworks.
- Develop advance financing plans combining buffers, contingent financing, and risk-transfer instruments.
- Expand and tailor Fund access and policy-assessment tools to better meet small states’ post-disaster needs and to support access to global climate finance.
- Prioritize capacity building and streamline administrative procedures to improve small states’ access to climate adaptation funding.

*Source: EXECUTIVE SUMMARY, November 4, 2016.*

### Box 2. Data on Natural Disasters

### Box 2. Data on Natural Disasters

### Coverage and data limitations
- EM-DAT database coverage and criteria:
  - Covers 13,000 natural disasters for the period 1950-2014, with information on date, location, type of disaster, and human and economic cost.
  - Includes disasters that meet at least one criterion: (i) 10 or more people reported killed; (ii) 100 or more people reported affected; (iii) a declaration of a state of emergency; or (iv) a call for international assistance.
- Reporting gaps and biases:
  - Human impact is reported for about 90 percent of disasters.
  - Economic damage is reported for only 32 percent of disasters (36 percent for small states).
  - Economic damage estimates are more readily available for storms; they are rarely available for epidemics.
  - Richer countries tend to have better records of economic damages; low-income countries tend to report people affected or killed more completely.
  - Separate estimates of property damage and income losses are available through PDNAs but only for a limited number of disasters.
- Definitions (table of terms summarized):
  - Direct losses: conventionally measured as property damage (e.g., houses, buildings, structures damaged; crops or forests destroyed).
  - Damage (economic costs): property damage plus incomes foregone (e.g., lower tourism receipts, disrupted export shipments).
  - Non-market costs: costs not captured in national accounts (e.g., time spent by unremunerated family workers on rebuilding).

### Frequency and cost of disasters for small states
- Frequency and concentration:
  - Small states, as a consolidated group, experienced 460 disasters between 1950-2014, an average of 7 disasters within the group each year.
  - Eight countries with roughly similar overall land area to the combined small states experienced 66 disasters over the same period (roughly one each year).
  - Ranked by frequency of disasters in relation to land area, 21 of 33 small states are in the global top-50.
- Costs and relative impact:
  - Over the last 25 years, the annual damage (including both disaster and non-disaster years) averaged 1.8 percent of GDP for small states compared to 0.4 percent of GDP for other countries.
  - Data for the period 1950–2014 show a smaller annual average cost of 1.2 percent of GDP, which probably represents under-recording.
  - EM-DAT data suggest about 9 percent of disasters impacting small states create damages equivalent to 30 percent or more of GDP, compared to less than 1 percent for larger states.
  - Adjusting for under-reporting, Acevedo (2016) suggests that damages for the Caribbean could be 1.6 to 3.6 times larger than reported in EM-DAT.

### Macroeconomic transmission channels and empirical findings
- Three-stage cycle of loss and recovery:
  - Stage 1: direct losses from destruction of infrastructure and property.
  - Stage 2: indirect losses from foregone output and incomes and costs from disruptions.
  - Stage 3: recovery and rebuilding generate a temporary boost in activity and employment and an opportunity to upgrade infrastructure (possible leakage if outside contractors are used).
  - Periodic destruction of productive assets acts as an implicit tax on capital, deterring investment and lowering productivity and living standards over time.
- Heterogeneity by disaster type and country characteristics:
  - Earthquakes: large up-front damage and heavy rebuilding costs.
  - Droughts: more drawn-out damages and costs.
  - Same-magnitude events can have very different outcomes (example: 2010 Chile vs Haiti earthquakes: 200,000 people killed in Haiti (1,000 in Chile); destruction equivalent to 120 percent of GDP in Haiti (14 percent of GDP in Chile)).
- Empirical findings from the literature:
  - Short-term growth: natural disasters have a clear temporary negative impact on growth due to destroyed physical assets and disrupted infrastructures.
  - Reconstruction: can produce positive growth effects for small disasters during the rebuilding phase.
  - Medium-term growth: significant negative medium-term impacts are found mainly for large shocks.
  - Long-run growth: evidence is mixed—some studies find no significant long-run impact, while others (for Pacific islands) estimate trend growth over 1980–2014 was 0.7 percentage point lower than without natural disasters.
  - Fiscal effects: fiscal balances tend to be adversely affected through weakened tax bases and higher spending on relief and recovery; findings include higher tax revenue volatility and increases in public indebtedness in disaster-prone small states.
  - External sector: disasters tend to worsen trade balances (damaged production and transport reduce exports; imports may rise during recovery). Disaster episodes can also increase international aid, remittances, and insurance-related inflows.
  - Distributional impacts: disasters disproportionately affect the poor (who live in more vulnerable areas and lack access to credit/insurance) and have a larger impact on life expectancy for women and girls.
- Role of institutions and initial conditions:
  - Better institutions (literacy, openness, government spending) improve mobilization for reconstruction and mitigate macroeconomic spillovers.
  - Economic diversification and fiscal space facilitate counter-cyclical responses.
  - Financial buffers (reserves, domestic credit access) and less open capital accounts improve coping capacity.

### Climate change: projected impacts and scenarios
- General statement:
  - Climate change is expected to exacerbate natural disaster impacts and worsen vulnerabilities of small states; about one-third of small states are highly or extremely vulnerable to climate change within the lifespan of the current generation.
- Key projected channels and quantitative projections:
  - Tropical storms:
    - By 2100, tropical storms making landfall could inflict damages up to 77 percent higher than today (with an impact up to 42 percent higher even when storms do not make landfall).
    - Estimate based on a high CO2 climate change scenario where higher sea surface temperatures cause more intense storms.
  - Sea-level rise (SLR):
    - SLR of 50cm by the 2050s is expected based on existing carbon emissions.
    - SLR could reach 70cm with 2°C global warming (the central goal of the Paris Agreement).
    - SLR could exceed 1m with 4°C global warming.
    - SLR close to the tropics could be 10-15 percent higher.
    - The Maldives is at risk of disappearing entirely with SLR of 1m; other small states at significant risk include Dominica, Grenada, Kiribati, the Marshall Islands, St. Vincent and the Grenadines, and Tuvalu.
  - Extreme temperatures:
    - Global warming will lead to more frequent and intense extreme heat episodes; marginal impacts may be smaller near the equator but add to already high average temperatures in many small states.
  - Water stress:
    - SLR can cause salt water contamination of freshwater aquifers, reducing access to drinking and irrigation water.
    - Under a 2°C scenario (for the 2040s), water runoff available for drinking and irrigation could decline by as much as 30 percent in Latin America and the Caribbean and 50 percent in sub-Saharan Africa.
- Broader persistent costs:
  - Climate change can reduce agricultural productivity, threaten tourism, stress ecosystems, increase poverty, and encourage emigration.
  - Estimates and scenarios depend on future emissions pathways and degree of warming.

### Box 3 — Climate Change Basics (key numeric points)
- Current and projected warming:
  - Global mean temperature is now about 0.8°C higher than pre-industrial levels.
  - If CO2-equivalent concentrations were stabilized at 450, 550, and 650 parts per million (ppm), mean projected warming over pre-industrial levels would be 2, 3, and 4°C, respectively.
  - Absent mitigation and adaptation, indications are that global mean temperature increase could reach about 3-4°C or more by the end of this century.
  - The central goal of the Paris Agreement is to limit global warming to 2°C.

*Source: Box 2. Data on Natural Disasters, (excerpt).*

### 18.      Small developing states are estimated to be at greater risk than developed

### 18.      Small developing states are estimated to be at greater risk than developed countries.

### Key findings and vulnerability assessments
- IPCC projections and Maplecroft’s 2016 climate change vulnerability index indicate countries closer to the equator and low-lying coastal countries (including many small states) are "extremely or highly vulnerable" to climate change.
- Roughly three-quarters of low-income countries and one-third of small developing states are assessed as extremely or highly vulnerable to climate change, compared to one-quarter of the rest of the world.
- The 2016 Maplecroft exposure index assesses risks for 24 small states: three at extreme risk (Fiji, Mauritius, and Montenegro) and four at high risk (Belize, Djibouti, Timor Leste, and Vanuatu). The assessment likely understates risks because some vulnerable states are not covered (example: Kiribati, Tuvalu, Maldives).

### Economic channels and sectors at risk
- Main channels of impact identified (Roson and van der Mensbrugghe, 2012):
  - Sea-level rise and agriculture for Southeast Asia, Latin America and the Caribbean.
  - Water scarcity for MENA.
  - Labor productivity and health for sub-Saharan Africa.
- Key sectors at risk:
  - Coastal ecosystems: Damage from sea-level rise (SLR) will affect infrastructure, livelihoods (e.g., fishing), and habitability; long-term risk of some ecosystems becoming uninhabitable.
  - Tourism: Erosion of beaches, reduced freshwater supplies, and extreme climate events (floods, storms, tsunami) damaging critical infrastructure (airports, roads, hotels) undermine tourist-based economies. Loss of tourism competitiveness expected to be greatest for developing countries, particularly small developing states vulnerable to SLR.
    - Tourism receipts are equivalent to more than 25 percent of GDP for Antigua and Barbuda, the Bahamas, Maldives, Palau, Seychelles, St. Lucia, and Vanuatu.
    - Tourism receipts exceed 15 percent of GDP for Barbados, Belize, Cabo Verde, Dominica, Fiji, Mauritius, Montenegro, Samoa, and St. Kitts and Nevis.
  - Agricultural productivity: Rising temperatures and greater rainfall volatility (including drought) reduce agricultural productivity and GDP growth. With 97 percent of crop land being rain-fed rather than irrigated, countries in sub-Saharan Africa and Southeast Asia are particularly vulnerable.
    - One study projects output in poor countries could fall by 1.3 percent on average from baseline levels for each 1°C rise in global mean temperatures, largely due to reduced agricultural and industrial output (Dell et al., 2012).
    - Lower crop yields are projected to boost food prices, with implications for low-income groups (Hallegatte et al., 2015).

### Projected economic costs
- Economic costs for small states are projected at 15 percent of GDP or more.
  - Caribbean small states: a one-meter sea-level rise by 2080 is projected to result in losses and damages of about 8 percent of projected GDP (Simpson et al., 2010).
  - Pacific island small states: a sea level rise of between 1 and 1.7 meters is projected to result in an economic impact of between 3 and 15 percent of GDP due to lost agricultural production, tourism and fisheries and infrastructure damage (Asia Development Bank, 2013).
- Global projections for market and nonmarket losses and damages range from 1 to 4 percent of output for a 4°C increase in global mean temperature.
- There is considerable variation and uncertainty across studies regarding potential damages from extreme temperature and related catastrophic weather events.

### Social impacts: poverty and emigration
- Low-income communities are particularly vulnerable due to reliance on agricultural incomes, a high proportion of incomes devoted to food, and limited access to savings or credit.
- Globally, climate change could push more than 100 million people into poverty by 2030 (Hallegatte et al., 2015).
- Climate change’s progressive impact on incomes, job opportunities, and living conditions suggests emigration is likely to increase further—already twice that for larger countries and rising since the early-2000s (Figure 3).

### Policy responses — overview
- Public policies can reduce human and economic costs, alleviate output losses, and improve growth potential for small states by strengthening preparedness and resilience.
- Frameworks promoted by World Bank, UN, and other organizations emphasize:
  - Readiness and contingency planning.
  - Risk reduction investments (physical infrastructure and financial risk toleration).
  - Appropriate regulations (e.g., safe zoning) within a coherent long-term plan for economic resilience.
- Success of resilience plans depends on consistency with macro-stability and sustainability.
- The Fund’s immediate issue: align macro, fiscal, and financial policies to support resilience while maintaining stability and sustainability. For small states facing existential threats (e.g., SLR), more fundamental reassessment of macroeconomic policies will be necessary.

### Main elements to mainstream into fiscal and other policy frameworks
- Identification and quantification: identify and quantify main disaster or climate risks, likelihood, potential impacts, and key vulnerabilities (infrastructure at risk, vulnerable populations).
- Invest in risk reduction: guided by risk assessments, decide whether and how to invest in risk reduction.
- Develop contingency plans: where risks cannot be mitigated, prepare disaster-response contingency plans.
- Arrange contingency financing: include self-insurance (fiscal reserves and contingency funds), contingent plans using borrowed or grant resources, and risk-transfer arrangements (insurance or capital market options).

### Implementation challenges
- Underinvestment in risk reduction persists despite high calculated rates of return on marginal projects.
  - Example: One dollar of US federal investment in preparedness is estimated to yield a reduction in damage of approximately $15 (Healy and Mulhotra, 2009).
- Practical obstacles include inadequate contingency planning, coordination failures across multiple partners, and lack of access to financing (Clarke and Dercon, 2016).
- Political obstacles: politicians may receive higher electoral rewards for post-disaster response than for preventive investments; preventive programs may span multiple administrations, reducing perceived ownership; preference to retain discretion in responding to events can impede pre-committed plans.
- Financing is a major hurdle for small states where disaster risk reduction competes with other public service needs and maintaining cash buffers.

### Tailoring approaches and Fund role
- Disaster risk management approaches differ across countries; policy advice should be tailored to country circumstances.
- Many policy areas important for reducing macroeconomic impact are outside the Fund’s core competence; collaboration with organizations like the World Bank is needed.
- The Fund should operate within areas of macroeconomic competence while helping at-risk countries explore long-term macro-options.
- The Fund’s tools for assessing risks and vulnerabilities need adjustment to incorporate natural disasters; past work on small states offers examples of explicit integration into projections and policy advice, but more standardized good-practice approaches are possible.

### Identifying risks and integrating into macro frameworks
- The Fund should identify risks and vulnerabilities and ensure appropriate reflection in macroeconomic policy frameworks.
- Transparent communication of risks is important.
- Preparation of a fiscal risk statement (FRS) is a key element of Fund guidance on macro risk management; for countries where natural disasters are important, the FRS should cover associated risks and be presented with the budget.
- The Fund provides TA to develop fiscal risk statements and has a Fiscal Transparency Code and evaluations that cover disaster risks.
- Sound macroeconomic data are key; Fund capacity building is important across national accounts, fiscal and external accounts, and financial sector data collection and compilation. Regional collaboration on macroeconomic data compilation may be an option.

### Fiscal risk management and fiscal risk statements (summary)
- The IMF’s Fiscal Transparency Code defines twelve major risks including natural disasters and specifies that countries should analyze, disclose, and manage potential fiscal exposure based on a published strategy.
- Fiscal risk statements should:
  - Describe and quantify main fiscal risks, discuss likelihood, and propose fiscal measures to mitigate and manage them.
  - Identify and quantify fiscal exposure to disaster risks, detailing quantifiable and unquantifiable contingent liabilities and their likelihood (probable, possible, remote).
  - Propose mitigation steps (public infrastructure investment, tax incentives, regulatory interventions) and contingency procedures to allow rapid release of funds after disasters.
  - Identify contingency financing in advance where possible.

*Source: _110416 - 18.      Small developing states are estimated to be at greater risk than developed countries.*

### 33.      A risk reduction program to address identified vulnerabilities should be developed.

### 33.      A risk reduction program to address identified vulnerabilities should be developed.

### Risk reduction measures and options
- Develop information campaigns to increase preparedness, early warning systems, and contingency planning.
- Risk reduction steps could involve:
  - Public infrastructure projects (e.g., more effective seawalls along urban coastlines; maintenance or reinforcement of bridges; investments in urban resilience—resilient construction and building back better).
  - Incentives to encourage private sector investments in risk reduction (e.g., targeted subsidies for retrofitting properties; accelerated capital depreciation provisions).
  - Financial investment to offset risk (e.g., public insurance subsidies tailored by risk).
- Public information provision:
  - Risk maps on flood zones, areas at risk from coastal erosion, and landslide areas to inform property investors and insurers.
  - Adequate funding for public early warning systems (e.g., hydro-meteorological and communication systems).
- Property rights and regulation:
  - Land use and zoning rules (e.g., limit building in flood plains), building codes, affordable land titling procedures, and market-friendly rent controls.
- Fiscal policies and pricing incentives:
  - Subsidies for retrofitting, accelerated capital depreciation, fiscal incentives for drought-resilient crops, forest protection, and water resource preservation.

### Role of the Fund and investment assessment
- The Fund can help determine whether public investment is financeable and consistent with a medium-term development plan.
- Public spending on risk reduction needs to be consistent with fiscal space, debt sustainability, and macroeconomic absorptive capacity.
- Assessment depends in part on projected economic returns from risk reduction programs; staff are extending debt sustainability analysis on a case-by-case basis to reflect such returns.
- General equilibrium models such as the Fund’s Debt, Investment, and Growth (DIG) model provide a comprehensive approach for exploring the impact of scaled-up investment on the macro-economy (see Annex V).

### Public investment management and prioritization
- All resilience-building public investments should be undertaken within the framework of each country’s comprehensive public investment program.
- The Fund can help assess and build public investment management strength using the Public Investment Management Assessment (PIMA), which provides a diagnostic and recommendations to raise efficiency.
- Fiscal buffers should be accumulated via a saving strategy consistent with medium-term fiscal objectives (e.g., through the gradual accumulation of a rainy-day fund).
- Integrate spending and contingency allowances into a multi-year budget process; unspent contingency funds in a given year may be used for risk reduction measures the following year (examples: Mexico and Vietnam).
- For small states, limited administrative skills and weak PFM systems may hamper effectiveness; the Fund can play an important role in capacity building.
- Specific PIMA points:
  - PIMA diagnoses institutional capacity under 15 categories at three stages of the public investment cycle: (i) investment planning; (ii) investment allocation; and (iii) investment implementation.
  - Following a 2015 report identifying average inefficiencies in public investment processes at around 30 percent, the Fund has been deploying PIMA across several countries and with the World Bank in more than 15 pilot countries.

### Regional approaches and economic diversification
- Regional approaches can achieve administrative economies of scale via regional regulatory standards or regional administrative bodies (example: Caribbean Disaster Emergency Management Agency (CDEMA) coordinating regional disaster responses and codes of good practice).
- Shared regional PFM capacity-building examples in the Pacific: University of the South Pacific, Pacific Islands Center for Public Administration; Pacific Financial Technical Assistance Center; Pacific Islands Forum Secretariat; Pacific Islands Financial Managers’ Association; Pacific Islands Tax Administrators Association; World Bank’s Pacific Resilience Program (PREP).
- More diverse income sources can reduce risks from natural disasters and climate change:
  - Where economies are highly concentrated (e.g., agriculture or tourism), develop new, more resilient income sources.
  - Example: large territorial waters and the “blue economy” as pioneered by Seychelles.
- The Fund’s role: advise on macroeconomic policies needed for effective transitions to new growth models.

### Disaster contingency plans and social safety nets
- Combine risk reduction activities with contingency plans for disaster response; contingency plans should be aligned with key risks and vulnerabilities.
  - Examples: drought plans focused on food security and income support for farmers; hurricane plans focused on emergency housing, compensation for the homeless, restoration of key public infrastructure.
- To ensure rapid disaster response, keep discretion to a minimum:
  - Clearly defined rules for public intervention (e.g., size of payments), explicit leadership responsibilities, programs triggered by clearly-defined criteria (e.g., hurricanes at or above a certain category).
  - Contingency plans should align incentives for private sector risk reduction behavior.
- Social safety nets:
  - Contingent plans should be in place to scale up existing safety nets; design of new programs post-disaster may not allow sufficiently prompt intervention.
  - Cash transfers or vouchers are increasingly preferred where local markets can meet needs because they offer choice, flexibility, and stimulate domestic supply.
  - Large inflows of food and clothing aid can disrupt local value chains and undermine livelihoods; effects can be worsened by monetization of aid or corruption.
  - Public works programs can provide post-disaster income support while aiding recovery and rebuilding; may be more politically amenable than cash transfers.
  - Scale relief to immediate needs without undermining incentives to return to normal labor market participation.
- The Fund can support members by sharing country experience with safety nets; for technical design advice, countries should draw on World Bank and other institutions.
- Contingent financing arrangements with development partners should be explored to support disaster-related safety net programs.
- Caution on using pension/provident funds:
  - Example: Vanuatu National Provident Fund (VNPF) allowed active members to withdraw up to 30 percent of their pension fund after cyclone Pam; this provided financing equivalent to 2 percent of GDP over a three-month period but left the VNPF illiquid and less able to finance pension needs.
  - Similar concerns in Fiji when public pension fund assets were used for disaster recovery.

### Legal and budgetary frameworks for post-disaster flexibility
- The Fund can advise on design of budget laws to ensure budget systems function after a disaster, including:
  - (i) provisions in organic budget laws allowing government to exceed spending limits up to a defined amount in the event of a formally declared natural disaster;
  - (ii) escape clause provisions in fiscal responsibility laws to allow breaking numerical or procedural targets in case of a major natural disaster;
  - (iii) provision in the annual budget law giving flexibility to shift resources in case of a major natural disaster;
  - (iv) establishment of contingency space in the budget to cope with emergency needs.
- The appropriate approach depends on the PFM legal tradition in a given country.

### Public finance, debt management, and capacity building
- Integrate disaster risk management into a sound budget framework; risk reduction investments, contingency financing plans, and disaster financing approaches should be part of a top-down budgeting approach under a transparent and sustainable medium-term fiscal framework.
- The Fund should continue to provide technical assistance on PFM practices in small developing states and disaster-vulnerable countries.
- Fund capacity building can help small states strengthen public debt management after disasters (example: Vanuatu established a public debt management office following cyclone Pam).
- Introduce liquidity management innovations into domestic and external debt instruments to provide temporary cash flow relief (e.g., triggering deferral of debt service for qualifying natural disasters).

### Carbon taxes, energy pricing reform, and environmental fiscal policy
- The Fund can advise small states on carbon taxation and energy pricing reform:
  - Small states contribute little to global CO2 emissions but carbon taxes can help meet emissions commitments and raise revenue.
  - Examples of INDC pledges: Mauritius pledged to reduce emissions by 30 percent relative to business as usual emissions in 2030; Seychelles pledged to reduce emissions by 20 percent relative to business as usual emissions in 2030.
  - Carbon taxes (or tax-like instruments) are the most efficient instruments for reducing emissions and can be implemented through extensions of fuel taxes.
  - The Fiscal Affairs Department has developed spreadsheet tools to quantify required carbon pricing, and to assess environmental, fiscal, economic, and incidence impacts and trade-offs.
  - IMF provides guidance on broader reform of energy prices to reflect environmental impacts (e.g., air pollution, road congestion).

*Source: _110416 - 33.      A risk reduction program to address identified vulnerabilities should be developed.*

### 47.      Adequate fiscal buffers are a critical part of disaster contingency planning. As

### 47.      Adequate fiscal buffers are a critical part of disaster contingency planning. As

### Fiscal buffers, stance, rules, and debt management
- Domestic resources represent the first “layer” of potential disaster financing, providing immediate liquidity for disaster relief; for small disasters, domestic deposit buffers may provide the only necessary financing.
- Once the appropriate size of the fiscal buffer has been established, a first challenge may be to accumulate additional savings if the current buffer falls short:
  - Options include additional revenue measures, savings on expenditures, and including a sizeable provision for future natural disasters in the annual budget (if the disaster does not occur, the allocation could be saved).
  - The pace of buffer accumulation should follow a cost-benefit assessment and consider whether boosting savings would require cuts to priority spending; a more gradual accumulation could draw on new revenue measures.
- Fiscal stance:
  - Should take into account the need to build and maintain contingency buffers; it may be necessary to “look through the cycle,” running a stronger fiscal stance in non-disaster years to accumulate buffers (savings or debt reduction) that offset future disaster impacts.
  - The appropriate stance depends on starting conditions and may come on top of primary surpluses needed to reduce a historically high debt burden.
  - Distinguish temporary disaster-related shocks from more permanent fiscal shocks; the Fund can help disentangle temporary disaster elements that merit financing from permanent fiscal shocks requiring macroeconomic adjustment.
- Fiscal rules:
  - Can provide discipline to sustain buffers; an appropriate rule could target an underlying fiscal balance during normal times to build buffers and borrowing space.
  - Rules could include an escape clause allowing larger deficits for shocks such as natural disasters and a “debt brake” requiring fiscal adjustment in case of large ex-post slippages and debt buildup.
  - Where initial fiscal consolidation is necessary to reduce debt burdens, this should precede the introduction of a fiscal rule to make the rule more credible and lock-in gains.
- Debt sustainability and management:
  - Debt sustainability assessments (DSAs) are particularly important for disaster-vulnerable countries; post-disaster recovery and rebuilding programs often include debt-financed elements that should be carefully reviewed.
  - Rapid debt accumulation is not uncommon in countries experiencing a series of disasters; this may reflect a weak underlying fiscal stance or looser scrutiny of borrowing post-disaster.
  - DSAs should incorporate assumptions about trend economic growth and the future fiscal stance that include risks of adverse shocks from further disasters over the projection period.
  - Debt management can strengthen fiscal buffers: refinancing short-term obligations at longer maturities may improve credit access; where debt burden is excessive, improved market access requires sustained stronger fiscal performance and steps to deepen domestic debt markets.

### Monetary policy and financial sector issues
- Financial sector risks should be identified, and contingency plans adopted and communicated; deep, well-regulated banking systems and developed capital markets are better able to withstand shocks and provide credit for post-disaster recovery.
- Inflation effects:
  - Natural disasters have negligible impact on inflation in advanced economies but can affect inflation for several years in developing countries (Parker, 2016).
  - Storms can boost food price inflation for up to a year; earthquakes tend to reduce CPI inflation excluding food, housing, and energy.
  - Understanding these effects aids policy setting immediately after a disaster.
- Financial sector support and risk-management instruments:
  - Identify financial sector risks, adopt and communicate contingency plans, and pursue reforms to improve regulation and financial deepening to increase the sector’s resilience.
  - Ideally the financial system provides insurance, hedging instruments, and financing for risk reduction, though scale inefficiencies in small states make external provision of these likely to continue.
- FSAPs and FSSRs:
  - Financial Sector Assessment Program (FSAP) reviews and Financial Sector Stability Reviews (FSSRs) can assess disaster risks; stress tests can identify financial risks for banking and insurance sectors.
  - FSSRs support long-term financial sector development and short-term risk management frameworks, with potential to boost resilience to natural disasters.
- Crisis management and contingency planning (tailored to identified risks):
  - Infrastructure goals: ensure continued access to the banking system, continuity of the payment system, and ability to conduct cash transfers; ensure resilient microfinance and mobile banking; local insurance sectors should have prompt-response infrastructure.
  - Institutional roles: define responsibilities and actions for central bank, ministry of finance, regulatory authorities, and parliament; establish contingency plans for financial sector response and recovery; public lending institutions may finance recovery but risks must be carefully considered.
  - Examples: Samoa FSAP included stress tests modeling a category 4 tropical cyclone’s damage; Palestine Monetary Authority issued banking regulations requiring business continuity and disaster recovery plans.
- Longer-term planning for financial resilience:
  - Improve financial access, develop insurance and capital markets, and resilient mobile banking and microfinance networks to support remittances and cash transfers.
  - Prioritize development of private insurance domestically or via regional/international arrangements.
  - Strengthen regulatory and supervisory frameworks, crisis preparedness/safety nets, bank resolution frameworks, and deposit insurance schemes; for small states with limited supervisory capacity, focus on basics like access to financial data and off-/on-site supervision.
- Prudential ratios and stress testing:
  - Higher prudential capital and liquidity ratios may be appropriate for disaster-vulnerable countries.
  - Developing and running stress tests helps determine suitable macro-prudential measures to address potentially acute liquidity stresses in smaller countries.
  - Regulators must balance profitability, capital adequacy, NPLs, deposit growth, and overall economic growth with disaster risk impacts.

### External sector policies and reserve adequacy
- Small states’ features relevant for external buffers:
  - Disasters’ impact on balance of payments is proportionately higher as a share of GDP.
  - Most small states have fixed exchange rate arrangements.
  - These factors suggest optimal reserve cover is likely higher than for other economies; natural disasters increase demand for foreign currency and require substantial intervention to support pegs.
  - Even in flexible exchange rate regimes, higher reserves help prevent disorderly foreign exchange market developments.
- Reserve adequacy metrics:
  - Standard reserve adequacy metrics often do not factor in disaster risk and underestimate reserves needed for disaster-susceptible countries.
  - The Mwase (2012) metric for small states incorporates susceptibility to natural disasters, placing greater weight on short-term debt and exports and therefore requiring higher reserve holdings to reduce crisis probability.
  - The metric is not yet reflected in the IMF’s current toolkit.
  - Example advice: Swaziland Article IV consultations (2014 and 2015) recommended boosting reserve cover to 5-7 months of imports based on analysis that accounts for large exogenous shocks.
  - Based on a sample, small states do not appear to significantly draw on reserves following disasters (Annex VII, Figure 2); one possibility is that with limited reserves, imports are delayed until external financing is mobilized.
- Regional reserve pooling:
  - Pooling reserves regionally (e.g., FLAR, CMI) allows risk sharing and lowers reserve needs per country, benefits from economies of scale, reduces reserve hoarding, permits faster recovery and balance of payments cushioning, and can mitigate capital outflows by instilling confidence.
  - Main drawback is moral hazard and sovereign risk concerns from risk sharing across countries.
  - World Bank PCRAFI is considering a mutual fund to meet country needs for smaller disasters that do not trigger sovereign insurance payouts.

### Financing approaches for natural disasters and climate change
- Advance planning and mix of instruments:
  - Countries should develop advance plans for financing natural disasters rather than choosing options only after the event.
  - Advance plans should comprise a mix of fiscal buffers, contingent grant and loan arrangements, and risk transfer options.
  - Limited progress has been made; large disasters tend to be under-financed for small states despite relatively small global costs.
- Financing needs across phases:
  - Pre-disaster: financing for risk reduction investments (predictable and integrable into medium-term fiscal frameworks).
  - Post-disaster (relief and recovery): financing for urgent, unpredictable needs not envisaged in budgets.
  - Longer-term: financing for rebuilding.
  - Each element should be integrated into fiscal and debt management frameworks.
- Ex-ante risk reduction priority:
  - Uncertainty in post-disaster relief and rebuilding costs makes ex-ante risk reduction a priority; greater success in risk reduction reduces expected ex-post damages and financing needs.
- Current practice and ODA patterns:
  - Small states’ disaster financing is predominantly ex-post recovery focused; governments face constraints on domestic and external resources and difficulty accessing affordable financial instruments, resulting in reliance on ex-post borrowing and international support.
  - Resulting underinvestment in adaptation and risk reduction and slow, fragmented, unreliable disaster response.
  - Data on ODA (1990-2010): emergency response and reconstruction accounted for 86 percent of disaster-related ODA disbursements, with disaster prevention and preparedness representing only 14 percent.
  - For small developing states, prevention and preparedness represented 24 percent.
  - ODA financing is also less than fully additional; in the aftermath of disasters, external partners may reassign previously allocated funding, implying reprogramming of spending priorities and tradeoffs between disaster recovery and other developmental goals.

*Source: Excerpt from IMF chapter/section on disaster contingency planning and financing approaches.*

### 65.      The World Bank has developed a risk-layered framework for optimizing disaster

### _110416 - 65.      The World Bank has developed a risk-layered framework for optimizing disaster

### Risk-layered disaster-financing framework (World Bank model)
- Core principle: choose a mix of financial instruments that finances contingent disaster liabilities at the lowest economic opportunity cost (Clarke et al. 2016).
- Framework balances speed of access to post-disaster resources with cost and potential availability of financing.
- Layering by event size and typical instruments (as presented in Figure 4):
  - Small disasters (5 percent or ≤ 20 years (≤ 3 percent of GDP)):
    - Use self-insurance: reallocating spending or drawing down government deposits for quick, lower-cost resources versus sovereign insurance.
  - Moderate sized disasters (3.33 percent or 20-30 years (≤ 5 percent of GDP)):
    - Need access to external resources; establish contingent arrangements; develop risk transfer options where a third party takes portion of risk for a fee/premium.
  - Large disasters (1 percent or 30-100 years (≥ 5 percent of GDP)):
    - Insurance and reinsurance considered; contingent financing and risk transfer are important.
  - Very large/catastrophic events (0.5 percent or 100-200 years (≥ 5 percent of GDP); Below 0.5 percent or ≥ 200 years (≥ 5 percent of GDP)):
    - Catastrophe bonds, grants, humanitarian aid, global partnerships, exogenous shocks and pandemics. Debt sustainability constraints often make borrowing impractical; reliance on grants/humanitarian assistance is common but financing flows are slow and unpredictable.

### Empirical findings on actual practice (24 disasters, 1995-2015)
- Data examined: disaster damages (EM-DAT) and estimated fiscal and balance-of-payments financing sources for 24 disasters affecting small developing states.
- Key patterns:
  - Smallest disasters: financing appears to come from internal resources; no identified increase in external financing.
  - Medium-sized disasters: diversification of financing — domestic bank credits plus external grants and loans.
  - Largest disasters: less use of domestic bank financing; more exclusive reliance on external resources, including remittances by the private sector.
- Implication: small states have sufficient external financing for mid-sized but not the largest disasters. For largest disasters, new external financing over a three-year period covered less than half of estimated disaster losses, implying recovery is typically incomplete or extends well beyond three years with extended costs from sub-par infrastructure.
- Table summary excerpts (preserve source values exactly):
  - Disaster scale categories:
    - Large Disasters (more than 35 percent of GDP)
    - Middle-range Disasters (2 to 35 percent of GDP)
    - Small Disasters (1 percent of GDP or less)
  - Sources of financing (Yes/No by category):
    - Reserve drawdown: No / No / No
    - Domestic bank financing: No / Yes / No
    - External grant financing: Yes / Yes / No
    - External loan financing: Yes / Yes / No
    - Remittances: Yes / No / No
  - Adequacy of BoP financing to cover losses:
    - Number of disaster events 888
    - Average losses (percent of GDP) 4830.6
    - Additional ext. financing (percent of GDP) 2/224.5-1.8
  - Note: “The over-financing of middle-range disasters is due to one outlier (Seychelles).”

### Risk Financing Toolkit — domestic options and buffers
- Central and commercial bank financing:
  - Central bank budgetary financing may provide limited option where authority exists, but should be strictly limited to avoid fiscal dominance and undermine monetary policy.
  - Domestic commercial bank borrowing is likely limited by system liquidity constraints; most useful for small-scale disasters.
- Government deposit buffers:
  - Designed to cover early disaster response without compressing priority spending.
  - Example practice: some Pacific countries aim to maintain a deposit buffer equivalent to 3 months of recurrent spending.
  - Buffer design options: general fund deposits, “virtual” contingency fund within general fund, or dedicated disaster fund.
  - Drawdown of deposit buffers has liquidity implications similar to government borrowing and needs management.
  - Fund can advise on accumulating assets and buffer design; timeline constrained by broader fiscal priorities and public investment/debt strategies.

### External borrowing, contingent credit, and insurance
- Contingent lines of credit:
  - Help reduce ex ante financing uncertainty; can be arranged bilaterally, multilaterally, or commercially.
  - Examples: compacts with the United States (Marshall Islands, Micronesia, Palau) providing emergency access to FEMA and USAID; World Bank CAT DDO for middle-income countries (Seychelles is only small state covered under availability at time of writing).
  - Pandemic Emergency Financing Facility (World Bank/G20) combines catastrophe bonds, reinsurance, and a cash window — model for natural-disaster financing.
  - IMF’s RCF and RFI are not fully contingent (subject to access conditions) but disburse more rapidly because they do not require a Fund-supported program; downside: fiscal cost deferred until debt service falls due.
- Insurance and risk transfer:
  - Insuring public assets and encouraging private insurance reduces public contingent liabilities and lowers output/income losses from disasters (empirical studies cited).
  - Prompt insurance compensation reduces downtime and indemnifies producers.
  - Countries with low insurance penetration stand to gain most from increased coverage, but uptake must reflect cost-benefit tradeoffs.
  - Empirical examples:
    - Clarke and Dercon (2016): insurance-inclusive strategy far less costly for large (1-in-30 year) events; advantage declines for smaller/common events.
    - Bevan and Adam (2016): insurance less costly than tax increases and expenditure reallocation for some disasters.
  - Traditional indemnity insurance in small states:
    - Uptake low; premium payments for non-life cover average just 1 percent of GDP for typical small states.
    - Belize and Grenada rely on traditional insurance in severe disasters; in one recent large disaster Grenada’s insurance covered about 4.5 percent of total damages (9.2 percent of GDP).
    - Public-private partnerships have shown more success/sustainability than purely private or public provision; contingent fiscal risks must be monitored. Possible role for mandatory catastrophe insurance.
  - Innovative instruments:
    - Parametric insurance: pays out when pre-specified severity trigger (storm, flood, earthquake intensity from third-party data) is exceeded; rapid disbursement; can be costly and basis risk exists; regional pooling can achieve economies of scale.
    - Catastrophe (CAT) bonds: investors receive generous coupons and agree to forgive principal if parametric trigger is met, releasing debt-service resources for disaster response.
  - Fund’s role in insurance development:
    - Provide technical assistance on debt management to assess optimal mix of debt and insurance instruments.
    - Help countries weigh costs of borrowing (debt service, market access risks) against insurance costs (premia, basis risk).
    - Support sustainable private insurance market development and oversight via FSAPs and FSSRs; engage in deeper dialogue with the insurance industry.

### Climate change financing context for small states
- Funding landscape:
  - Estimated global climate financing: US$391 billion in 2014 (most comprehensive source cited).
  - Private sector accounts for largest share, concentrated in carbon emissions mitigation in advanced and emerging countries.
  - Alternative broader estimate: including private investment in energy efficiency and domestic public financing, global climate finance would reach US$933 billion in 2014.
  - By comparison, investment in fossil energy was US$1.6 trillion in 2014.
- Challenges:
  - Small states face an annual under-funding of adaptation needs by as much as $1 billion.
  - Available financing is biased toward mitigation rather than adaptation.
  - Access to climate funds is complex, administratively cumbersome, and capacity-constraining for small states.
  - Data on climate finance are uncertain and fragmented due to multiplicity of reporting entities and definitions; significant gaps remain, particularly for private financing and public financing not channeled through multilateral/national development banks.

*Source: IMF, extracted from content unit _110416 - 65.      The World Bank has developed a risk-layered framework for optimizing disaster*

### 76.      Developed countries have committed to jointly mobilizing US$100 billion of

### 110416 - 76.      Developed countries have committed to jointly mobilizing US$100 billion of

### International commitment and roadmap
- Developed countries committed to jointly mobilizing US$100 billion of climate change financing for developing countries by 2020 (COP15, Copenhagen, 2009).
- The US$100 billion goal was to be raised each year from both public and private sources with a balanced allocation between mitigation and adaptation.
- COP16 (Cancun, 2010) affirmed a clear priority for adaptation finance to the most vulnerable developing countries.
- COP21 (Paris, 2015) strengthened the commitment with a concrete roadmap agreed upon by 38 advanced countries to:
  - help developing countries develop and implement mitigation contributions and adaptation plans,
  - scale-up climate finance,
  - significantly increase finance for adaptation.

### Recent financing flows and progress toward US$100 billion
- Rough estimate: financing for low-income countries has reached the $50-60 billion range.
- Data points:
  - Financing flows increased from $52 billion in 2013 to $62 billion in 2014.
  - Official bilateral and multilateral sources comprise around 70 percent of the total, the majority in the form of grants and concessional loans.
- OECD projections (based on current commitments) suggest financing flows could approach $100 billion by 2020.

### Climate finance for small developing states (2014)
- Climate finance for small developing states remains small, reaching less than US$1 billion in 2014.
- Multilateral development banks channeled $444 million to small states in 2014.
- Direct assistance from bilateral donors in 2014: US$368 million.
- Dedicated multilateral and bilateral climate funds provided US$140 million in 2014.
- Distribution by purpose:
  - Mitigation accounts for some 58 percent of total climate change financing for small developing states.
- Adaptation financing gap and needs:
  - Global adaptation costs are 2 to 3 times higher than international public finance available for adaptation.
  - To close the gap, adaptation finance would have to be between 6 to 13 times larger by 2030 (United Nations, 2016).
  - For small states, the World Bank estimated an annual adaptation financing shortfall of about $800 million in 2010.
    - Of this shortfall: 66 percent was for Caribbean states, 27 percent for Pacific states, and 7 percent for Africa and the Indian Ocean.
  - Adaptation priorities in small states: infrastructure (largest cost, expected to increase with urbanization), coastal zones, water supplies, agriculture, human health, preparedness for extreme weather events.

### Additionality, fragmentation, and eligibility challenges
- Additionality concern: bilateral and multilateral climate finance may crowd out pre-existing commitments.
  - Bilateral climate finance to small developing states increased more rapidly than overall official development assistance over the last decade.
  - Projections suggest aid to these countries will stagnate at current levels going forward.
- Tracking complication: difficulty distinguishing between resources made available under previous commitments and new/additional resources.
- Eligibility criteria are fragmented and administratively cumbersome:
  - Common eligibility elements across funds include: party to the UNFCCC/Kyoto Protocol; eligibility for general financing/technical assistance from the institution (including debt sustainability and macroeconomic context); consistency with the funding institution’s strategic objectives; consistency with national plans/strategies; recipient government commitment.
  - Many funds require applicants to have coherent national climate plans already in place—challenging for small developing states with low capacity.
- Project size and representation:
  - Over half of the climate and disaster resilience projects in SIDS are smaller than $200,000.
  - The combined total of SIDS projects represents just 2 percent of global projects.

### Strengthening administrative capacity and enabling domestic environment
- Administrative capacity is critical to access, manage, and use climate finance effectively.
  - Small developing states with lower institutional capacity have less access to multilateral climate finance (based on CPIA scores).
- Supporting domestic policies can promote adaptation and attract/clobal climate finance.
  - Key enabling factors: stable domestic policies and consistent legal and regulatory frameworks.
- Initiatives:
  - Commonwealth Climate Finance Access Hub launched in 2016 (Mauritius) to place climate finance advisors in small states for 1-2 years to help identify and apply for climate change funding.

### IMF role in disaster and climate-related financing
- IMF comparative advantage: rapid disbursement to meet urgent balance of payments and fiscal financing needs; catalytic role in mobilizing other external financing through early engagement and assessment.
- Disaster financing features:
  - Fund financing typically approved within three months across instruments and facilities.
  - Disaster financing is available on concessional terms for PRGT-eligible members and for certain members benefiting from higher income threshold treatment.
  - Currently 13 countries benefit from the higher income threshold for PRGT treatment (list provided in source).
- Use patterns:
  - Of 49 instances of disaster-related Fund lending since 2000, small states accounted for a little over one-third of instances.
  - Small states accounted for 60 percent of the number of disbursements of emergency financing facilities since 2000.
  - Of 53 natural disasters reported by EM-DAT for small states since 2000, the Fund provided financial assistance in 16 cases.
  - Some disasters with damages >30 percent of GDP and between 20-30 percent of GDP did not receive Fund assistance.
- Fund financing relative to disaster impact:
  - For smaller disasters (costs <30 percent of GDP), Fund emergency financing was equivalent to 11.6 percent of disaster impact.
  - For larger disasters (costs >30 percent of GDP), Fund emergency financing was equivalent to 2.4 percent of disaster impact.
  - Examples where approved Fund financing exceeded normal access limits:
    - In 2015, following hurricane damage to Dominica and cyclone damage in Vanuatu, Fund financing under RCF and RCF/RFI blends were approved in amounts equivalent to 53.5 and 71.4 percent of current quotas, respectively.

### Program engagement, merits, and barriers
- Merits of broader program engagement:
  - Supports ex ante development of institutions and policies for responding to natural disasters.
  - Provides structured framework for design, implementation, monitoring of resilience-building policies and capacity building coordination.
  - Program reporting can help countries access other external financing on better terms.
  - Arrangements can be quickly augmented if a new natural disaster exacerbates balance of payments needs.
- Barriers to program engagement for small states:
  - Limited administrative capacity increases resource burden for program design and implementation.
  - Perception that Fund conditionality may be mismatched to country priorities.
  - Low historical engagement: small states represent 18 percent of membership and 29 percent of PRGT-eligible countries, but accounted for 12 percent of PRGT-supported programs since 2000 and 8 percent of new GRA arrangements.

### Emergency financing access limits, recent reforms, and gaps
- July 2015 reforms:
  - Access limits under the RCF and RFI were increased by 50 percent (with a broader increase under the PRGT) to address erosion of access norms relative to GDP, trade, and gross financing needs.
  - The increase did not fully reverse a two-thirds cumulative erosion of RCF access since 2004.
- 2016 quota doubling and effects:
  - When PRGT and RFI access limits were halved in 2016 alongside the doubling of Fund quotas under the 14th General Review, many small states (half those with smallest quota increases) saw only a minor increase in the SDR value of access to RCF and RFI financing.
- Remaining gaps:
  - The RCF/RFI safety net remains small relative to the largest natural disasters.
  - For severe disasters, Fund financing increases are not fully proportional to disaster costs; the RCF/RFI shock window limit is 37.5 percent of quota.
  - For the most severe disasters, Fund financing needs can exceed current annual RFI and RCF shock-window limits.

### Proposed adjustments for severe disasters (policy options)
- Consideration could be given to higher RCF/RFI access limits for countries impacted by severe disasters (damages of 30 percent of GDP or higher). Proposed features:
  - Annual access:
    - For severe disasters (damage ≥30 percent of GDP), annual access limit under the RCF and RFI would be set at 60 percent of quota.
    - In all other cases, the current annual access limit of 37.5 percent of quota would apply.
    - Access would be determined case-by-case based on balance of payments need, capacity to repay, and catalytic role of Fund financing.
    - The augmented access limit would apply to the full Fund membership.
  - Cumulative access:
    - Cumulative access limits would remain unchanged at 75 percent of quota.
    - Higher annual access under the severe disaster window would reduce remaining cumulative access below 37.5 percent of quota.
  - Measurement of damages:
    - Damages would comprise destruction of physical assets plus foregone output, measured relative to pre-disaster GDP projections.
    - The Fund would draw on assessments by national authorities, UNDP, World Bank, and other relevant agencies.
  - Letter of intent:
    - For financing within the augmented window, the authorities’ letter of intent would be expected to document existing and planned practices regarding adoption and implementation of disaster risk reduction approaches.
    - This documentation requirement would not slow access to Fund financing and would not establish conditionality, but would allow the Board to assess adequacy of policy efforts and capacity building needs.
  - Consistency with current policy:
    - Higher access under the RCF shocks window would be expected only where the member’s existing and prospective policies are sufficiently strong to address the shock.

*Source: IMF staff paper excerpt (sections 76–92).*

### 93.      Eligibility for the augmented access window for severe disasters would be relatively

### _110416 - 93.      Eligibility for the augmented access window for severe disasters would be relatively

### Eligibility and historical incidence
- Eligibility for the augmented access window for severe disasters would be relatively rare.
- Historically:
  - fewer than one-in-ten disasters in small states resulted in damages of 30 percent of GDP or higher;
  - a ratio that falls below one-in-one hundred for larger states (Text Figure 1).
- Over the period 2000-2015, eleven countries would have met the proposed threshold (Table 6).
  - Of this group:
    - ten were PRGT eligible,
    - nine were small states,
    - nine sought Fund financing (generally through the Fund’s emergency facilities and instruments).
- A further country, Kenya, would have come very close, with a drought causing damages equivalent to 28.8 percent of GDP.

### Projected demand on Fund resources and PRGT sustainability
- An augmented access limit for the RCF and RFI would result in only modest additional demand for Fund resources.
- On the assumption that the augmented access limit is used, on average, roughly once each year, and given the typical size of countries that may prove eligible, the additional demand on PRGT and GRA resources is projected to be limited.
- Projections for additional RCF loan demand would under most scenarios remain within less than 5 percent of the annual average lending capacity of the PRGT, and well within the observed swings in loan demand the PRGT is equipped to cope with (IMF, 2016c).
- The proposed reform would preserve the financial sustainability of the PRGT.
- Ring-fencing access to countries facing disaster damages of more than 30 percent of GDP reduces potential loan demand considerably compared to the option of an across-the-board increase in RCF and RFI access limits.
- The potential impact on PRGT and GRA loan demand would likely remain modest with other relatively high thresholds (e.g., 20 or 40 percent of GDP).
- Raising the threshold above 30 percent of GDP could make use of the new access window unnecessarily rare; a much lower threshold could result in some smaller disasters being overstated to access the new financing window.
- After several years’ experience, use of the higher access window and the associated disaster damage threshold could be reviewed.

### Moral hazard, facilities shopping, and incentives
- The narrowly-targeted nature of the reform would limit moral hazard considerations.
  - Additional Fund access would provide important balance of payments support, at the margin, for the most severe disasters, but it would be available only rarely.
  - Fund financing would remain small in relation to total damages.
  - Members would retain strong incentives to develop other contingent financing arrangements and to adopt policies that foster risk reduction.
  - The expectation that such policies would be discussed in the authorities’ letter of intent would help identify cases where preparedness falls short and inform discussions on possible successor arrangements in support of resilience building.
- The reform would not encourage facilities shopping.
  - Countries typically seek stand-alone shocks financing under the RCF/RFI, rather than requesting Fund arrangements.
  - The proposal for augmented access would have no material impact on facilities shopping.
  - The unchanged cumulative access limit for the RCF and RFI would maintain incentives for countries to shift toward financing under Fund arrangements in the event of repeated large disasters.

### Catalytic role of Fund financing and limits relative to total damages
- The impact of Fund financing will inevitably depend on a very large catalytic role.
- Even with scope for higher access under the RCF and RFI, the proportion of disaster costs to be met from other financing sources would remain very large.
  - Annex table 2 suggests that average shocks facility financing of 36 percent of quota met just 2.4 percent of disaster damages for small states.
  - Even with access of 60 percent of quota, Fund financing would remain only 4 percent of overall damages.
- The Fund would continue to play an important catalytic role in:
  - identifying balance of payments needs,
  - providing quick-disbursing funds for immediate needs,
  - confirming a sound macroeconomic framework for disaster relief and recovery.
- In the case of severe disasters, the ability to access a rarely-used higher access window could send a strong message of the Fund’s support, helping trigger comparable exceptional support from other development partners, which will likely involve large scale grants to maintain sustainable debt positions.

### Role of the Fund in climate change financing and policy assessments
- The Fund could support global efforts to combat climate change by assessing and advising on countries’ macroeconomic policies as they relate to climate change preparedness.
- Assessments could be conducted in collaboration with the World Bank, with the Fund covering macroeconomic policy goals and implementation in its areas of competence, including:
  - adoption of energy taxes and subsidy reforms that appropriately price carbon emissions;
  - quality of frameworks for managing public infrastructure investments, including in climate change mitigation and adaptation;
  - strength of public finance management systems and their capacity to effectively intermediate budget resources dedicated to climate change programs;
  - consistency of climate change spending programs with goals for fiscal and debt sustainability and macroeconomic absorption capacities.
- Climate change policy advice could help countries develop coherent macro policy frameworks aligned with their INDCs and national climate change programs through 2020.
- Fund engagement would be particularly important where domestic policy capacity is limited (for example in small states and fragile states).

### Catalyzing climate change financing and resource implications
- Assessments could help catalyze climate change financing:
  - Official bilateral and multilateral agencies have a strong interest in providing climate change financing to countries maintaining sound macroeconomic policy frameworks.
  - A favorable Bank-Fund assessment of a country’s climate change policy framework could simplify the process of qualifying for financing.
  - Staff exchanges with the Green Climate Fund (GCF), World Bank, and UN agencies suggested IMF macroeconomic policy assessments would be welcome, though further work would be needed to establish the specific catalytic role of Fund assessments.
  - Given the fragmented climate change financing architecture, the Fund’s assessments would likely remain one of many factors determining funding decisions.
- Climate change policy assessments would have resource implications and would be funded through prioritization of existing resources:
  - Article IV surveillance would normally cover macroeconomic policies relating to climate change where macro-critical, but coverage would not typically be comprehensive.
  - A full assessment would typically require additional Fund resources, either to complement the Article IV consultation process or to staff a separate staff visit.
  - This would involve additional effort of country teams and drawing on technical assistance expertise, depending on the number and type of countries covered.
  - Given the Fund’s budget ceiling, this would require prioritization of country teams’ work and within the overall technical assistance resource envelope.
- Consideration could be given to IMF climate change policy assessments on a pilot basis:
  - Small and fragile states would be priorities for Fund engagement.
  - A pilot approach would provide implementation lessons that could be adapted more widely, depending on the Fund’s evolving role.
  - A future review of the Fund’s role in supporting climate change, including through such pilots, would be useful to refine and guide policies.

### Issues for discussion (as posed in the text)
- Policy approaches:
  - Should strengthened domestic policy frameworks play an important role in mitigating disaster vulnerabilities?
  - Is greater emphasis needed on developing ex ante disaster risk management frameworks and integrating macroeconomic elements into public fiscal, debt, and financial management practices?
- Financing for natural disasters:
  - Should small states seek to develop more ex ante financing arrangements, including insurance and other options for risk transfer?
  - Is there scope for the international community to better support small states by developing contingent financing arrangements and supporting regional insurance pooling arrangements?
- Climate change financing:
  - Is enhanced access to financing for climate change adjustment a priority for small states?
  - Is it important to develop less complex and administratively cumbersome application procedures to enhance financing access for small states?
- IMF arrangements:
  - Could use of Fund arrangements by small states help develop policies and institutions necessary for resilience to natural disasters?
  - Where natural disasters are the main factor giving rise to potential balance of payments need, should program design be streamlined and focused on resilience building policies?
- RCF and RFI financing:
  - Is there merit in an increase in the annual access limits under the RCF and RFI to better meet urgent balance of payments needs following severe natural disasters?
- IMF climate change assessments:
  - Is there value in IMF assessments of macroeconomic policies related to climate change mitigation and adaptation?
  - Should the Fund explore such assessments, on a pilot basis, for small states in partnership with the World Bank?
- Capacity building:
  - With strained administrative capacity in small states, should sustained Fund support be critical across the full range of its activities, with emphasis on capacity building?

*Source: Excerpt from IMF chapter/section on small states (text and tables referenced within the provided content).*

### References

### References

### Key reference collections and datasets
- Comprehensive bibliography covering natural disasters, climate change, and small states, including working papers, journal articles, World Bank and IMF reports, and UN and OECD publications (selected examples in source: Acevedo 2014; Acevedo 2016; Asia Development Bank 2013; Barnett and Adger 2003; Bevan and Adam 2016; Bluedorn 2005; Buffie et al. 2012; Burkett 2011; Cabezon et al. 2015; Cavallo and Noy 2010; Clarke 2016; Clarke and Dercon 2016; Clarke et al. 2016; Climate Policy Initiative 2016; Dell et al. 2012; Dellink et al. 2014; Ewing and Kruse 2002).
- Major databases and indices cited: EM-DAT (Guha-Sapir, Below, and Hoyois 2015), Climate Change Vulnerability Index, IPCC assessments, Maplecroft risk calculations.
- Institutional reports and policy notes from IMF (multiple entries 2003–2016), World Bank (multiple entries 2003–2016), OECD (2016a, 2016b), UNFCCC (2007, 2014, 2016), United Nations Environment Program (United Nations, 2016), Munich Re (2013), and others.

### Annex Table notes and IMF financing metrics (Annex Table 1 and Annex Table 2)
- Source: IMF and EM-DAT (see Annex Table 1).
- Footnotes preserved exactly:
  - 1/ Includes a few cases of double-counting. Specifically, Ebola support in 2014-15 for Guinea and Liberia is included as both RCF disbursements and ECF augmentation, and support following Haiti’s 2010 earthquake is included as both ECF augmentation and under the PCDR.
  - 2/ Includes purchases under the RCF, RFI, ENDA, Exogenous Shock Facility - Rapid Access Component, augmentations of existing ECF and SBA arrangements, and debt relief under the PCDR.
  - 3/ Disbursements measured in percentage of current (2016) quota.
  - 4/ Support for Djibouti following a drought in 2012; no damage estimates available.
  - 5/ The RCF request followed Nepal’s 2015 earthquake which resulted in damage of 33 percent of GDP.
  - 6/ The ratio of IMF financing to damage excludes one outlier (2008 Kyrgyz Republic earthquake) where disaster damages appear to be under-reported, leading to a high ratio of Fund financing relative to reported damages.
  - 7/ Following Haiti’s 2010 earthquake, the Fund provided financing equivalent to 0.9 percent of GDP through ECF augmentation plus PCDR debt relief equivalent to 4 percent of GDP.
  - 8/ This ratio excludes three outliers (2001 Malawi food crisis, 2001 Chad food emergencies, and 2000 Madagascar cyclone) where disaster damages appear to be under-reported, leading to a high ratio of Fund financing relative to reported damages.
- Extracted numeric entries as presented in table excerpt:
  - Small states — Number of Disaster Events: 16, 1, 8, 7, 1, 17 (as shown in table rows).
  - Small states — Damage (% of GDP) entries: ... , 9.0, 72.1, ...
  - Small states — IMF Financing (% of quota) entries: 17.8, 21.4, 35.9, 30.0.
  - Small states — IMF Financing (% of GDP) entries: 0.5, 0.7, 1.3, 1.0.
  - Small states — IMF Financing (% of damage) entries: ... , 11.6, 2.4, ... 
  - Larger states — Number of Disaster Events and financing entries as shown: 10, 3, 6, 1, 21, 1, 31; damage entries: ... , 4.3, 32.8, 16.7, 120.8; IMF Financing (% of quota): 10.5, 17.9, 22.7, 17.8, 108.7; IMF Financing (% of GDP): 0.5, 1.1, 0.2, 0.9, 4.0; IMF Financing (% of damage): ... , 13.7, 6/, 0.7, 6.4, 8/, 3.4.
- Note: Table excerpts include ellipses and numeric fragments as presented in the source pages.

### Annex I — Relative vulnerabilities of small states to natural disasters and climate change
- Core messages:
  - Vulnerabilities vary across small developing states; climate change and natural disaster risks are related but often distinct (example: Mauritius more at risk from climate change than natural disasters; Samoa vice versa).
  - "About two-thirds of small developing states are estimated to be extremely or highly vulnerable to natural disasters."
  - "About one-third of small states are similarly assessed as vulnerable to climate change within the current generation (next 30 years) based on risks calculated by the IPCC and Maplecroft."
  - Vulnerability rankings are sensitive to methodology; rankings are indicative and should be complemented with country-specific vulnerability measures.
  - For climate change, coverage of vulnerability ratings is limited; several countries lacking ratings are identified from other sources as being at high risk from sea level rise (Kiribati, Maldives, Marshall Islands, Micronesia, and Tuvalu).
- Attribution and drafting:
  - Drafted by Mai Farid and Sebastian Acevedo, based on a background study by a team also comprising Ricardo Marto, Dan Nyberg, and Vimal Thakoor, led by Prakash Loungani.
- Definitions and indices referenced:
  - "Climate Change Vulnerability Index assesses the combined risk of exposure to extreme climate-related weather events and changes in major climate parameters (temperature, precipitation, sea-level), and sensitivity to exposure in life-supporting sectors of food, water, health, infrastructure, and ecosystems services."
  - Other indices noted: Center for Global Development—Quantifying Climate change, DARA Climate Vulnerability Monitor, University of Notre Dame—Global Adaptation Index (ND-Gain), World Food Programme, Food Insecurity and Climate Change Vulnerability.

### Annex II — Macroeconomic impacts of natural disasters (methodology and main findings)
- Data and sample:
  - Uses EM-DAT data for 1990-2014.
  - Measures vulnerability along three dimensions: frequency of disasters; economic cost (damages as percent of GDP); and social cost (percentage of population affected).
  - Disasters included only where economic and social cost data are available, where the economic cost is at most 3 percent of GDP, and where at most 8 percent of the population are affected.
  - Excludes a few large-area countries with many recorded disasters (China, India, Philippines, US) to avoid dominance of results.
  - Drafted by Mai Farid and Sebastian Acevedo, based on a background study by the team noted in Annex I.
- Summary of empirical findings (preserve original directional relationships and phrasing):
  - General: Disasters have an adverse impact on some key macro outcomes, with small states disproportionately impacted. More frequent exposure to disasters tends to result in long-run economic and social costs; effects strongest for GDP per capita, agricultural activity, and poverty.
  - GDP per capita:
    - Countries hit more frequently by disasters tend to have a lower GDP per capita, with the largest impact for small states.
    - Frequent disasters with a high social cost also tend to be associated with lower GDP per capita.
    - The reverse is the case for economic cost—which is positively related to GDP per capita; causality may run in the opposite direction with more advanced economies standing to lose more from disasters.
  - Poverty (% of population):
    - Poverty tends to be higher for countries impacted most frequently by disasters and facing the highest social cost.
  - Agricultural contribution to GDP (% share):
    - Countries more reliant on agriculture tend to face higher social costs from natural disasters, notably in the case of small states.
    - Agriculture-based economies also tend to experience more frequent disasters (causality unclear).
  - Tax revenue (% of GDP):
    - Tax ratios tend to be lower for countries most frequently impacted by natural disasters and for countries where disasters have the highest economic cost.
  - Government consumption (% of GDP):
    - For small states, government spending tends to be highest for countries impacted most frequently by disasters and those experiencing disasters with a higher social cost.
  - Trade balance (% of GDP):
    - Countries vulnerable to disasters tend to have less favorable trade balances, though this effect is found only for large countries, not small states.
  - Overall and private gross capital formation (% of GDP):
    - Countries facing frequent and economically costly disasters tend to have lower overall and private sector capital formation, with the largest impact for small states. This may be a channel affecting GDP per capita and living standards via capital stocks.
  - External development assistance (% of budget financing):
    - There is no evidence for greater access to long-term external development assistance for countries more vulnerable to disasters.

*Italic source attribution preserved from document header and annexes.*

### Annex III. Vanuatu: Coping with the Damages of Cyclone Pam—

### Annex III. Vanuatu: Coping with the Damages of Cyclone Pam— Policy Lessons

### Overview and Economic Impact
- Cyclone Pam struck Vanuatu in March 2015 and was “one of the most damaging natural disasters in Vanuatu’s history.”
- Overall damages amounted to more than 60 percent of GDP.
- The cyclone affected almost 72 percent of the population (more than 188,000 inhabitants).
- Main productive sectors highly affected: tourism, transport infrastructure, and production losses in agriculture and tourism.
- Damages exceeded that of any other natural disaster experienced in the region in recent memory.
- Fifteen months after Cyclone Pam, reconstruction began to yield positive results: reopening of damaged hotels and refurbishment of Port Vila’s international airport supported the return of tourists; major infrastructure projects (roads, international wharfs, inter-island shipping) have started and social infrastructure reconstruction is in the pipeline.
- Medium- to long-term recovery was more sluggish: schools still held in tents and health centers still partially destroyed in the most-affected islands; some recovery procedures proved burdensome and delayed key initiatives.

### External and IMF Financial Support
- IMF financial assistance under the RCF and RFI: about USD23.8 million.
- Bilateral and multilateral partners committed more than USD210 million (28 percent of GDP).
- Grants received in 2015: about USD72 million.
- Donor responses were swift and generous, but financing disbursements have been slow due to reconstruction program delays.
- Sovereign insurance payout through the PCRFI initiative covered less than 1 percent of damages.

### Key Institutional and Fiscal Lessons
- Institutions matter: Vanuatu established in 2013 a Ministry dealing exclusively with climate change issues, making the National Disaster Management Office (NDMO) central to coordinating preparedness and recovery initiatives; NDMO responded adequately to basic needs, but advance attention to avoiding bureaucratic obstacles in the Recovery Committee’s operations would have been useful.
- Domestic buffers were limited:
  - The Response Fund can provide up to 1.5 percent of the government’s budget for that fiscal year (0.3 percent of GDP), falling short of expenses needed to restore basic services.
  - Recommendation: consider a permanent mechanism to expedite response to average-size natural disasters.
- External buffers need to be actionable and predictable:
  - Partners should ensure disbursements are timely and at concessional terms.
  - Authorities should contemplate instruments that commit pre-approved resources drawndownable in major disasters, and seek greater donor contributions for sovereign insurance mechanisms.
- Resilient infrastructure requires maintenance:
  - Budget should include an explicit allocation for disaster risk reduction and climate change adaptation.
  - Ensure adequate funding for infrastructure maintenance in addition to investing in new infrastructure.
- Social safety nets should be well-targeted:
  - Vanuatu resorted to ad hoc interventions: temporary suspension of VAT and import duties on construction materials; deferred payment of vehicle registration fees and VAT payments; subsidies for agricultural seedlings to affected households.
  - The National Provident Fund allowed members to withdraw part of retirement savings to cover damage-related expenses.
  - These ad hoc programs provided relief but raise questions about effective targeting and appropriate use of scarce resources.

### Monetary and Financial Sector Response
- IMF support helped consolidate Reserve Bank of Vanuatu’s (RBV) comfortable level of reserves, smoothing the cyclone’s impact.
- RBV provided liquidity support by:
  - Reducing its monetary policy rate by about 340 basis points.
  - Cutting the statutory reserve deposit requirement for commercial banks from 7 to 5 percent.
- Supervisory recommendation: ensure banks have adequate business continuity plans.
- Operational outcomes observed:
  - Banks provided enough physical currency to proceed with daily activities when banks were closed and ATMs were down.
  - Banks provided waivers on retail customers’ loan repayments for 2 to 3 months.
  - Some corporate customers had loan repayments delayed for 6 to 12 months pending an insurance payout.

### Guidance for Macroeconomic Frameworks and Risk Analysis (Annex IV excerpt)
- Focus: design macro frameworks and risk analysis to reflect impact of natural disasters and climate change, especially for small states where impact is significant.
- Data sources and assumptions:
  - Use EM-DAT to identify timing of past disasters and economic/social impact, noting its limited coverage of economic losses and lack of direct measures for GDP, budgets, or balance of payments.
  - Supplement EM-DAT with country-level data (national accounts, fiscal accounts, balance of payments) and stakeholder consultations.
  - Use World Bank Post-Disaster Needs Assessments (PDNAs) for physical damage and production loss estimates, while recognizing no one-to-one relationship between PDNA production losses and measured GDP impacts.
    - Example: Vanuatu PDNA estimated production losses at 24 percent of GDP, while Fund staff estimated measured GDP growth in 2015 would be reduced by only 5½ percent of GDP.
    - Example: Samoa PDNA estimated production losses at over 12 percent of GDP, while the staff report requesting RCF financing estimated the GDP impact at 1.1 percent of GDP.
  - Transparently document assumptions on size/frequency of disasters, macro impact, and policy responses; document dynamic models where used.
- Developing macroeconomic baselines:
  - Adjust long-term projections to account for episodic disaster down-cycles and potential benefits from investing in resilience.
  - Approaches:
    - Base projections on long-term historic averages (e.g., 20 years) to capture average disaster effects; drawback: may not distinguish underlying non-disaster performance from disaster impacts and may be unsuitable for revenue/expenditure ratios.
    - Adjust non-disaster projections using estimated/modeled impacts of disasters by incorporating disaster frequency, magnitude, macro impact, and expected policy response (e.g., use probability-weighted average impacts).
      - Example methodology: if average disaster occurs once every 10 years (0.1 probability), baseline adjustment equals probability times cumulative multi-year fiscal impact (illustrative cumulative impact example: immediate year worsens overall fiscal balance by 2 percentage points and by 1 percentage point in each of following two years → cumulative impact 4 percentage points; disaster probability 0.1 → disaster fiscal adjustment factor 0.4 percentage points).
    - Where data are poor, mix approaches: long-run trends, synthetic control comparisons with peer countries, and judgment.
      - Synthetic control: compare outcomes for a disaster-prone country with a control group similar except for disaster exposure; results subject to margin of error.
- Reporting practice:
  - Past practice survey: many country reports cover impact of actual disaster events; macro-financial baselines do not typically reflect long-term impact of periodic natural disasters; no standard practice for modeling/reporting disaster risks; disaster risks most comprehensively analyzed for small states in the Caribbean and Pacific.

*Prepared by Ricardo Marto (RES); Annex IV prepared by a team comprising Ms. Gold (WHD) and Messrs. Allum (SPR), Atolia (RES), Cihak (MCM), Ding (APD), Geiregat (FIN), Guerson (WHD), Mooney (FIN), and Takizawa (SPR).*

### 12. Adjustments should, in principle, include “second round effects”, as the public and private

### 12. Adjustments should, in principle, include “second round effects”, as the public and private

### Adjusting macro baselines and second-round effects
- Macro baselines should reflect not only the first-round impact of natural disasters but also the most important reactions by governments, households, and corporations.
- Policy reactions to be included only where there are good reasons to expect adoption—based on past practices or an established policy framework.
- There should be no presumption that policy reactions will fully address the costs of natural disaster, ensuring sustainability of the adjusted macro baseline.
- Example reactions:
  - Governments may undertake fiscal adjustment to offset part of the costs of a natural disaster.
  - Governments may gain access to new grant financing to pay for disaster recovery.

### Fiscal presentation and identifying disaster impacts
- Fiscal projections could be adjusted in two ways:
  - Adjust budget lines individually (revenues adjusted downwards, public expenditure and grant receipts adjusted upwards); or
  - Introduce a new line into the fiscal accounts showing the net impact of disasters (recommended for presentational clarity).
- The recommended presentation: show a “net disaster impact” line above-the-line, after the unadjusted overall balance including grants.
- For the balance of payments, detailed analysis is less important; disaster effects can be integrated into variables separately (exports, grant inflows, etc.) rather than via a separate line item.

### Near-term projections and presentation caution
- For the current year and possibly one year ahead, baseline macroeconomic projections could be “clean”, excluding adjustments for natural disaster impacts to align with authorities’ growth assumptions and planned budgets.
- This approach can cause variables to “deteriorate” between the clean baseline (years 0-1) and the baseline including annual average disaster effects (years 2 and beyond); the basis for such shifts must be explained in the country report.
- Staff must be clear that a clean baseline does not imply a lower probability of near-term disaster or a lower need for contingency planning.

### Resilience investments and long-term frameworks
- Where countries invest to become more resilient, reduce negative disaster adjustments in outer years of the macro framework to reflect beneficial impact.
- Key questions:
  - Do debt-financed investments in resilience-building generate sufficient additional future fiscal savings and growth-related tax collections to be self-financing?
  - Or do taxes need to rise in parallel to ensure fiscal sustainability?
- Teams should be cautious in projecting future savings from resilience-building investments and, where possible, use independent evidence of likely rates of return.
- Footnote observation: The significant historic debt accumulation by several Caribbean countries at high risk of natural disasters suggests that policy reactions have not fully offset disaster costs in the past.

### Constructing alternative shocks scenarios (Section D)
- Alternative scenario analysis or stress tests should model a single large disaster event to assess risks to the baseline and the appropriate size of fiscal and external buffers.
- Debt sustainability analysis (DSAs) should typically include an alternative scenario featuring an appropriately scaled disaster event.
- Reserve adequacy discussions in external sector assessments (ESAs) should examine potential reserve drains arising from disasters.
- Such risk analysis should be standard practice for all DSAs and ESAs for countries at high risk of natural disasters and inform Risk Assessment Matrices (RAMs).

### Scenario design and time horizon
- Scenarios should chart dynamic response to a large shock, tracing immediate and subsequent response of key macro variables over several years of post-disaster reconstruction.
- Standard scenario: an “average” disaster.
- Tail risks: model disasters that might occur once every 50 or 100 years.
- These scenarios have been used by country teams; implications for debt can be studied using the LIC DSA toolkit.

### Stochastic simulation (Monte Carlo) approaches
- Stochastic simulation can draw random shocks calibrated to the statistical distribution of historical natural disasters (size and frequency) to produce probabilistic distributions of economic variables.
- Uses:
  - Inform policy decisions on required savings to achieve fiscal sustainability given recurrent disasters.
  - Assess adequacy of buffers or contingency plans.
  - Calculate probability that disaster-related public spending would exceed a particular level in a given year or group of years.
  - Produce similar probabilistic results for growth, external balance, etc.
- Caveats:
  - Results depend critically on assumed probability distribution of disasters, which is uncertain.
  - Country disaster data are available only for 60 years at best, providing only an approximate measure of the underlying probability distribution.
  - Probabilistic simulation approaches are not part of the standard Fund modeling tool kit and would be resource-intensive to implement team-by-team.
  - Widespread adoption would likely require a computational tool allowing teams to run simulations using country-specific parameters.
- Footnotes:
  - Since individual country data are not available to clearly define the scale of “a once in 50 years” disaster, estimates would typically be informed by data across a range of countries and periods.
  - The Monte Carlo approach has been used in an innovative manner in the case of Dominica, tailored to specific circumstances.

### Financial sector risk analysis and macro-financial linkages (Section E)
- For vulnerable states, Financial Sector Assessment Programs (FSAPs) are likely to cover disaster risks; stress tests sometimes identify financial risks associated with natural disasters, and insurance sector stress tests often consider sizeable disaster events.
- Modeling disaster shocks for banking sector:
  - Less straightforward; disasters introduce operational risk.
  - Disaster impacts could be assessed via effects on banks’ income statements, but in practice disaster risks are typically evaluated from solvency perspective—linking disasters to lower GDP and declines in asset quality.
  - Example: 2015 Samoa FSAP used two stress tests based on a category 4 tropical cyclone, modeling damage to physical property and production with consequences for bank solvency.
- Macro-financial linkages:
  - Banking system savings provide buffers for private sector post-disaster.
  - Quality of bank assets may deteriorate if clients are impacted (e.g., crop destruction leading to higher non-performing loans).
  - Severe disasters may impair short-run functioning of the financial system, delaying recovery.
  - Example: Vanuatu’s 2015 Article IV and RCF/RFI staff report discussed voluntary suspension of debt service over 2-3 months and activation of an emergency borrowing facility plus other liquidity measures by the central bank following Cyclone Pam.

### Reserve adequacy (Sections 23–24)
- External sector assessments should account for buffers needed to cope with disaster vulnerability.
- Post-disaster balance of payments typically deteriorates (lost exports, additional import needs); financing relies on remittances, external grants and borrowing, and possible reserve drawdowns.
- Countries vulnerable to natural disasters may need higher external buffers if financing is not readily available at reasonable cost.
- The Fund’s existing reserve adequacy assessment tools can be tailored to disaster-prone countries:
  - Of the Excel-based templates available for assessing reserve adequacy (ARA), the ARA-CC methodology for credit-constrained economies is likely most relevant to small developing states.
  - The guidance note discusses how tools can take into account: (i) expected shocks (e.g., future disasters); (ii) structural changes (e.g., investing in resilience); (iii) alternative scenarios (e.g., a natural disaster in the next year); and (iv) risk aversion (precautionary incentives because of higher vulnerability to natural disasters).
- Examples from FSAPs: Portugal considered an earthquake equivalent to 1755; France considered a storm similar to 1999; United States considered hurricanes, earthquakes, and tornadoes combined with adverse macro scenarios.

### General equilibrium modeling (Section F)
- The Debt, Investment, and Growth (DIG) model can be used to explore general equilibrium impacts of natural disasters and provide policy advice within a coherent framework.
- Introducing disasters into DIG:
  - Assume disaster wipes out part of current output.
  - Destroy a portion of existing productive capital, constraining production until assets are replaced.
  - Disasters may temporarily reduce productivity of capital while business activities are disrupted.
- DIG model applications:
  - Explore how rapidly public and private sectors can rebuild productive capacity.
  - Analyze impact of policy responses, access to credit or insurance, and labor/product market flexibility on recovery.
  - Further discussion and illustrative charts are provided in Annex IV (not reproduced here).
- Constraint noted: DIG does not currently capture higher required investor returns in disaster-prone countries due to more uncertain investment environments.

### Climate change considerations (Section G)
- Over the coming 50 years, climate change is expected to have major macroeconomic consequences (rising sea levels, desertification, excessive heat), affecting production and employment even after adaptation outlays.
- Challenges for integrating climate change into long-term macro baselines:
  - High uncertainty about climate change path and economic impacts.
  - Climate change builds up gradually; macro impact may become significant toward the end or beyond a standard 20-year baseline.
- Near-term Fund focus: natural disasters rather than long-term climate change effects; alternative scenario analysis modeling peak disaster events (one-in-a-century disasters) can serve as a proxy for climate change risks.
- Near-term relevance of baseline adjustments:
  - Adjustments most relevant for mitigation and adaptation investments launched within the period covered by Fund macro baselines (could be significant in scale).
  - Teams should ensure fiscal baselines adequately reflect likely climate change-related outlays.
  - Some substitution within public investment programs may be possible, but often higher overall spending will be required.
  - Where authorities have not considered fiscal impacts of climate change, Fund analysis of potential climate-related investments would be an important contribution to macro surveillance.
  - Teams must seek independent information on likely costs and recognize associated uncertainties.

*Source: Excerpt from IMF chapter/section on disaster and climate adjustments in macro baselines.*

### Introduction

### _110416 - Introduction

### Purpose and scope
- Assesses the feasibility and value of model-based approaches for assessing the economic impact of natural disasters in a typical low-income developing country.
- Focuses on the Debt, Investment, and Growth (DIG) model of RES and SPR, and its variants.
- Describes merits of a model-based approach; summarizes the DIG model and recent country applications; outlines how a natural disaster can be modeled in the DIG framework; provides a stylized example application; and lists policy questions the DIG framework could address.

### Merits of a model-based approach
- Incorporates reasonable economic behavior and constraints (e.g., demand responses to price changes, budget constraints) systematically.
- Makes explicit the relationship between underlying assumptions and resulting outcomes.
- Allows consideration of costs and benefits of policy choices and policy trade-offs in an internally consistent manner, including inter-temporal dimensions through discounting.

### The DIG and DIGNAR models: description and applications
- DIG model features:
  - Dynamic LIDC-specific open-economy model (Buffie et al. (2012)).
  - Incorporates nexus between public investment and growth.
  - Captures different financing strategies: external concessional, external commercial, and domestic.
  - Includes fiscal reaction rules.
  - Captures high rates of return on public capital and inefficiencies in public investment and absorptive capacity constraints.
  - Link: outputs of traded and non-traded sectors depend on labor, private capital, and stock of public infrastructure (public capital determines productivity).
- DIG applications (Fund staff):
  - Applied to 14 countries and a custom economic union: Afghanistan, Benin, Burkina Faso, Cabo Verde, CEMAC, Cote d’Ivoire, Ethiopia, Ghana, Lesotho, Liberia, Rwanda, Senegal, Togo, and Yemen.
  - Used in Article IV consultations, program reviews, and donor meetings.
  - Extensions analyzed investment in energy (Ethiopia and Senegal) and security (Afghanistan).
  - On-going applications include Cambodia, Maldives, Nigeria and Sri Lanka.
  - Used to inform policy dialogue on trade-offs of financing strategies and role of structural characteristics for growth and debt sustainability.
- DIGNAR model:
  - Debt, public Investment, Growth and Natural Resources model (Melina et al. (2014)).
  - Extended DIG to incorporate natural resource features: volatility of resource prices, uncertainty of resource output, exhaustibility of reserves.
  - Applied to 12 countries: Angola, Côte d’Ivoire, Chad, Guinea, Kazakhstan, Liberia, Mauritania, Mongolia, Mozambique, Myanmar, Niger, and Sierra Leone.
  - On-going applications include Botswana and Iran.
  - Findings emphasized use of gradual investment scaling-up combined with a resource fund (fiscal buffer mechanism) to smooth boom-bust cycles and support macro stability (example cited: Angola).

### Extending the DIG approach to natural disasters
- Three key negative effects of natural disasters to capture:
  - Loss of current output.
  - Loss of productive assets.
  - Disruptions in critical infrastructure reducing productivity of surviving assets.
- Modeling strategy in DIG:
  - Loss of current output modeled as a decrease in current-year productivity.
  - (Permanent) loss of public and private capital modeled as reduction in capital stock.
  - (Temporary) decline in productivity modeled as persistent productivity shock over subsequent years.
- Limitations:
  - Recurrent and severe disasters create uncertainty about outcomes; assessing these adverse effects properly may require a stochastic model.
  - Current DIG models assume perfect foresight; steps to incorporate uncertainty are underway but challenges remain.

### Stylized example: scenario parameters and assumptions
- Baseline economy assumptions:
  - Long-run growth rate: 4 percent per year.
  - Government can borrow in international market at interest rate of 9.55 percent per annum.
- Disaster timing and direct effects:
  - Disaster strikes towards the end of the year.
  - Destroys 8 percent of current year output (modeled as decrease in current year productivity of 8 percent).
  - Wipes out 20 percent of country’s capital stock which amounts to a loss of 56.8 percent in terms of GDP.
  - Total loss from the disaster: 64.8 percent of GDP.
- Persistent productivity disruption:
  - Productivity reductions in the next three years of 5, 3, and 2 percent respectively.
- Financing assumption for public capital loss:
  - Loss of public capital approximately fully offset by grants inflows amounting to 12 percent of GDP (5, 4, and 3 percent in first three years).

### Stylized example: simulated impacts and key results
- Immediate macro effects:
  - Growth in the period of the disaster falls from 4 to -4 percent per year.
  - Growth further falls to -5 percent per year in the subsequent period due to combined effects of lower productivity and loss of capital.
  - Growth subsequently reverts back closer to the long-run trend, though adverse effects on the level of GDP persist for a long period.
- Fiscal and debt implications:
  - Tax rate hits the ceiling of 15 percent.
  - Debt rises from close to 65 percent of GDP to over 90 percent of GDP.
- Note: Responses of macro and fiscal variables are illustrated in Annex Figure 1 (figure not reproduced here).

### Potential extensions and policy applications of the DIG framework to natural disasters
- Ex ante resilience-building trade-offs:
  - Analyze costs and benefits of initial investment in resilience that reduces losses from future disasters by feeding the effectiveness of resilience investments into the model.
- Financial and insurance policies:
  - Compare carrying disaster risk domestically versus off-loading to financial markets (insurance with broad or catastrophic coverage).
  - Study trade-offs between pay-when-disaster-strikes approaches and self-insurance via fiscal and foreign exchange buffers built during good times.
- Organizing and financing post-disaster reconstruction:
  - Assess implications of suspending regular development activities, directing effort to reconstruction, and government choices to borrow and/or increase taxes to finance reconstruction.
- Effects on investment and FDI:
  - Model can assess reduced returns on investment post-disaster; uncertainty channel requires stochastic modeling to fully capture deterrent effects on investors.
- Limitations for certain questions without significant extensions:
  - Long-run sustained growth: trend long-run growth is exogenous in DIG, so current form cannot address how disasters alter endogenous long-run growth.
  - Migration and brain drain: DIG assumes labor not mobile across countries; modeling migration choices would require significant changes.

*Source: _110416 - Introduction (IMF annex text).*

### Annex Figure 1. Government Financing following Natural Disasters

### Annex Figure 1. Government Financing following Natural Disasters

### Financing patterns by disaster size
- For large-damage disasters, total financing jumps by over 3% GDP between t-1 and t+1, mostly driven by grants and external financing.
- For middle range disasters, the rise in total financing is mainly driven by grants although external financing may have come in between t-1 and t.
- In the face of volatile external financing, countries were somewhat cushioned by domestic financing.
- The countries with the least amount of damages did not experience an increase in total financing.

### External financing, remittances, disbursements, and reserves (Annex Figure 2)
- There is an increase in grants for the large natural disasters although it may come with a lag.
- Large disasters also see a discernible increase in remittances.
- Disbursements increase for both large and mid-range natural disasters, but more so for large disasters.
- International reserves are not drawn down.

### Country case studies of disaster financing (Annex Figure 3)
- Timing note: The timing of disasters affects how much of the financing can be mobilized in t=0. Cabo Verde disaster hit in September; Guyana in February; the drought in Swaziland started in 2000 and continued through 2001; Hurricane Tomas struck St. Lucia in October 2010.
- Cape Verde (2009): Intensity Index: 1.2. No information on damages. (Charts show external financing, domestic financing, grants by t-3 to t+5 as percentages of GDP.)
- Swaziland (2001): Intensity Index: 16.7. No information on damages. (Charts show total financing, external financing, domestic financing, grants by t-3 to t+5 as percentages of GDP.)
- St. Lucia (2010): Intensity Index: 32.8. Damages: 34 % of GDP. (Charts show total financing, external financing, domestic financing, grants by t-3 to t+5 as percentages of GDP; source: IMF Staff Papers.)
- Guyana (2005): Intensity Index: 10.8. Damages: 35.8 % of GDP. (Charts show total financing, external financing, domestic financing, grants by t-3 to t+5 as percentages of GDP; source: EM-DAT.)

### Design of deposit buffers (Annex VIII)
- Size of buffers:
  - Depends on projected probability of natural disasters and associated financing needs (loss of revenues, new spending pressures).
  - Depends on expected timeline for accessing alternative financing sources (external grants, loans, insurance payouts), capacity to preserve the buffer against other spending pressures, and scope to reduce disaster risks through mitigation measures.
  - Where countries have ready access to borrowed resources, optimal buffer size depends on relative costs of holding buffers versus taking on new post-disaster debts; for most small states, constrained short-run borrowing makes relative costs less of a consideration.
  - Appropriate size should be determined on a case-by-case basis, rather than using a standardized metric.
- Using deposit buffers:
  - Drawdown of deposits at the central bank has the same effect as borrowing from the central bank—generates liquidity that could jeopardize goals for inflation or the exchange rate.
  - Scope to draw on deposits held with domestic commercial banks may be constrained by disaster-related stress affecting the banking system; weak banks could face deposit runs following a disaster.
  - Credit and liquidity risk from deposits held with commercial banks could be addressed through higher capital ratios, liquidity ratios specific to government deposit buffers, separation of buffer-related assets from other investments, other investment restrictions, or an emergency liquidity assistance facility operated by the central bank.
  - Overall, deposit buffers held with domestic banks are best suited for financing modest post-disaster spending needs.
- Overseas buffers:
  - Larger deposit buffers would be more readily usable if invested abroad (central bank international reserves or government deposits with foreign commercial banks); drawdown would not, in the first instance, impact domestic liquidity conditions.
  - Repatriation and use of foreign funds could have implications for exchange rate management; could be beneficial if supply of foreign currency helps meet balance of payments needs.
  - Holding foreign currency buffers involves opportunity costs that should be weighed in today’s interest rate environment.

### Use of dedicated contingency funds
- Characteristics and advantages:
  - Dedicated financing source, specific governance and investment rules, very restrictive rules regarding how resources are to be utilized.
  - Provide considerable flexibility in timing expenditures across years and can hold money in reserve until needed.
- Risks and design mitigations:
  - Many funds are extra-budgetary (EBFs) and thus less transparent and can allocate resources without accounting for alternative budget needs.
  - Recommended framework features:
    - Consolidate the fund with budget information; at minimum, fund balance should appear in financial statements and drawdowns should appear in budget execution reports.
    - Standing appropriation allowing spending immediately after trigger events (e.g., declaration of a disaster emergency by the executive).
    - Clear rules governing use of resources; follow normal government accounting standards; prepare and publish audited financial statements; define governance rules; adopt prudent and transparent investment policies.
    - Normal PFM rules should apply, but procurement rules for immediate disaster response should be adjusted for quicker procurement.
    - Limit fund to respond to disasters with large fiscal impacts: drawdowns should only start above a threshold size, or a minimum total cost estimate; smaller needs should be covered through budget contingencies.
    - Determine fund size by considering (i) expected damages, (ii) likely available support from the international community (incl. IMF support), (iii) ability to borrow in an emergency, and (iv) opportunity costs for building up buffers.
    - The fund should not get too large because its primary purpose is to “buy time” and a large fund will generate pressures to tap it for other purposes.
    - The fund is a funding source, not an implementing agency—spending authority should rest with implementing agencies; the fund typically should not have staff dedicated to it.
  - Dedicated funds are useful for expenditures that cannot be included in the budget because of unpredictability; they should not be used for predictable medium- to long-term expenditures such as climate change adaptation or resiliency investment, which should be included in medium-term budget frameworks or standing legislation and executed through the budget.

### Innovative risk transfer approaches (Annex IX)
- Overview:
  - Two important developments: parametric insurance and catastrophe (CAT) bonds.
  - A blend of traditional insurance, parametric insurance, and CAT bonds can reduce the overall cost of coverage across risk layers.
  - Access may depend on maintaining incentives for risk reduction; arrangements should be conditional on efforts to reduce disaster risks or include financial incentives.
- Parametric insurance:
  - Pays out when third party data confirms a disaster event based on pre-defined parameters (e.g., hurricane wind speed, earthquake intensity).
  - Key advantage: quick-disbursing; use is growing from a low base.
  - Costs of cover tend to be high; best used for most severe, uncommon disasters.
  - Uncertainties about distribution of disaster risks raise costs until insurers develop accurate models.
  - Basis risk reduces cost-effectiveness; research can improve design.
  - Initial sovereign participation can help price discovery and reduce costs.
  - Payouts have typically covered just 1 percent at most of total losses, reflecting limited coverage and basis risk.
- Regional pooling:
  - Regional risk pooling can exploit economies of scale and reduce ex-ante financial costs of insurance by up to 50 percent (World Bank, 2014b), reflecting partial sharing of capital, administrative and operating economies, and improved access to reinsurance.
  - Examples:
    - Caribbean: CCRIF launched in 2007; expansion to include Central America projected to reduce premiums for Caribbean countries by 25 percent and 36 percent for Central America; Caribbean countries already enjoy a 50 percent reduction in premiums from what they would have paid individually.
    - Pacific: Pacific Catastrophe Risk Insurance Pilot created in 2013.
    - Africa: African Risk Capacity issued first policies in May 2014 for droughts; current membership of 32 countries including Comoros, Djibouti, and Sao Tome and Principe.
- Catastrophe (CAT) bonds:
  - Provide risk transfer where bond principal is forgiven in the event of a disaster if a parametric trigger is met; investors receive high coupons otherwise.
  - Facilitates quick action while protecting investors from moral hazard.
  - Mexico is, to date, the only sovereign to issue a CAT bond (2012 issue for earthquakes and hurricanes).
  - The World Bank has issued a CAT bond to finance CCRIF.
  - Grenada’s 2014/15 debt restructurings included hurricane clauses: new bonds featured a haircut and a “hurricane clause” that will defer up to 2 semi-annual payments for all debt service in the event of qualifying hurricane; depending on timing, deferment could provide as much as 5 percent of GDP in cash flow relief.
  - A similar clause was included in Grenada’s debt restructuring with the export-Import Bank of Taiwan; a weaker hurricane clause was included in Grenada’s November 2015 Paris Club rescheduling agreement.
- Parametric Insurance Payouts and Estimated Total Losses (table entries preserved):
  - Anguilla CCRIF 2010 — Payout $4.2 million — Total losses $1332.3 million — Payout (in percent of losses) [table shows these columns].
  - Barbados CCRIF 2010 — Payout $8.5 million — Total losses $7411.1 million.
  - St. Lucia CCRIF 2010 — Payout $3.2 million — Total losses $880.5 million.
  - St. Vincent and the Grenadines CCRIF 2010 — Payout $1.1 million — Total losses $880.4 million.
  - Haiti CCRIF 2010 — Payout $81400 million — Total losses $0.1 million.
  - Dominica CCRIF 2015 — Payout $2.4 million — Total losses $241.0 million.
  - Vanuatu PCRIP 2015 — Payout $1.9 million — Total losses $2680.7 million.
  - Source: CCRIF, PCRIP, and various media reports.

### Fund financing for natural disasters (Annex X)
- Rapid Credit Facility (RCF):
  - Established in 2009; provides rapid financial support in a single, up-front loan disbursement.
  - Access available to low-income countries eligible for concessional borrowing through the Poverty Reduction and Growth Trust (PRGT).
  - RCF financing carries a zero interest rate, has a grace period of 5½ years, and a final maturity of 10 years.
  - RCF replaced the earlier Emergency Natural Disaster Assistance (ENDA).
- Rapid Financing Instrument (RFI):
  - Established in 2011; available on non-concessional GRA terms, repayable within 3¼ to 5 years.
  - Both RCF and RFI are designed for members that do not require a full-fledged economic reform program or where need is urgent or policy implementation capacity is limited.
- Access limits under the RCF and RFI:
  - Annual access limit increased from 50 to 75 percent of quota in July 2015 as part of a financial safety net package for developing countries.
  - The package eliminated scope to use the RCF and RFI in parallel to obtain financing up to 100 percent of quota.
  - With the increase in quotas in 2016, annual access limits were halved to 37.5 percent of quota.
- Augmentation of an existing program:
  - When a country with an IMF-supported program is hit by a natural disaster, augmented financing under the existing program can provide additional support; an IMF program can catalyze international assistance even without augmentation (example: Solomon Islands, 2014).
- Catastrophe Containment and Relief (CCR) Trust:
  - Established in 2015; replaced the Post-Catastrophe Debt Relief (PCDR) Trust.
  - Allows the Fund to join international debt relief efforts when poor countries are hit by catastrophic natural and/or public health disasters.
  - Post-catastrophe relief under the CCR Trust is available to 38 low-income countries eligible for concessional borrowing through the PRGT and which also have either a per capita income below US$1,215—or, for small states, a population below 1.5 million and a per capita income below US$2,430.
  - A country qualifies for post-catastrophe relief under the CCR Trust if hit by a disaster that directly affects at least one third of the population and affects a large portion of the economy evidenced by either destruction of more than a quarter of the country’s productive capacity or damage exceeding 100 percent of GDP.
  - Note: Following the 2010 Haiti earthquake, the PCDR trust was established to permit the Fund to provide debt relief on IMF repayments when poor countries are hit by the most catastrophic natural disasters.
  - Among the Pacific islands, only Solomon Islands meet these criteria.

*Source: EM-DAT, IMF, World Bank, CCRIF, PCRIP, IMF Staff Papers, and associated annexes in the provided document.*

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