The IMF Staff Climate Note Series

The IMF Notes Series aims to quickly disseminate succinct IMF analysis on critical economic issues to member countries and the broader policy community. The IMF Staff Climate Notes provide analysis related to the impact of climate change on macroeconomic and financial stability, including on mitigation, adaptation, and transition. The views expressed in IMF Staff Climate Notes are those of the author(s), although they do not necessarily represent the views of the IMF, or its Executive Board, or its management.

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Mobilizing Private Climate Financing in Emerging Market and Developing Economies

<img src= July 27, 2022

Global investment to achieve the Paris Agreement’s temperature and adaptation goals requires immediate actions—first and foremost—on climate policies. Policies should be accompanied by commensurate financing flows to close the large financing gap globally, and in emerging market and developing economies (EMDEs) in particular. This note discusses potential ways to mobilize domestic and foreign private sector capital in climate finance, as a complement to climate-related policies, by mitigating relevant risks and constraints through public-private partnerships involving multilateral, regional, and national development banks. It also overviews the role the IMF can play in the process.

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Carbon Taxes or Emissions Trading Systems? Instrument Choice and Design

<img src= July 21, 2022

Carbon pricing should be a central element of climate mitigation strategies, helping countries rapidly transition to “net zero” greenhouse gas emissions. Policymakers considering carbon pricing face choices between carbon taxes and emissions trading systems (ETSs) and in their design. This includes administration, price levels, emissions coverage, relation to other mitigation instruments, use of revenues to address efficiency and distributional objectives, supporting measures to address competitiveness concerns, political economy aspects, and coordination at the global level. This paper discusses these issues, providing guidance on the choice between carbon taxes and ETSs and their design. Overall, carbon taxes have significant practical, environmental, and economic advantages (especially for developing countries) due to ease of administration, price certainty which promotes investment, the potential to raise significant revenues, and coverage of broader emissions sources. However, ETSs provide more certainty over emissions levels, can be implemented by environment ministries, and some free permit allocations might garner political support from affected firms (at a fiscal cost).

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Approaches to Climate Risk Analysis in FSAPs

<img src= July 14, 2022

Climate change presents risks and opportunities for the real economies and financial sectors of the IMF’s global membership. Understanding the risks is key to prepare for a successful transition to a lower carbon global economy. This will unlock the many opportunities for technological progress and structural transformation along the path that financial sectors around the world will need to adapt to and support. This note lays out the IMF staff’s emerging approach to assessing the impact of climate change on banking sector stability risks conducted in the context of the IMF Financial Sector Assessment Program (FSAP). The note starts with a primer on climate change risk, both transition and physical, explaining some of the technical terms and concepts used in this work. It explains the approach to standard risk analysis in FSAPs and how this would be modified in broad terms to incorporate climate risk. The note then discusses different approaches to the analysis of physical versus transition risk, their implications for the macro-economy and across sectors in the real economy and different geographies, and how all these effects map into the banking sector. The note illustrates concepts with examples of applications from recent FSAPs and takes note of the many challenges confronting this work, including data gaps and uncertainty regarding climate projections and long simulation horizons in conducting the climate risk analysis. As such the note is focused on methods that IMF staff are deploying to raise awareness of the risks, and adaptation needs, including need for banks to develop tools to manage climate risks and for financial sector supervisory authorities to identify pressure points in the financial system adequately respond and supervise this risk.

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Sovereign Climate Debt Instruments: An Overview of the Green and Catastrophe Bond Markets

<img alt= July 7, 2022

Financial markets will play a catalytic role in financing the adaptation and mitigation to climate change. Catastrophe and green bonds in the private sector have become the most prominent innovations in the field of sustainable finance in the last 15 years. Yet the issuances at the sovereign level have been relatively recent and not well documented in the literature. This note discusses the benefits of issuing these instruments as well as practical implementation challenges impairing the scaling up of these markets. The issuance of these instruments could provide a wider source of stable financing with more favorable market access conditions, mitigate the stress of climate risks on public finances, and facilitate the transition to greener low- carbon economies. Emerging market and developing economies stand to benefit the most from these financial innovations.

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Climate Change Adaptation Series

<img src=Economic Principles for Integrating Adaptation to Climate Change into Fiscal Policy

March 23, 2022

Adaptation to climate change is a necessity for advanced and developing economies alike. Policymakers face the challenge of facilitating this transition. This Note argues that adaptation to climate change should be part of a holistic development strategy involving both private and public sector responses. Governments can prioritize public investment in adaptation programs with positive externalities, address market imperfections and policies that make private adaptation inefficient, and mobilize revenues for, and distribute the benefits of, adaptation. Although the choice of what should be done and at what cost ultimately depends on each society’s preferences, economic theory provides a useful framework to maximize the impact of public spending. Cost-benefit analysis, complemented by the analysis of distributional effects, can be used to prioritize adaptation programs as well as all other development programs to promote an efficient and just transition to a changed climate. While compensations may be needed to offset damages that are either impossible or too expensive to abate, subsidies for adaptation require careful calibration to prevent excessive risk taking.

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<img src=Macro-Fiscal Implications of Adaptation to Climate Change

March 23, 2022

Adaptation reduces climate change damages but is costly and cannot eliminate all risks. Governments have to decide on an acceptable balance of residual risks and to determine adaptation investment needs by weighing costs, benefits, and distributional effects. A literature review suggests that well-designed and well-implemented adaptation can have large returns. Global public adaptation needs in 2030 are estimated in the literature at around ¼ percent of world GDP per year, but with very large disparities across countries and high uncertainty. Our analysis points to annual adaptation costs exceeding 1 percent of GDP for some developing countries, and above 10 percent of GDP for some island states. Many of these countries—despite typically not having contributed to global warming—face high adaptation needs while being challenged by limited fiscal space, limited capacity, or both, calling for additional support from the international community. To help guide national fiscal policies, countries could integrate climate risks and the cost of adaptation into their macro-fiscal frameworks. Shock scenarios are useful to reflect short-term impacts of climate disasters, while the long-term analysis of risks and uncertainties surrounding climate change requires scenarios that cover impacts from changes in both average and extreme events, as well as adaptation policies.

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<img src=Planning and Mainstreaming Adaptation to Climate Change in Fiscal Policy

March 23, 2022

Adaptation to climate change is an integral part of sustainable development and a necessity for advanced and developing economies alike. How can adaptation be planned for and mainstreamed into fiscal policy? Setting up inclusive coordination mechanisms and strengthening legal foundations to incorporate climate change can be a prerequisite. This Note identifies four building blocks: 1- Taking stock of present and future climate risks, identifying knowledge and capacity gaps, and establishing guidance for next steps. 2- Developing adaptation solutions. This block can be guided by extending the IMF three-pillar disaster resilience strategy to address changes in both extreme and average weather and would cover the prevention of risks, the alleviation of residual risks, and macro-fiscal resilience. 3- Mainstreaming these solutions into government operations. This requires strengthening public financial management institutions by factoring climate risks and adaptation plans into budgets and macro-frameworks, and in the management of public investment, assets and liabilities. 4- Providing for transparent evaluations to inform future plans. This involves continually monitoring progress and regularly updating adaptation plans.

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Not Yet on Track to Net Zero: The Urgent Need for Greater Ambition and Policy Action to Achieve Paris Temperature Goals

<img src=October 31, 2021

Achieving the Paris Agreement’s temperature goals requires cutting global CO2 emissions 25 to 50 percent this decade, followed by a rapid transition to net zero emissions. The world is currently not yet on track so there is an urgent need to narrow gaps in climate mitigation ambition and policy. Current mitigation pledges for 2030 would achieve just one to two thirds of the emissions reductions needed for limiting warming to 1.5 to 2 degrees Celsius. And additional measures equivalent to a global carbon price exceeding $75 per ton by 2030 are needed. This IMF Staff Climate Note presents extensive quantitative analyses to inform dialogue on closing mitigation ambition and policy gaps. It shows illustrative pathways to achieve the needed global emissions reductions while respecting international equity. The Note also presents country-level analyses of the emissions, fiscal, economic, and distributional impacts of carbon pricing and the trade-offs with other instruments—comprehensive mitigation strategies will be key.

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Carbon Pricing: What Role for Border Carbon Adjustments?

SCN-BCA-coverSeptember 27, 2021

This Climate Note discusses the rationale, design, and impacts of border carbon adjustments (BCAs), charges on embodied carbon in imports potentially matched by rebates for embodied carbon in exports. Large disparities in carbon pricing between countries is raising concerns about competitiveness and emissions leakage, and BCAs are a potentially effective instrument for addressing such concerns. Design details are critical, however. For example, limiting coverage of the BCA to energy-intensive, trade-exposed industries facilitates administration, and initially benchmarking BCAs on domestic emissions intensities would help ease the transition for emissions-intensive trading partners. It is also important to consider how to apply BCAs across countries with different approaches to emissions mitigation. BCAs are challenging because they pose legal risks and may be at odds with the differentiated responsibilities of developing countries. Furthermore, BCAs provide only modest incentives for other large emitting countries to scale carbon pricing—an international carbon price floor would be far more effective in this regard.

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Strengthening the Climate Information Architecture

SCN3September 08, 2021

Strengthening the climate information architecture is paramount to promote transparency and global comparability of data and thus improve market confidence, safeguard financial stability, and foster sustainable finance. This note provides a conceptual framework around the provision of climate-related information, discusses the progress made to date, and points toward the way forward. Progress and convergence are required on the three buildings blocks of a climate information architecture: (1) high-quality, reliable, and comparable data; (2) a globally harmonized and consistent set of climate disclosure standards; and (3) a globally agreed upon set of principles for climate finance taxonomies. A decisive, globally coordinated effort is needed to move forward on all three fronts.

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Climate-Sensitive Management of Public Finances—"Green PFM”

SCN2August 11, 2021

Public financial management (PFM) consists of all the government’s institutional arrangements in place to facilitate the implementation of fiscal policies. In response to the growing urgency to fight climate change, “green PFM” aims at adapting existing PFM practices to support climate-sensitive policies. With the cross-cutting nature of climate change and wider environmental concerns, green PFM can be a key enabler of an integrated government strategy to combat climate change. This note outlines a framework for green PFM, emphasizing the need for an approach combining various entry points within, across, and beyond the budget cycle. This includes components such as fiscal transparency and external oversight, and coordination with state-owned enterprises and subnational governments. The note also identifies principles for effective implementation of a green PFM strategy, among which the need for a strong stewardship located within the ministry of finance is paramount.

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Proposal for an International Carbon Price Floor Among Large Emitters

SCN1June 18, 2021

Countries are increasingly committing to midcentury ‘net-zero’ emissions targets under the Paris Agreement, but limiting global warming to 1.5 to 2°C requires cutting emissions by a quarter to a half in this decade. Making sufficient progress to stabilizing the climate therefore requires ratcheting up near-term mitigation action but doing so among 195 parties simultaneously is proving challenging. Reinforcing the Paris Agreement with an international carbon price floor (ICPF) could jump-start emissions reductions through substantive policy action, while circumventing emerging pressure for border carbon adjustments. The ICPF has two elements: (1) a small number of key large-emitting countries, and (2) the minimum carbon price each commits to implement. The arrangement can be pragmatically designed to accommodate equity considerations and emissions-equivalent alternatives to carbon pricing. The paper discusses the rationale for an ICPF, considers design issues, compares it with alternative global regimes, and quantifies its impacts.

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