IMF Working Papers

Climate disasters tend to be associated with increased sovereign default risk. Countries face an “impossible trilemma”: scale up adaptation investment, keep debt sustainable amidst high borrowing costs and avoid the higher risk of default from delayed adaptation. Using a global panel of disaster event-level shocks, we find that a 1pp increase in disaster related losses as a share of GDP raises the odds of sovereign default by approximately 2-3 percent. An additional US$1 billion in cumulative Official Development Assistance (ODA) is associated with a 0.13 point gain in a country’s adaptive capacity. Using average marginal effects and our predicted margins we then map concessional ODA finance to default probability and translate these relationships into a practical budgeting yardstick for calibrating needed ODA to sovereign default risk reduction targets. In a context of declining ODA, our findings highlight the crucial role of well-designed support in climate adaptation policies.