Scaling up climate adaptation finance in times of growing public debt, inflation and natural disasters

By Irene Monasterolo (Professor of Climate Finance, EDHEC Business School and Head of Research Programme, EDHEC-Risk Climate Impact Institute), Marie Briere (Head of Investor Intelligence & Academic Partnerships, Amundi Institute; Affiliate researcher, Paris Dauphine University-PSL; Senior Affiliate Researcher, Université Libre de Bruxelles), Kevin Gallagher (Director, Boston University Global Development Policy Center), Charlotte Gardes-Landolfini (Climate change and financial stability expert, IMF), Nicola Ranger (Oxford University)

printer-friendly version

Addressing the Financial Hurdles of Adapting to Climate Change Physical Risks in Emerging Markets and Developing Economies



In 2021, economic losses from natural catastrophes were USD 270 billion. Poor climate physical risk assessment limits the scaling up of adaptation finance, which is still lagging behind mitigation finance in emerging markets and developing economies (EMDEs) but also high-income countries.

Climate physical risk pricing and portfolio risk assessment is still at an early stage. Most analyses are focusing on firm level shocks, but they neglect the asset-level dimension of risks, which in turn lead to a severe underestimation of losses. Climate physical risk assessment and estimation of the transition investments needed should be incorporated into corporate valuation and sovereign debt sustainability analysis.

Adapting to climate physical risks requires massive investments. Because of high up-front costs and risks, and long time horizons of infrastructure projects, adaptation finance faces larger hurdles than mitigation investments. Climate vulnerable countries are sometimes in a vicious circle of debt and climate change. Limited fiscal space and debt sustainability challenges frequently prevent them to adapt a to climate change. Innovations in adaptation technologies are still slow and amply relies on public funding.

Financing could consist of multiple layers. Public finance should play a central role, followed by the international climate finance pledges, such as the adoption of the Glasgow Climate Pact. Private finance is also key, with blended finance arrangements by development finance institutions and multilateral development banks,  in addition to the issuance of sustainable debt instruments such as ‘pay-for-success’. Finally, there is a crucial need to develop climate-aligned debt restructuring accompanied by a substantial debt relief in some countries, as well as countercyclical financing instruments such as the IMF Catastrophe Containment and Relief Trust. This would allow EMDEs to have systems in place for quick release of finance when a disaster happens.


Financing climate adaptation in times of sovereign crisis

The Sixth Assessment Report (AR6) of the Intergovernmental Panel on Climate Change (IPCC) presented evidence of growing economic and financial impacts of climate[2]. Adapting to climate physical risks requires timely and massive investments.  Yet poor climate physical risk assessment limits the scaling up of adaptation finance, which is still lagging behind mitigation finance in both emerging markets and developing economies (EMDEs) and high-income countries (GCA, 2021; UNEP, 2021 and 2022).

Increasing fiscal spending during the COVID-19 pandemic, rising inflation from energy prices, and high levels of public debt in many EMDEs raise concerns about debt sustainability and their sovereign spending capacity for adaptation. Many of those countries are indeed highly vulnerable to climate change-related disasters and are already being severely hit by climate hazard, as well as by the chronic physical consequences of climate change (e.g. temperature increase, biodiversity loss, sea-level rise).

Research recently highlighted that climate risks do not happen in isolation but can compound both among themselves (e.g. multiform flood risks) as well as with shocks off other nature (e.g. pandemics) (Ranger et al., 2022). When risks compound, they affect the magnitude and duration of the shock in the economy (Dunz et al., 2021) with implications for the fiscal and financial policy response (Monasterolo et al., 2021). Nevertheless, a growing number of countries in both the Global North and the Global South, including EMDEs, do not have fiscal space and debt capacity to invest in the shock recovery, let alone a more resilient recovery that would lower their climate vulnerability.

The 2022 Annual Meetings of the Boards of Governors of the International Monetary Fund (IMF) and the World Bank (WB), as well as the Group of 7 (G7) Summit, highlighted a need to address debt sustainability in the process of making public spending work for climate. However, a strategic framework for climate adaptation finance has not been available yet, and there is a lack of tailored adaptation finance instruments.

There is a major gap in climate finance that needs to be filled to avoid the worst climate change impacts. Between 2011 and 2020, global finance almost doubled; yearly global climate investments amounted to approximately USD 480 billion. However, this amount needs to be scaled up and the world needs an additional USD 4.3 trillion in annual climate finance flows until 2030 (CPI, 2022).

Finance for adaptation consists of multiple layers. The central role is played by public finance, followed by the international climate finance pledges, such as the adoption of the Glasgow Climate Pact, with a commitment of providing USD 100 billion annually from developed to developing countries. Furthermore, mobilisation of private finance within blended finance arrangements by development finance institutions (DFIs) and multilateral development banks (MDBs) could play an important complementary role, in addition to sustainable debt issuance and instruments such as ‘pay-for-success’.

Given their mandate and structure, DFIs and MDBs can scale up adaptation finance in EMDEs in a sustainable and inclusive way, while nudging the private sector to invest more. Nevertheless, to deliver on the call for better climate finance for development coming from EMDEs[3], current climate finance architecture needs to be changed and adapted, and knowledge gaps for adaptation need to be addressed[4].

Although the Paris Agreement states that financial flows should be aligned with resilience goals[5], there is evidence that finance is potentially flowing into a wrong direction and exacerbating the problem[6]. In this regard, it would be crucial to build the wider financial system in a way that it supports the resilience, and not to try to act against the current one. The goal would be to build a banking and financial system which would finance productive, climate resilient, low-carbon, and socially inclusive development.


Sovereign financial challenges for climate vulnerable countries: between countercyclical financing instruments and debt restructuring

Climate vulnerable countries are in a vicious circle of debt and climate change. Their fiscal space for financing climate adaptation investments is at an all-time low. Limited fiscal space and debt sustainability challenges prevent several EMDEs from accessing climate finance to adapt and build resilience to climate change.

In these conditions, several and complementary options could be considered, involving different financial actors.

On the one hand, an increase countercyclical financing could allow EMDEs to have systems in place for quick release of finance when a disaster happens. The IMF has two tools that could address this gap: the Catastrophe Containment and Relief Trust (CCRT) and the Resilience and Sustainability Trust (RST). Both tools are being scaled up from their current countries’ coverage. Furthermore, a significant capital increase for MDBs is needed, in addition to reforms enhanced by the recent G20 report on MDBs’ capital adequacy framework. Notwithstanding a new liquidity and more concessional finance, some countries will still not be able to mobilise the finance needed for adaptation investments without a comprehensive debt restructuring.

On the other hand, traditional approaches to debt sustainability (e.g. debt restructuring) should be rethink in the context of the climate-debt conundrum, moving away from the concept of debt capacity to the concept of debt impact. Indeed, climate-aligned debt restructuring will not be possible without a substantial debt relief in many of these countries. In contrast, conditioning explicitly linking climate change mitigation and adaptation strategies to the outcomes of debt restructuring could help all climate vulnerable countries, in particular the most economic and climate vulnerable ones.

New tools, such as the Debt Sustainability Analysis (DSA) developed by the IMF and the World Bank, can incorporate climate physical risk and the transition investments needed into traditional debt sustainability analysis. Furthermore, many developing countries (particularly in South America) will need to cope not only with climate physical but also with transition spillover risks as a result of uncoordinated introduction of climate policies at the regional level (Gourdel et al., 2022a). Finally, consideration of tail risk emerging from the compounding of shocks – like hazards, such as multiform flood risk (Kruczkiewicz et al., 2022) or climate and pandemics (Dunz et al., 2021; Ranger et al., 2022) – should be integrated into debt sustainability analyses because when shocks compound, they amplify losses (Gourdel et al., 2022b).


Towards tailored adaptation finance

Adaptation finance faces larger hurdles than mitigation investments because there are high up-front costs and risks related to adaptation investments, in addition to well-known risks and challenges to invest in emerging markets and developing economies. Long time horizons of infrastructure projects make development of profitable business models very challenging. Investments in adaptation are split into capital and operating expenditures, which additionally complicates tracking of their performance. Furthermore, market failures and lack of long-term adaptation planning support and national adaptation investment plans limit private sector adaptation.

Concerns may also arise due to the fact that it is not always clear how emerging investment vehicles (e.g. green, sustainability-linked, social, impact, or resilience bonds) generate returns, as well as who should oversee the implementation of the projects and keep the risk of such instruments low. Uncertainty about the economic consequences of climate impacts and efficiency of adaptation technologies represents a major constraint and hinders project-level investments.

Adaptation finance is often unattractive to private finance because of underpriced risk and a lack of economies of scale. Indeed, while large climate physical risks are mostly expected to play out (losses) in the mid to long term, adaptation cost manifest in the short run. That is why almost all adaptation finance is provided through the public sector, although there are opportunities for the private sector as well[7].

Climate physical risk pricing and portfolio risk assessment is still at an early stage. Most analyses focusing on firm level shocks, but they neglect the asset-level dimension of risks, which in turn lead to a severe underestimation of losses (Bressan et al., 2022). Although stock markets seem to react here mildly to hazards occurrence (Hong et al., 2019 ; Kruttli et al., 2021), the pricing of risk is typically related to the general attention to climate change (Choi et al., 2020 ; Brière and Ramelli, 2022) and the personal experiences of professional investment managers, who tend to overreact to a climate-related disaster if they are located within the disaster region (Alok et al., 2020). Real estate markets show growing internalisation of extreme weather events: homes exposed to see-level rise sell at a 7 % discount, growing over time driven by sophisticated buyers (Bernstein et al., 2019, Nguyen et al., 2022). These mixed results can be explained by a heterogeneity in beliefs about inundation projections due to climate change (Baldauf et al., 2020).

Natural disasters related to climate change impose significant damages to corporate profits. In 2021, economic losses from natural catastrophes were USD 270 billion (Bevere and Remondi, 2022). However, firms’ efforts to cope with climate physical risks are limited. Only 23 % of firms have started communicating their short-term adaptation strategies (Li, 2022). Firms communicate on how they adapt by adjusting in the short run their operation capabilities but long-term measures such as capital expenditures, development of new technologies and relocation are rarely communicated. Furthermore, there is no rise in adaptation technologies’ patents in the last 20 years (Hötte and Jee, 2022). Adaptation patents are highly reliant on government support. Since mid-2000, more than 40 % of patents in adaptation technologies have received government support (Fleming et al., 2019).


Opportunities and way forward: data architecture, climate scenarios, climate economics and financial modelling

Currently, there is a proliferation of various models and datasets for climate physical risk assessment. However, lack of transparency about their methodologies and missing elements limits the usability of their results. Development of a better data and information architecture (through disclosures, taxonomies and transition plans including adaptation) is crucial to support the mobilisation of finance for adaptation and internalise the negative externalities of GHG emissions. Strengthening the climate data infrastructure would enable measurement of spatial and sectoral inequalities – the two very important components for the effectiveness of adaptation[8]. Climate risk-related data should be perceived as common good, and since investing in data infrastructure is costly, public sector should take the initiative[9].

Beyond data gaps that need to be filled, there are many opportunities for strengthening the relevance of climate finance tools with regard to:

  • climate physical risk scenarios which should account for tail acute risks and their compounding, as well as indirect losses and economy-financial sector feedbacks (Ranger et al., 2022);
  • geolocalised data that can contribute to firms’ business and value chain, and help avoid  large underestimation of climate financial shocks for investors (Bressan et al., 2022);
  • macro-financial models that are able to analyse the full extent of the double materiality of climate physical and transition risks in the economy and finance. Such models will allow to consider the economic-financial feedbacks, the interplay of investors’ expectations and policy credibility, and the departure from rationale expectations in context of climate deep uncertainty. For example, Stock-Flow Consistent (SFC) behavioral models can be used to analyse the double materiality of climate physical and transition risks (Gourdel et al., 2022b);
  • financial network models for balance-sheet climate stress-tests. These will allow to identify drivers of contagion from shock reverberation and implications on financial stability at the individual and systemic level (Battiston et al., 2017, Roncoroni et al., 2021).

Scaling up climate adaptation investments requires the identification of risks and co-benefits related to projects’ implementation. Accounting for co-benefits from investments in adaptation would increase their profitability and make them more attractive to private finance. Net present values of investing in climate change are outweighed by benefits[10].

However, if adaptation co-benefits are not recognised and properly accounted for, improved DSA, which considers climate-related risks of countries, may even exacerbate the issues for climate vulnerable countries. Thus, it may lead to a decrease in their sovereign credit rating and an outflow of capital. Furthermore, if climate vulnerable countries are also exposed to climate transition risk (e.g. fossil fuel exporters), their sovereign credit ratings would additionally decrease. For that reason, climate risk models are needed to support the analysis of the potential reduction of risk that can be achieved through investments in adaptation, and account for positive externalities.

It is important to remember that mitigation and adaptation are complementary and yet the cost and impact of action (or inaction) plays out at different time scales. Mitigation and adaptation can be considered as substitutes if a reduction in the cost of a strategy increases its use and thus decreases the reliance on the other. They can also be considered as complements if a strategy increases when the marginal productivity of the other increases.

An important step for adaptation was announced last November at COP27 with the launch of a ‘loss and damage’ fund to EMDES. Nevertheless, in absence of ambitious mitigation policies aimed to decrease the global use of fossil fuels and thus GHG emissions, financing adaptation would not be sufficient to build resilience to climate change, since the driver of the problem persists.

Low-carbon transition may also be subject to trade-offs. For instance, a global net zero strategy would have negative fiscal impacts in most of South America’s countries because a large share of their fiscal revenues is related to the production of hydroelectric power. Another example is the trade-off between biodiversity preservation and climate neutrality in New Zealand.

That is why growth trajectories need to be aligned with climate and development goals. Investing in low-carbon climate resilient and socially inclusive growth path would be a desirable solution. The goal is to re-orient the whole economy and not only to focus on project finance. Climate change measures are currently ‘going against the wind’ because the policy structure is not made to fight climate change. A re-thinking of economy and policy would induce benefits for the implementation of climate policies.

However, uncertainty of political decision-making processes makes this idea less feasible. Without a clear policy signals for investing in low-carbon technologies and adaptation, and policy credibility, investors may not adjust their expectations about risk associated to high vs low-carbon technologies, or vulnerable vs resilient activities, to mobilise the capital needed. Indeed, the interplay between investors’ expectations and climate policy credibility is crucial for mobilising (or not) the climate finance needed to achieve the Paris Agreement climate targets at the global level (Battiston et al., 2021).

Taxes and energy markets regulation are a good example of policies which could create incentives for a change in behavior and increase funds available for some measures, if properly designed and implemented. Global fiscal measures like a global carbon tax could prevent environmental spillovers and environmental dumping from the Global North to the Global South. Such measures would be the first commitment device to bring policy credibility and set up the enabling conditions for investors to deliver. High-level policy reforms should start in the global North, and they need to be tailored to each country’s financing needs and other specificities of their economies.


Professor Irene Monasterolo, EDHEC-Risk Climate Impact Institute and Chatham House co-organised a COP27 side-event "Scaling up climate adaptation finance in times of growing public debt, inflation and natural disasters" on November 9, 2022, with over 500 people registered to learn from top experts on climate physical risk adaptation strategies. To watch the replay of the virtual rountable, follow this link:



[1] All views presented here reflect the exchanges had during the panel and are not necessarily attributed to all the panelists. This Policy Brief is the result of the COP27 side event co-organised within the Horizon 2020 CASCADES project and Chatham House on 9 November 2022. All views presented here reflect the exchanges had during the panel and are not necessarily attributed to all the panelists and their respective institutions. The authors thank Anja Duranovic (EDHEC Business School and EDHEC-Risk Climate Impact Institute) for the excellent research support, and Apostolos Thomadakis and Karel Lannoo for excellent comments.

[2] See in particular Chapter 15.

[3] See for example the Barbados Prime Minister’s Mia Amor Mottley address at the General Debate at the 77th Session of the General Assembly of the United Nations, New York, 20-26 September 2022.

[4] See Article 6.4 of the Paris Agreement, which introduces a mechanism to contribute to the mitigation of greenhouse gas (GHG) emissions and support sustainable development.

[5] In particular Article 2.1(c).

[6] For example, infrastructure investments which are not climate resilient, as well as the gross fixed capital formation in high-carbon activities (Mullan and Ranger, 2022).

[7] Especially when it comes to early warning systems, mangrove protection, and climate resilient infrastructure. For more information, see Chapter 2 of the IMF’s Global Financial Stability Report: ‘Navigating the high-inflation environment’, October 2022.

[8] A step forward is the Global Resilience Risk Initiative (GRII) which was launched at COP27.

[9] In this regard, the IMF is engaging in many projects related to capacity building in developing countries and is planning to issue a joint IMF/Bank for International Settlements/Organisation for Economic Co-operation and Development/World Bank implementation guidance for high-level principles related to taxonomies and other alignment methodologies.

[10] See for example, the IMF’s World Economic Outlook: ‘Countering the Cost-of-Living Crisis’, October 2022. And the ‘Climate Change 2022: Impacts, Adaptation and Vulnerability’, Contribution of Working Group II to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC).




Alok, S., Kumar, N. and Wermers, R. (2020), ‘Do fund managers misestimate climatic disaster risk’, Review of Financial Studies, Vol. 33, Issue 3, pp. 1146–1183.

Baldauf, M., Garlappi, L. and Yannelis, C. (2020), ‘Does climate change affect real estate prices? Only if you believe in it’, Review of Financial Studies, Vol. 33, Issue 3, pp. 1256-1295.

Battiston, S., Monasterolo, I., Riahi, K. and van Ruijven, B. (2021), ‘Accounting for finance is key for climate mitigation pathways’, Science, Vol. 372, Issue 6545, pp. 918-920.

Battiston, S., Mandel, A., Monasterolo, I., Schütze, F. and Visentin, G. (2017), ‘A climate stress-test of the financial system’, Nature Climate Change, Vl. 7, Issue 4, pp. 283-288.

Bernstein, A., Gustafson, M. and Lewis, R. (2019), ‘Disaster on the horizon: The price effect of sea level rise’, Journal of Financial Economics, Vol. 134, Issue 2, pp. 253-272.

Bevere, L. and Remondi, F. (2022), ‘Natural catastrophes in 2021: The floodgates are open’, sigma, No 1, Swiss Re Institute,  March.

Bressan, G., Duranovic, A., Monasterolo, I. and Battiston, S. (2022), Asset-level climate physical risk Assessment and cascading financial losses, September 6. Available at SSRN:

Brière, M. and Ramelli, S. (2022), Green sentiment, stock returns and corporate behavior, December 14. Available at SSRN:

Choi, D., Gao, Z. and Jiang, W. (2020), ‘Attention to global warming’, Review of Financial Studies, Vol. 33, Issue 3, pp. 1112-1145.

CPI (2022), GLobal landscape of climate finance: A decade of data 2011-2020, Climate Policy Initiative, 27 October.

Dunz, N., Hrast Essenfelder, A., Mazzocchetti, A., Monasterolo, I. and Raberto, M. (2021), ‘Compounding Covid-19 and climate risks: The interplay of banks’ lending and government’s policy in the shock recovery’, Journal of Banking and Finance, Article No. 106306, pp. 1-24.

Fleming, L., Greene, H., Li, G., Marx, M. and Yao, D. (2019), ‘Government-funded research increasingly fuels innovation’, Science, Vol. 364, Issue 6446, pp. 1139-1141.

GCA (2021), Adaptation finance in the context of Covid-19. The role of development finance in promoting a resilient recovery, Global Center on Adaptation, 22 January.

Gourdel, R., Monasterolo, I. and Gallagher, K. (2022a), Climate transition spillovers and sovereign risk: Evidence from Indonesia, Task Force on Climate, Development and the International Monetary Fund, March.

Gourdel, R., Monasterolo, I., Dunz, N., Mazzocchetti, A. and Parisi, L. (2022b), The double materiality of climate physical and transition risks in the euro area. Working Paper, No 2665, European Central Bank, 20 May.

Hong, H., Li, F.W. and Xu, J. (2019), ‘Climate risks and market efficiency’, Journal of Econometrics, Vol. 208, Issue 1, pp. 265-281.

Hötte, K. and Jee, S. (2022), ‘Knowledge for a warmer world: A patent analysis of climate change adaptation technologies’, Technological Forecasting and Social Change, Vol. 183, pp. 1-19.

Kruczkiewicz, A., Cian, F., Monasterolo, I., Di Baldassarre, G., Caldas, A., Royz, M., Glasscoe, M., Ranger, N. and van Aalst, M. (2022), ‘Multiform flood risk in a rapidly changing world: what we do not do, what we should and why it matters’, Environmental Research Letters, Vol. 17, No 8, pp. 1-8.

Kruttli, M., Tran, B. and Watugala. S. (2021), Pricing Poseidon: Extreme weather uncertainty and firm return dynamics, Working Paper, No 23, Federal Reserve of San Francisco, March.

Li, X. (2022), Physical climate risk and firms’ adaptation strategy, June 9. Available at SSRN:

Monasterolo, I., Dunz, N., Mazzocchetti, A. and Essenfelder, A. (2021), Financial risk assessment and management in times of compounding climate and pandemics shocks, Future Development, Brookings Institute, 22 October.

Mullan, M. and Ranger, N. (2022), Climate-resilient finance and investment: Framing paper, OECD Environment Working Paper, No 196, Organisation for Economic Co-operation and Development, 21 July.

Nguyen, D., Ongena, S., Qi, S. and Sila, V. (2022), ‘Climate change risk and the cost of mortgage credit’, Review of Finance, Vol. 26, Issue 6, pp. 1509-1549.

Ranger, N., Mahul, O. and Monasterolo, I. (2022), Assessing financial risks from physical climate shocks: A framework for scenario generation, Equitable Growth, Finance & Institutions Insight, Other Financial Sector Studies, Washington, DC: World Bank.

Roncoroni, A., Battiston, S., Escobar-Farfán, L. and Martinez-Jaramillo, S. (2021), ‘Climate risk and financial stability in the network of banks and investment funds’, Journal of Financial Stability, Vol 54.

Titelman, D., Benítez, N.P., Hanni, M., Verdía Canales, C. P., and Saade Hazin, M. (2022). Fiscal Impact Estimates of a Net-Zero Emissions Transition for Major Hydrocarbon Producers in Latin America and the Caribbean: The Plurinational State of Bolivia, Brazil, Colombia, Ecuador, Mexico and Trinidad and Tobago. Task Force on Climate, Development and the International Monetary Fund (April). Global Development Policy Center Working Paper, Boston University, Boston, US.

UNEP, (2021), Adaptation Gap Report 2021: the gathering storm – Adapting to climate change in a post-pandemic world, United Nations Environment Programme, 1 November.

UNEP, (2022), Emissions Gap Report 2022: The Closing Window – Climate crisis calls for rapid transformation of societies, United Nations Environment Programme, 27 October.