Sovereigns on thinning ice: Debt sustainability, climate impacts, and adaptation
1 : Politecnico di Milano [Milan]
2 : RFF-CMCC European Institute on Economics and the Environment
3 : CMCC Foundation - Euro-Mediterranean Center on Climate Change
4 : Università degli studi di Palermo - University of Palermo
5 : Durham University
6 : University of Cyprus [Nicosia]
7 : Cyprus Academy of Sciences, Letters, and Arts
8 : Bruegel
We stress-test sovereign debt for representative countries under the IPCC marker narrative scenarios of climate change using a stochastic debt sustainability analysis that integrates a coupled climate-economy model with debt financing scenario optimization. Our approach combines socioeconomic and climate pathways with calibrated aleatory scenario trees of economic, fiscal, and financial variables, generating forward-looking debt projections over the century. These projections incorporate climate-induced damages to economic growth spanning the broad spectrum of impact functions from the literature. Our findings reveal significant risks to sovereign debt stability, particularly under high-impact climate damage scenarios. We assess whether adaptation investments or fiscal consolidation can mitigate potential climate-debt crises. Notably, public financing of reactive adaptation can enhance debt sustainability, making it a justified expenditure. However, maintaining public spending at current levels while ensuring debt sustainability appears infeasible under climate impacts.