Many countries vulnerable to climate change, especially emerging economies, also face macro-financial fragility and nature-related financial risks. Alongside intensifying climate change, developing and other vulnerable countries that house global biodiversity hotspots, which are nature-dependent and face accelerating ecological degradation, also face a looming sovereign debt crisis. This triple crisis forms compound, systemic risks with disproportional consequences. Governments can play a vital role in financing adaptation and resilience to manage these compounding effects across environmental and economic systems, yet their fiscal capacity hinges on stable debts and borrowing costs.

However, research on the macro-fiscal implications of compound climate- and nature-related financial risks with macro-financial fragility is limited on two fronts. First, modelling efforts on the economic consequences of nature-related financial risks remain in their infancy relative to those of climate change. Equivalently, the upside opportunities from nature-linked sovereign finance and financial co-benefits remain absent in prevailing credit analysis and financial models. Second, risks rarely materialise in isolation, yet compound risks and their consequences remain largely unexamined in practice. An integrated approach is needed, as understated risks can lead to misdiagnosed debt sustainability and policy recommendations.

Against this backdrop, this project investigates the overarching research question – ‘What are the fiscal consequences of compound climate, nature-related and macro-financial risks?’

Structured across three objectives.

First, to empirically examine how the impact of climate and nature-related financial risks on sovereign borrowing costs can depend on the level of macro-financial fragility through advanced regression analysis using historical data.
Second, model the sector-specific macro-financial consequences over time, such as employment and economic activity, from varying intensities of ecosystem service degradation through input-output and agent-based models.
Third, integrate these in a scenario-based fiscal stress test quantifying the implications of varying intensities of nature loss for macro-financial health and debt distress, and evaluate the financial adaptation potential of novel public financing instruments, such as sustainability-linked financing and disaster clauses jointly targeting nature recovery and debt sustainability.

Geographically, the second paper expands model coverage to African economies, which have received little academic attention to date. These scenario-based analyses aim to improve the assessment of risks and opportunities along scenarios to enhance governments’ systemic resilience to compound risks.