Managing climate risks and economic resilience go hand in hand

June 21, 2023|Written by Saliem Fakir
A man sits on a chair in front of a single-storey house made of cement bricks. In front of the man on the ground is a solar panel.
Domestic solar power in South Africa. Lower-income countries are exposed to transition risks generated by wealthier nations. © Mujahid Safodien / Greenpeace

“Belief is like love: it cannot be compelled; and as any attempt to compel produces hate, so it is the attempt to compel belief which first produces unbelief” – Arthur Schopenhauer, Essays and Aphorisms

It is encouraging that the financial sector and central banks have begun to take on board the idea that climate risks are systemic risks – they are inseparable from other risks. With time one thing is entangled with the other.

They not only add to but also compound the risks and vulnerabilities of countries battling the “polycrisis” – Covid, high debt (especially for low income countries), financial sector risks and the Ukraine war. There are also climate risks, in terms of climate vulnerability as well as transition risks which are largely associated with stranded assets.

There is no financial sector conference or forum that does not have climate and transition risks as part of its core programme: belief is no longer an issue but making rapid progress in dealing with the challenge is.

The push for net-zero targets is a positive signal. It sets the direction in which things need to go, but a lot more hard work needs to go into ensuring these goals are hardwired into economies and the financial sector.

Decarbonisation afterschocks

Just as the physical impacts of the climate crisis are driven by emissions from richer countries, transition risks on the African continent are being driven by industrialised countries as they make efforts to decarbonise.

The aftershocks generated by the decarbonisation trajectories of highly industrialised economies will ripple through the export sectors of middle-income and emerging economies which export substantial quantities to the EU. They will be subject to carbon border tax adjustment measures and other restrictions if they do not embark on transition processes themselves. In addition, the cost of finance will increase for assets deemed carbon intensive and risky due to the fact they may end up as stranded assets.

This area of risk, which is a point of growing friction, will add to the systemic risk dimensions that central banks and the financial sector will have to bring into their calculus. The challenge is that oil and gas importing countries are creating a false illusion, that recent spikes in demand for fossil fuels to deal with energy security issues in Europe are a sign that decarbonisation will never happen. In Africa, this creates the impression that business as usual is fine.

The most recent example of this is the East African Crude Oil Pipeline Project – a vast stretch of a pipeline that aims to export crude oil from Uganda via Tanzania. The project is being developed by Total and the China National Offshore Oil Cooperation, both non-African companies, and will be one of the longest electrically heated crude pipelines in the world. It also stands to be both expensive and at risk of becoming a stranded asset.

Economic resilience on the global agenda

The issue of transition risks was a key topic of the recent Green Swan conference, hosted by the Bank of International Settlements, and will be on the agenda at the BIS annual general meeting later this month. Around the same time, Macron’s summit will seek to rally global leaders behind the new financial compact with an emphasis on the relation between climate, poverty and prosperity.

Two threads run through the messaging for this summit: the need to scale up access to low-cost capital to tackle global climate challenges, and the need to incorporate climate resilience measures in debt instruments. At the heart of the issue is the need to appreciate that climate issues are central to economic well-being. The challenge is to ensure, in Africa at least, that building economic resilience is the pathway to climate resilience.

When systemic risks hit African nations, debt distress is increased. The Covid pandemic is a good example of this, as well as being a black swan event which has hit economies in unexpected ways. However, the famous risk analyst Nassim Nicholas Taleb has said Covid was not a black swan because the risk from a pandemic has been known for a long time, but we were slow to respond until it actually happened. The same can be said of climate risks which are slow and corroding in between the sudden wrecking balls like hurricanes, floods, extreme heat or snowstorms.

A group of people wade through ankle-deep water in an urban area, some are carrying suitcases or bags on their heads
Cyclones striking eastern Africa are increasing in intensity due to climate change. © Denis Onyodi / IFRC/DRK

The effects of climate change are spread across the world, dispersed from full view so we cannot see it all at once or in a holistic way. What happens in Italy is often not thought to be connected to what happens in Mozambique. Only scientists and people worrying about various sorts of systemic risks, manifesting as local liabilities, see the individual spurts of nature’s wrath as part of a global mosaic connected to the surge in greenhouse gases and global warming.

We are increasingly making these connections, though. Central banks, aided by the work of the Network for Greening the Financial System, are developing modelling and risk assessment tools to ensure climate risks, in concert with other risks, do not magnify in scale so they cause both financial and social instability.

Multiple risks now add complexity to the life of central banks and economists are seeking ways of getting out of the spiral of vulnerability as they have three interrelated dimensions to factor into their assessments: debt (being able to service it without borrowing more), fiscal space (having to use your limited resources to service debt when it should be going to enhance economic and social resilience), and dealing with inflation which reduces the value of money (not as a result of demand but exogenous risks such as climate percolating into the national sphere).

The polycrisis is narrowing the fiscal space

For African countries, the Covid pandemic has been nothing but devastating, leading to increased debt and narrowing of the fiscal space, all in a context of persistent climate risks. African central banks need to foster increased collaboration as climate risks are not bounded by political definitions of territory, but instead climate geographies and the risks are transnational in nature.

You only have to consider Cyclone Freddy in the Indian Ocean which recently hit Madagascar, Mozambique, Malawi and South Africa. Compared to the history of similar events in that part of the African continent, the cyclone hit a much wider area and over many more days.

The economic impact of these events is dependent on which sectors are most affected. Damage to those sectors crucial for jobs, exports, food security and balance of payments obligations can heighten financial distress and reduce availability of resources to resolve incipient climate vulnerability. The pandemic depleted state responses to the extent that the ability to deal with climate risks is now weaker as they do not occur in isolation but often acting in concert with other risks. The manifestation of multiple risks increases the debt burden and retards development progress.

The incapacity of African states to deal with catastrophic weather events also weakens their ability to invest in the low-carbon transition which is crucial for economic transformation and resilience on the continent. At the African Climate Foundation, we view climate and development as being part of one nexus. What happens in the economy affects the climate and, in turn, climate risks affect present and future economic progress and resilience.

This page was last updated June 21, 2023

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