The impacts of climate change on fiscal and monetary policy in Africa

Having contributed almost nothing to climate change, African governments are already bearing the direct and indirect costs of this crisis as it continues to compromise economic growth, erode GDP per capita growth, have targeted sectoral effects, and compromise the livelihoods of hundreds of millions of Africans. The article will focus on the fiscal effects of climate change but also highlight some monetary policy effects.

Fiscal Impacts of Climate Change

The fiscal impact of climate change is linked to the effects of climate change which include:

• Hotter temperatures that increase heat-related illnesses and cause other effects listed below.
• More severe storms causing more flooding and landslides, and destruction of property and communities.
• Increased drought due to water scarcity, desert expansion, and reduction of land available for food production.
• Rise in hunger due to increases in extreme weather events and heat stress that destroy crops, fisheries, and livestock or make them less productive. 
• Poverty and displacement due to extreme weather events that destroy homes and livelihoods. Weather-related disasters displace 23 million people a year, leaving many more vulnerable to poverty.

"Africa’s historical and current carbon emission share is below 3  percent of global emissions, but the burden of climate change on economies and livelihoods across the continent is disproportionately high—a climate injustice." (African Development Bank, 2022)

Countries most at risk from climate change

Source: TheEcoExperts, 2022

The negative fiscal effects being borne by African governments fall into two main categories:

• Lost fiscal strength and space (i.e., lost revenue growth, negative impacts on productive debt, lower exports, etc.) due to the macroeconomic and sectoral effects of climate change.
• Increases in planned and unplanned expenditure to address climate-related disasters and chronic climate change effects. 

Lost Fiscal Strength and Space

Rising temperatures and changes in rainfall are affecting economic activity more in sub-Saharan Africa than elsewhere. The combined macroeconomic effects of climate change could lower the continent’s gross domestic product (GDP) by up to 3 percent by 2050. The African Development Bank estimates that loss and damage costs due to climate change in Africa are between $289.2 billion to $440.5 billion. Within that, key sectors are disproportionately affected such as agriculture, water, fisheries and aquaculture, forestry, and tourism (most of which are natural-asset dependent). Agriculture is of particular concern not only because the sector is a key source of livelihood for 55–62% of Africans, but it also constitutes almost a quarter of the continent’s GDP and yet is almost entirely rain-fed. Indeed, Sub-Saharan Africa makes up 95% of global rain-fed agriculture. 

For African governments, lower agricultural productivity, and sectoral growth means lower revenue generation possibilities from a crucial and large sector. Climate change also interferes with export receipts and forex earnings due to lowered activity from key agricultural commodity exports such as tea, coffee, floriculture, and horticulture, etc. This is particularly concerning given the scale of foreign-denominated debt which African governments must service in the short to medium term. Linked to this, lower agricultural commodity exports exacerbate already high current account deficits, particularly for non-resource-intensive economies.

Climate change is changing rainfall patterns and is expected to follow a pattern of ‘dry gets drier and wet gets wetter’. This causes extreme weather events where Africa’s wet regions along the equator will see a 30 percent increase in rainfall while the continent’s already dry regions will experience a 20 percent decrease—leading to prolonged periods of both drought and flooding depending on the region. This has implications for public investment in and revenue earnings from energy infrastructure for example. Investments in hydropower infrastructure and related revenues in certain regions are jeopardised by climate change as future levels of rainfall, evaporation, and runoff fall. Hydropower revenues in the driest climate scenarios could be between 7 to 58 percent lower in key water basins in Africa.

African governments are bearing the cost of extreme weather events. Between 2005-2020, flood-induced damage in Africa was estimated at over USD 4.4 billion, and droughts and floods have respectively lowered African countries’ GDP levels by 0.7 percent and 0.4 percent since 1990. Eight of the 20 countries with the highest expected annual damages to road and rail assets, relative to the country’s GDP due to climate change, are in Africa. Climate-related damage to infrastructure puts massive investments by African governments in jeopardy which is particularly concerning given the bulk of these have been financed through public debt. The impact of weather on transport infrastructure also has the monetary policy effects of raising the cost of transportation as infrastructure is damaged or made impassable. These costs are passed on to consumers, placing upward pressure on inflation. 

Climate change is not only interfering with the multiplier effects of infrastructure investment, but also compromising the productive potential of debt, putting millions of dollars at risk for which African governments are still liable.

More seriously, climate change pushes large portions of Africa’s population into poverty and destitution as livelihoods are lost to drought and floods. For African governments, this means lost current and future economic growth and fiscal health as the current effects of climate change impact Africa’s future labour force as children and young people grow up hungry. As the International Monetary Fund points out, the human capital loss from deaths, malnutrition, or lower school enrolment after a climate-related disaster is unrecoverable. Yet under current climate projections, Africa will lose up to 16 percent of its GDP as a result of malnutrition alone by 2050.

Increases in Public Expenditure

It is estimated that African countries are already spending between 2 and 9 percent of their budgets in unplanned allocations to respond to extreme weather events. More seriously, climate change increases the likelihood of conflict; a 1°C higher temperature is associated with a greater risk of conflict in Africa of about 11 percent—although this link varies depending on the conflict type and different subregions of Africa. Such conflict leads to increased expenditure to manage related insecurity and finance the relocation and resettlement of people displaced by the climate-related conflict in addition to those displaced by extreme weather events.

Climate change causes and exacerbates poverty, and has reduced economic output and growth in Africa more than in other regions of the world. The IPCC states that global warming has increased economic inequality between temperate regions in the Northern Hemisphere and Africa. For African governments, the poverty effects of climate change on income and food poverty translate to increased costs to pay for food relief and expanded social protection programmes. It also makes it more difficult and expensive to finance economic transformation strategies aimed at addressing poverty and creating wealth.

Climate change is already impacting certain health outcomes in Africa and most health outcomes are projected to increase with increasing global warming. These include the expansion of malaria-prone areas, increases in diarrhoeal diseases (due to high land and sea temperatures and extreme rainfall increasing), cardio-respiratory issues (due to dust storms and wildfires), and severe mental health effects in individuals impacted by extreme weather events. African governments will have to bear increased expenditure requirements to not only rebuild health facilities destroyed by extreme climate events but the increased need for care due to the health effects of climate change. 

Since climate change interferes with domestic food production, this informs why the region is heavily reliant on food imports. This not only exacerbates the CAD, but it also erodes foreign reserves, eats into forex available to service external debt, and has the monetary policy effects of weighing on exchange rates and exposing African governments to inflation spurred by weather shocks in regions where imports are produced. African governments are essentially stuck in a vicious cycle of the fiscal and monetary policy effects of climate change as follows:  

The fiscal and monetary policy impacts of climate change effects 

This cycle translates to persistent vulnerability to climate change and the related economic and fiscal shocks that prevent governments from doing more to make their economies more climate resilient. 

It is grim and unfair to expect Africans to continue to shoulder the effects of a crisis they did little to create. And it is unseemly that African governments are not losing only current and future economic, fiscal, and monetary policy space to climate change, but that this comes at a time when these fiscal and monetary policy options are needed. Obviously, remaining vigilant to the persistent challenge of fiscal mismanagement and ensuring fiscal accountability are key. But it is important to reckon with the systemic fiscal and monetary policy vulnerabilities being introduced by climate change.

So what can be done? There are already useful ideas and concrete recommendations on how African governments can address these challenges. I think the following actions are key:

• An environment of Fairness: Create an environment where the African government can be honest about the impact climate change is having on fiscal and monetary policy and space—and still be treated fairly. A key concern is that if African governments encourage the integration of climate risks into the assessment of their fiscal and debt sustainability analysis, the market effect will be to penalise them by deeming them as even higher risk. This then makes it even more difficult for African governments to get access to affordable finance. It is important that African governments are not subjected to a triple injustice of: i) shouldering the impacts of climate change on economic resilience having contributed almost nothing to the problem; ii) bearing the fiscal and monetary policy effects of climate that limit their ability to respond to the crisis and iii) being penalised by the market should climate risks be more deeply integrated into fiscal and debt sustainability assessments. 
• Assess climate resilience of key public investments and take remedial action: Undertake a climate resilience assessment of key capital-intensive investments made by African governments, particularly in energy and transport infrastructure--and financed by debt. This will provide a clear view of public investments that are at risk of being damaged and/or destroyed by climate change. The assessment should include estimating the potential fiscal impacts on the productivity of their debt, the ability to service such debt, and the scale of action and financing required to make key infrastructure investment climate resilient.
• Integrate African climate priorities into debt relief and restructuring plans: The Debt Relief for Green Recovery Project estimates that only 12 countries can take on more external debt and that between 2022-2028, sub-Saharan African countries will face yearly debt servicing costs that amount to 80 percent of annual climate finance needs alone. It is therefore crucial that the climate priorities of African governments are centralised and integrated into debt relief and restructuring plans and that deeper pools of concessional and grant finance are made available.

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