Caribbean Climate Crisis Demands Urgent Action by Governments and Investors

(Credit: World Meteorological Organization)

By Alejandro Guerson, James Morsink and Sònia Muñoz

The Caribbean is the most exposed region to climate-related natural disasters, with estimated adaptation investment needs of more than $100 billion, equal to about one-third of its annual economic output.

Moreover, with electricity largely generated using fossil fuels, energy prices in the Caribbean are among the highest in the world, highlighting the need for investment in lower-cost and lower-carbon energy production.

The current level of private climate finance in the Caribbean region falls well short of what is needed. Some recent initiatives are promising, including:

Issuance of blue bonds combined with debt-nature swaps for debt service reduction opening fiscal space for nature conservation investments in coastal areas (Belize and Barbados).
Issuance of a catastrophe bond for financial protection against hurricane damage (Jamaica).
State-contingent debt instruments that provide debt service relief after natural disasters in the context of debt restructuring in IMF-supported programs (Barbados and Grenada).

However, Caribbean countries have only been approved for about $800 million from climate funds (Green Climate Fund, Global Environment Fund, and Adaptation Fund).

While most countries purchase disaster insurance from the Caribbean Catastrophe Risk Insurance Facility, and a few countries are also enrolled in World Bank contingency credit lines, coverage levels are below the needs for rehabilitation and reconstruction.

Access to private climate financing has been low due to several factors.

A pipeline of bankable climate projects is critical for raising private financing, but this remains insufficient due to limited capacity and expertise for project preparatio n. Similarly, qualification requirements to access climate funds are often beyond the administrative capacity of small country and microstates’ governments, given the fixed costs of project evaluation and appraisal.

The multifaceted nature of climate finance operations, which include finance, legal, environmental and budget aspects, requires the involvement of several departments across the public administration leading to costly and lengthy preparation periods. Also, data gaps undermine project appraisal and monitoring, limiting risk pricing and impact evaluation. Also, private financing usually requires information about collateral and creditworthiness, which is often not readily available. Finally, a lack of effective carbon pricing reduces the incentive of investors to channel funds into climate-beneficial projects.

In many countries, the high level of government debt reduces the fiscal space for sharing risks (for example, government guarantees for private sector financing). This is particularly critical considering that climate investments are needed now while the return accrues in the long term. Also, the fixed costs of issuing financial instruments to raise money for climate adaptation constrain access to private financing.

Collaborative Solutions

Addressing these obstacles to private climate finance requires coordinated action by all those involved.

Governments need to strengthen the institutions and processes that develop, execute, and fund climate-related projects. These include green tagging of projects in budgets, accreditation to apply to climate finance, and upgrading procurement, transparency and reporting standards. To overcome constraints related to small size, Caribbean countries could pool administrative resources to reduce costs, while strengthening communication across departments involved in climate finance operations. Sustainable fiscal positions, supported by transparent and binding medium-term fiscal frameworks to signal commitment to debt sustainability, are critical to sustain access to climate finance at favorable terms.

Governments could also facilitate access to private sector finance with the modernization of foreclosure procedures and accounting and reporting standards, and the establishment of credit bureaus. Given that social benefits will be larger than private benefits, governments should also remove bottlenecks at the sectoral level by adopting clear legal and regulatory environments for renewable energy and eliminating fossil fuel subsidies, especially those for electricity production.

Financial markets that supply climate finance can simplify application processes, qualification requirements, and financial instruments, without weakening standards. Some options include establishing frameworks to pool applications of several countries and projects, making application requirements proportional to the amounts being requested. Climate finance instruments can be standardized to reduce appraisal cost and potentially facilitate the development of secondary markets for climate instruments.

The IMF and other international financial institutions can give advice to help countries maintain fiscal sustainability and provide climate-specific technical assistance to develop administrative capacity, and climate data and diagnostic tools. The IMF also provides long-term concessional climate financing to strengthen the enabling environment, institutions and implementation capacity to address climate challenges and helps support private climate financing with the Resilience and Sustainability Facility. Multilateral development banks could play role in helping Caribbean countries with high levels of government debt to leverage equity financing from private sources.

Jeff Kearns

Managing Editor

IMF Blog

jkearns@IMF.org

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Dear maria,

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Europe’s Inflation Outlook Depends on How Corporate Profits Absorb Wage Gains

(Credit: RossHelen/Getty Images)

By Niels-Jakob Hansen, Frederik Toscani, Jing Zhou

Rising corporate profits account for almost half the increase in Europe’s inflation over the past two years as companies increased prices by more than spiking costs of imported energy. Now that workers are pushing for pay rises to recoup lost purchasing power, companies may have to accept a smaller profit share if inflation is to remain on track to reach the European Central Bank’s 2-percent target in 2025, as projected in our most recent World Economic Outlook.

Inflation in the euro area peaked at 10.6 percent in October 2022 as import costs surged after Russia’s invasion of Ukraine and companies passed on more than this direct increase in costs to consumers. Inflation has since retreated to 6.1 percent in May, but core inflation—a more reliable measure of underlying price pressures—has proven more persistent. This is keeping the pressure on the ECB to add to recent interest-rate rises even though the euro area slipped into recession at the start of the year. Policymakers raised rates to a 22-year high of 3.5 percent in June.

As the Chart of the Week shows, the higher inflation so far mainly reflects higher profits and import prices, with profits accounting for 45 percent of price rises since the start of 2022. That’s according to our new paper, which breaks down inflation, as measured by the consumption deflator, into labor costs, import costs, taxes, and profits. Import costs accounted for about 40 percent of inflation, while labor costs accounted for 25 percent. Taxes had a slightly deflationary impact.

View the interactive version here

In other words, Europe’s businesses have so far been shielded more than workers from the adverse cost shock. Profits (adjusted for inflation) were about 1 percent above their pre-pandemic level in the first quarter of this year. Meanwhile, compensation of employees (also adjusted) was about 2 percent below trend. This is not the same as saying that profitability has increased, as discussed in our paper.

Previous episodes of surging energy prices suggest that labor costs’ contribution to inflation should grow going forward. In fact, it has already picked up over recent quarters. At the same time, the contribution from import prices has fallen since its peak in mid-2022.

This lag in wage gains makes sense: wages are slower than prices to react to shocks. This is partly because wage negotiations are held infrequently. But after seeing their wages drop by about 5 percent in real terms in 2022, workers are now pushing for pay rises. The key questions are how fast wages will rise and whether companies will absorb higher wage costs without further increasing prices.

Assuming that nominal wages rise at a pace of around 4.5 percent over the next two years (slightly below the growth rate seen in the first quarter of 2023) and labor productivity stays broadly flat in the next couple of years, businesses’ profit share would have to fall back to pre-pandemic levels for inflation to reach the ECB’s target by mid-2025. Our calculations assume that commodity prices continue to decline, as projected in April’s World Economic Outlook.

Should wages increase more significantly—by, say, the 5.5 percent rate needed to guide real wages back to their pre-pandemic level by end-2024—the profit share would have to drop to the lowest level since the mid-1990s (barring any unexpected increase in productivity) for inflation to return to target.

As noted in our recent review of the euro-area economy, macroeconomic policies thus need to remain tight to anchor expectations and maintain subdued demand. This would coax firms to accept a compression of the profit share and real wages could recover at a measured pace.

Jeff Kearns

Managing Editor

IMF Blog

jkearns@IMF.org

(CREDIT: ISTOCK / YOH4NN)

Dear maria,

The Sudan crisis that exploded in April is a stark reminder of the far-reaching spillovers of violent conflict in today’s integrated global economy, the IMF’s Franck Bousquet writes in a new article for Finance & Development Magazine.

Sadly, Sudan is just one recent flashpoint in a worsening global fragility and conflict landscape aggravated by Russia’s invasion of Ukraine. More than 60 percent of the world’s poor could live in fragile and conflict-affected states by 2030, Bousquet says.

“The international community must scale up assistance and develop financing solutions that support peace and stability as global public goods.”