The International Monetary Fund is working on developing a green fiscal policy rule to protect green public investments during times of public tightening and deficit reduction. The goal is to address the increasing costs associated with green adaptation and mitigation, which may lead to increased public deficit or a large fiscal adjustment. Implementing a green fiscal policy rule will ensure commitment to meeting climate change requirements and promoting fiscal sustainability.
The report includes a simulation highlighting the challenges associated with calibrating green fiscal rules. Excluding green spending from the rule would have significant implications on fiscal balances and debts, especially for emerging markets. Analyzing this impact requires estimating the size of the required green investment and the available fiscal space.
According to the report, the maximum level of sustainable debt associated with a feasible fiscal balance is around 95% of GDP for a typical emerging market, pre-pandemic. It is estimated that a safety net of around 20% of GDP is needed for normal macroeconomic volatility and up to 30% for tail risks, resulting in a debt anchor of around 40% of GDP. To reach net zero emissions by 2050, an additional expenditure of around 2% of GDP is needed for a representative emerging market. Additional costs related to mitigation measures account for an average of 1-2% of GDP per year for many developing countries.
Several fiscal scenarios are considered – (1) an additional 2% of GDP in annual green spending for mitigation measures without any fiscal rule (Considered business-as-usual scenario); (2) a green rule excluding mitigation spending (consists of 3% GDP deficit ceiling excluding mitigation spending and a 2% GDP annual green spending on mitigation); and (3) a green rule excluding adaptation and mitigation spending (consisting of a 3% GDP deficit ceiling excluding mitigation and adaptation spending accounting for 4% of GDP combined).
Under scenario 1 business as usual, the overall deficit is projected to deteriorate to almost 9% of GDP by 2050, and the debt-to-GDP ratio is estimated to reach 140% on average. With the second scenario, the deficit is estimated to remain at 7% on average, and the debt-to-GDP ratio is projected to reach 125 by 2050 for developed countries. However, under all scenarios, the rise in public debt and deficit is projected to be unsustainable for a typical emerging country.
With such simulations, the article discusses an illustrative Green Medium Term Fiscal Framework (MTFF) which includes the effect of climate change and natural disasters in macroeconomic projections and sets a series of targets to better calibrate climate considerations in fiscal policy. The MTFF provides an optimal mix of fiscal tools to determine the cost of the different policies and measures implemented to achieve climate objectives. It is also based on a risk-based framework to consider climate in debt sustainability analysis.
Green Fiscal Rules? Challenges and Policy Alternatives (imf.org)
