Background

The current macroeconomic environment has started a renewed cycle of debt renegotiations for multiple countries around the globe. Many countries, in an attempt to mitigate the damage done by COVID-19 to local economies, took on increasingly large quantities of debt at relatively cheaper levels, owing to a fairly low interest rate environment. This debt is once again becoming increasingly unsustainable, exacerbated by global inflation which has put pressure on central banks to raise rates and keep pace with the US Federal Reserve. The subsequent rise in the Dollar’s value makes these debt stocks, in local currency terms, more expensive and increases the potential for default in highly indebted countries.

The ensuing sovereign debt crisis is equally alarming due to its implications for climate adaptation and mitigation. Some of the most vulnerable countries to climate change also happen to have significant levels of debt, coupled with poor fiscal health and rising debt service costs. At the same time countries are attempting to recover from two years of depressed growth amid the COVID pandemic, countries are being asked to invest more money in mitigation and adaptation measures, requiring the accumulation of more debt to finance the expenses. This is especially true in Africa, where five of the top ten most climate vulnerable countries reside in Sub-Saharan Africa. Figure 1 shows total debt for Sub-Saharan Africa among low and lower-middle income countries. Total debt among these countries rose sharply leading into 2020, with external debt sharply rising over that same period. Normally denominated in non-domestic currency, external debt constitutes a risky exposure to changes in foreign exchange rates and variable interest rates.

This report will look at the health and debt exposure of some of the most climate vulnerable countries in Africa, specifically Zimbabwe, Mozambique, and Malawi which rank in the top five of countries most vulnerable to climate change. These states are in a tough position moving forward, as accumulations of additional debt become unsustainable and trigger a fresh round of crises in the coming years.

Climate Vulnerability

According to Germanwatch’s 2021 Global Climate Index, Mozambique, Zimbabwe, and the Bahamas were the countries most impacted by the effects of extreme weather in 2019. This index takes data from MunichRe, a major global reinsurance company, to conduct trend analysis on the extent and intensity of individual natural disaster events in countries. Mozambique, Zimbabwe, and Malawi rank 1st, 2nd, and 5th respectively for the year 2019, suggesting a high degree of vulnerability to extreme weather events.

Another dataset to compare with is Notre Dame’s Global Adaptation Initiative (ND-GAIN). ND-GAIN’s Country Index combines data into two categories: vulnerability and readiness, to develop an overall score of the country’s vulnerability to climate change and its readiness to improve resilience (a lower score means higher vulnerability). Researchers at Notre Dame have determined that people living in the least developed countries have ten times greater chance of being affected by climate disasters versus higher income countries. Research based on the data also shows that it could take over 100 years for lower income countries to reach a similar resilience level as high-income countries. Figure 2 shows the movement of Mozambique, Malawi, and Zimbabwe’s gain scores over time, showing that all three countries, for the most part, have kept their scores within a tight band. Zimbabwe has managed to raise its score by several points but is still marginal by comparison.

In the case of Zimbabwe, Mozambique, and Malawi, all three rank in the lower 25 percent of countries globally, with scores suggesting a high level of vulnerability and low level of readiness. Figure 3 highlights the three against countries with a similar income status. A low readiness score and high vulnerability indicates larger economic consequences to climate shocks, with little current capacity to mitigate. This implies a longer runway for adapting to climate change, with more money needed to become more resilient and adapt the economy to a potential new reality. This in turn suggests more debt may need to be taken on to support these initiatives. With the global economy possibly moving towards a recession, funds in the form of grants will be much less common than in previous years, suggesting a higher percentage of loans at market rate.

Debt Analysis

Zimbabwe, Mozambique, and Malawi all experience high levels of total and external debt while also running large fiscal deficits. This combination increases the country’s exposure to external credit markets while narrowing the fiscal space needed to both service that debt and finance climate adaptation measures. In a tightening credit environment, rolling over that debt will become increasingly expensive, potentially requiring future rounds of restructuring and possibly austerity measures to correct the fiscal imbalance. This is a critical vulnerability for countries needing high amounts of funding to combat the effects of climate change.

As Figure 4 shows, Mozambique’s total debt ballooned well above 100 percent of its GDP, reaching a peak in 2016 and stayed above 100 percent well into 2022. Malawi and Zimbabwe’s total debt stocks, on the other hand, rapidly expand, with both closing in on 100 percent of GDP. Mozambique in particular is infamous for defaulting on its debt in 2016 following revelations of $1.3 billion in additional loans that caused foreign donors and the IMF to cut off support, leading to a currency collapse and a default on the country’s debt. Malawi, meanwhile, has a debt to GDP of about 73 percent and Zimbabwe 92 percent. Both countries are in debt distress, with Zimbabwe having just completed a round of debt restructuring negotiations to avoid a default on its loans.

External debt for Mozambique in particular was rising at a rapid pace into 2020, stretching well over 140 percent of GDP. This is fairly alarming, given Mozambique’s financial history. Since defaulting in 2016, Mozambique has had a difficult time obtaining loans at below market interest rates, suggesting larger percentages of its GDP are going to interest payments. The story is only marginally better for Zimbabwe and Malawi. Zimbabwe is hovering at just under 60% of its GDP in external debt stocks, though it remains to be seen how debt restructuring agreements will affect these numbers. Malawi maintains the lowest level of the group at roughly a quarter of its GDP.

All three countries run fiscal deficits, with Malawi hovering just above seven percent of its GDP, though Figure 6 shows that all three countries have seen some improvement in their position since 2020. Running high fiscal deficits can be an exacerbating situation for debt distressed countries, as it restricts the ability of the government to continue spending on GDP improving projects without additional borrowing or raising of taxes. In the context of climate adaptation, the combination of poor fiscal health and high debt burdens constrain a country’s options for addressing these challenges. Increasing the debt burden for climate related measures slowly sucks money away from other critical development needs, while running fiscal deficits requires the accumulation of more debt, potentially at incrementally higher interest rates.

Conclusion

In a tightening credit environment, with global rates rising, we are already beginning to see the effects large levels of debt accumulation during the pandemic are having on some of the most vulnerable countries in the world. With a trillion dollars needed each year to fight climate change, the world’s most vulnerable countries face an uphill battle, simultaneously required to mitigate emissions while developing their economies and adapting to inevitable shifts in global weather patterns. Sitting in the top five of most vulnerable countries to climate change, Malawi, Mozambique, and Zimbabwe are in a tough position moving forward, as accumulations of additional debt become unsustainable and trigger a fresh round of crises in the coming years. If this cycle continues, these countries, and others like it, will find themselves in a downward spiral requiring drastic levels of restructuring, something the world might not be ready to accommodate in today’s constrained fiscal environment.