Bangladesh’s Climate Risks and External Debt Tightrope: Safeguarding Sustainability Amid Transition

By Fahmida Khatun, Syed Yusuf Saadat, Afrin Mahbub and Zazeeba Waziha Saleh

Following the conclusion of the 2025 International Monetary Fund (IMF)/World Bank Group Annual Meetings in Washington, D.C., the fiscal constraints faced by least developed countries (LDCs) in meeting their external debt obligations are a key topic of conversation, alongside the growing impacts of climate vulnerability, which together pose significant risks to LDCs’ economic resilience.

Bangladesh, a country which is set to transition from its status as an LDC in 2026, sits at the nexus of debt sustainability concerns and climate vulnerability. Economic loss and damage due to climate change put Bangladesh at risk of failing to service its external debt obligations in the event of a large climate change-induced natural disaster. In addition, Bangladesh’s poor domestic resource mobilization record implies its primary budget deficit is rising, making it increasingly challenging to service future external debt repayments without taking on new external debt.

A new technical paper from the Task Force on Climate, Development and the International Financial Architecture evaluates the impact of climate change on Bangladesh’s debt sustainability by integrating climate-related risks and the resource requirements associated with the climate transition into the debt sustainability analysis. It also discusses practical policy options to address these challenges.

Bangladesh’s external debt exposure and climate vulnerability

Over the past several years, notable changes have occurred in Bangladesh’s borrowing situation. There has been a transition from loans with concessional terms (meaning terms more favorable than market-rate loans) to loans with standard commercial terms. As of December 2023, Bangladesh’s external debt, including both public and private debt, was $100.64 billion—a 4.3 percent increase from December 2022. This raises concerns, as it indicates that Bangladesh’s external debt is growing at a considerable rate, thereby increasing the likelihood that the debt may become unmanageable in the future.

Additionally, Bangladesh’s major lending sources have shifted from multilateral to bilateral agreements. Furthermore, the technical paper authors observed a significant transition toward utilizing suppliers’ credit. Meanwhile, the proportion of variable interest rate loans, such as those linked to Secured Overnight Financing Rate (SOFR), Euro Interbank Offered Rate (EURIBOR) and London Interbank Offered Rate (LIBOR), has been increasing. These interest rates tend to float and are variable throughout the debt obligation period. Moreover, there has been a transition towards stricter term loans, distinguished by shorter grace and maturity periods. Taken together, these trends exhibit clear indications of a forthcoming rise in debt servicing liabilities in the near and medium term.

Bangladesh’s ability to service its rapidly growing external debt is severely compromised by its low tax-to-GDP ratio (total tax revenue as a percentage of gross domestic product). This low ratio means the government must use a substantial portion of its meager revenue to service its external debt, diverting funding from sectors that can enhance economic growth and human welfare, such as education, health and social protection. Although Bangladesh’s debt sustainability has been considered manageable thus far, this perception may be tested as the repayment period for many of its accrued loans commences.

Furthermore, the threat of climate change presents numerous challenges. Bangladesh is susceptible to natural disasters, which have become more frequent and damaging. These calamities result in significant economic losses, including the loss of income and capital, particularly for individuals residing in the most vulnerable segments of the population. It is expected that, due to the repeated frequency of floods and cyclones, Bangladesh may incur a loss of 2.2 percent of its GDP every year, equivalent to about $3.2 billion. Subsequently, this imposes an additional burden on the government, necessitating increased spending on resources to support those affected by climate change, as well as spending on adaptation and mitigation measures to enhance resilience. Bangladesh also faces a substantial financing gap for climate change, which can only be addressed through increased external loans from bilateral and multilateral partners, potentially leading to long-term debt distress for the country.

Scorecard: low risk of insolvency, but high risk of liquidity factors

Against this backdrop, the technical paper assesses how climate change will impact Bangladesh’s debt sustainability. Adopting the International Monetary Fund’s Debt Sustainability Framework (DSF) for Low Income Countries (LIC) as the foundation, it ascertains different scenarios concerning climate change shocks to assess their impacts on several of Bangladesh’s debt burden indicators.

Regarding solvency—the long-term ability of Bangladesh to repay its debts—the indicators assessed remained below sustainable thresholds across baseline and stress test scenarios, suggesting that Bangladesh faces a low risk of long-term debt unsustainability due to climate change. However, liquidity indicators—which capture Bangladesh’s short-term ability to meet its financial obligations—were more vulnerable. Even modest declines in export earnings and revenues or increases in variable interest rates can push these indicators above sustainable thresholds, particularly when combined with climate change-related losses. This sensitivity underscores Bangladesh’s vulnerability to short-term external shocks and highlights the need to safeguard stable finances to ensure debt sustainability in the immediate term.

On the other hand, when the authors treated loans provided to Bangladesh as part of mitigation and adaptation measures against climate change as grants, they discovered a rather optimistic scenario for the country: the debt burden indicators across both solvency and liquidity ratios remained well below the debt sustainability ratios, indicating a low risk of debt distress for Bangladesh. Even if exports decline due to the European Union’s Carbon Border Adjustment Mechanism (CBAM), the technical paper found that debt burden indicators remain stable if climate loans are converted into grants.

These findings reinforce the notion that if financing were provided in the form of grants rather than loans, Bangladesh’s capacity to manage its debt burden would be considerably strengthened. This notion is similar to Samoa’s Climate Macroeconomic Assessment Program (CMAP), which underscores how concessional and grant-based climate finance can improve debt sustainability for vulnerable economies.

Policy options to help address risks

This analysis indicates that Bangladesh faces some acute challenges regarding short-term financial stability amid increasing climate shocks. The country has an opportunity to manage its debt burden prudently, while also addressing challenges arising from climate change impacts.

The technical paper identifies several policy options. Firstly, climate change indicators, especially those that include a valuation of total damage incurred due to climate change, must be incorporated when making projections about Bangladesh’s debt sustainability.  This will facilitate the calculation of Bangladesh’s current and future risk of debt distress, closely mirroring the actual economic scenario. This will also assist policymakers in formulating more effective debt management strategies, strengthening infrastructure and building institutional capacities to mitigate further economic loss.

Secondly, Bangladesh must prepare itself to sustain any shocks to its export sector. Full implementation of the CBAM by the European Union may pose significant threats to Bangladesh’s debt sustainability. As per the 2023 Article IV Consultation Report for Bangladesh, the country needs to consistently implement reforms to uphold macroeconomic stability, improve the financial sector and strengthen resilience to climate change. Therefore, urgent and proactive steps are required to reduce emissions and ensure the resilience of Bangladesh’s exports in the face of the CBAM. To prepare for the imposition of the CBAM and similar measures from other trading partners, the government should formulate national emissions measurement, reporting and verification policies for every sector. Such policies should include quantitative mitigation targets for each industry, enabling exporters to maintain their competitive advantage while adhering to environmental responsibility and international standards.

Finally, climate finance should be provided as grants rather than loans. Considering Bangladesh’s substantial need for climate finance, securing adequate funding through domestic resources is not feasible. As such, Bangladesh must rely on external loans. Providing this much-needed finance as grants would significantly reduce Bangladesh’s debt burden while aiding the economy in addressing climate change risks. Reclassifying climate loans as grants would also enhance the country’s preparedness for future shocks while ensuring financial stability.