Navigating Debt, Development And Disasters: Making Debt Sustainability Analyses Work for Bangladesh

Bangladesh’s external debt servicing record has historically been stellar as a least developed country. The country has comfortably met its external debt servicing obligations, largely thanks to its strong export performance. However, Bangladesh has taken on a large volume of foreign debt to finance multiple infrastructure mega-projects. The country has struggled with macroeconomic management in recent years, and climate change-related economic loss and damage might generate instability and undermine Bangladesh’s debt sustainability.

A new technical paper from Fahmida Khatun, Syed Yusuf Saadat, Afrin Mahbub and Zazeeba Waziha Saleh for the Task Force on Climate, Development and the International Financial Architecture aims to assess the impact of climate change on Bangladesh’s debt sustainability by incorporating climate change risks and climate transition resource needs into the debt sustainability estimation.

Main findings:

• While Bangladesh might be in a favorable position to manage its external debt in the long run even after addressing the risks of climate change, in the short run, the country might face a liquidity crisis resulting in reduced ability to service its debt payments.
• Reclassifying climate loans into grants might ensure debt sustainability in the short term for Bangladesh, in addition to equipping the country with sufficient climate finance to support mitigation and adaptation measures.
• Bangladesh might face significant challenges owing to the Carbon Border Adjustment Mechanism (CBAM), a policy tool to be implemented by the European Union (EU) that would impose a levy on carbon-intensive products imported into the EU. If total government revenue falls even by a slight percentage owing to the impact of the CBAM, Bangladesh might experience a risk of debt unsustainability.
• Increased interest rates when combined with climate change’s economic loss and damage drive liquidity indicators past their threshold, indicating that Bangladesh must enhance its exports and government revenue and develop better debt management strategies.

Policy recommendations:

• 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.
• Full implementation of the Carbon Border Adjustment Mechanism (CBAM) by the EU may pose significant threats to Bangladesh’s debt sustainability in the coming days. Urgent and proactive steps are required to reduce emissions and ensure the resilience of Bangladesh’s exports in the face of the CBAM.
• Climate finance should be provided as grants rather than loans to significantly reduce Bangladesh’s debt burden while aiding the economy in addressing climate change risks.