Climate change has emerged as a significant risk to sovereign debt sustainability, impacting fiscal stability and growth prospects. For example, extreme weather events such as cyclones and floods lead to infrastructure destruction, reduced agricultural output and displacement, necessitating increased public expenditure for recovery.

For instance, Pakistan's floods in 2022 caused damages exceeding $30 billion. In Bangladesh, Cyclone Sidr (2007) caused damages of approximately $1.7 billion.

The European Central Bank warns that climate inaction could exacerbate sovereign risks due to materialised liabilities and financial instability. Their report highlights the growing impact of climate change on sovereign debt and financial stability, emphasising the urgency for integrating climate risks into fiscal planning.

It outlines how climate-related hazards, including extreme weather and long-term environmental changes, can directly harm public finances through increased recovery costs and indirectly disrupt economies, reducing tax revenues and raising borrowing costs. The report stresses that inaction on climate risks could lead to higher sovereign risk premiums and deteriorating credit ratings, especially for vulnerable countries.

It recommends that governments and financial institutions adopt proactive measures, such as incorporating climate risks into debt sustainability analyses, enhancing transparency, and mobilising green investments to mitigate these challenges.

Developing countries face a compounded crisis of rising sovereign debt and heightened vulnerability to climate change. For instance, countries like Mozambique, Bangladesh, etc. face acute fiscal constraints that limit their ability to finance climate resilience projects. This nexus creates a vicious cycle: climate events damage economies, increase debt burdens, and reduce fiscal capacity to address future risks. New financing mechanisms aim to alleviate fiscal constraints while driving climate action, with nations restructuring or forgiving parts of their debt in exchange for investments in conservation or renewable energy.

Green bonds offer investors the opportunity to align their portfolios with environmental objectives while earning returns. Bangladesh has begun exploring creative solutions to address climate finance challenges. Some key examples include sovereign green bonds.

Bangladesh's first sustainability-linked bond (SLB) was issued by Pran Agro Limited. The bond, arranged by Standard Chartered Bank, is a significant milestone in Bangladesh's sustainable finance sector. It links financial incentives to achieving specific sustainability targets, such as reducing greenhouse gas emissions and enhancing resource efficiency. This innovative financing approach aligns with global environmental and social priorities while supporting the country's economic development.

Partnerships with the private sector could help reduce public financing burdens.

Also, clean energy from rooftop solar installations in garment factories can reduce operational costs while meeting international buyers' renewable energy requirements. The success of factories in Gazipur demonstrates the viability of this approach. The BGMEA has identified rooftop solar as a significant opportunity to reduce energy costs and carbon footprints in the garments sector. However, high initial costs deter private investments in renewable energy projects. Besides, the aging infrastructure of Bangladesh's national grid limits its ability to incorporate renewable energy.

So, credit rating agencies and multilateral development banks should include climate risk factors in their analyses to facilitate climate-resilient investments. Developing countries need access to debt-for-climate swaps or concessional loans, coupled with technical support to implement climate projects.

Simplified processes for accessing funds under frameworks like the Green Climate Fund are essential to empower vulnerable nations. Additionally, developed nations must enhance contributions to climate funds, ensuring fair and adequate financial support for adaptation and mitigation.

The writer is chairman of Financial Excellence Ltd. This piece is based on his discussion points at COP29 in Baku, Azerbaijan.