Work-in-Progress: Economic Analysis for Integrated Risk Management Carter Brandon, Latin America Region, World Bank

Average losses from extreme weather events for selected Latin America and Caribbean countries from Source: Harmeling, S. and Eckstein D. “Global Climate Risk Index 2013”. Germanwatch, November () indicate Global Rank of 183 countries or territories evaluated. Showing the top 12 for the region. Sorted by Losses per GDP (%) Average Annual Losses per GDP (%) Deaths per 100,000 inhabitants

Select Damages from Disasters as a % of GDP

Disaster events are increasing as are disaster losses

Source: Planning Institute of Jmaica

Honduras – Growth impacts of Hurricane Mitch after 1998

The economic cost of disasters Negative economic impacts, especially on the poor: – Households sell assets – Children drop-out from school – Production systems/supply chains disrupted, sometimes for years Disasters are exogenous shocks to the budget and impact growth and development prospects: – Direct financial losses through damage to public assets and spending for emergency response and recovery; – Indirect costs through loss of growth and revenue generation

But countries face many sources of exogenous risk: Many advances, but still most risks are analyzed and managed sectorally, e.g., disaster risk management (DRM) investments and insurance, agricultural insurance, commodity price hedging Physical Risks Natural Disasters Climate Change Economic Risks Commodity price fluctuations Financial Sector Risks Liabilities from guarantees, PPPs

Physical Risks Natural Disasters Climate Change Economic Risks Commodity price fluctuations Financial Sector Risks Liabilities from guarantees, PPPs Needed, a common economic and fiscal framework to better quantify, compare, and prioritize risk Integrated Risk Management:

These types of risks can be grouped and addressed with different instruments

TYPE OF RISK FINANCIAL TOOLS COUNTRIES THAT HAVE USED THIS TOOL Food priceLoan indexed to food pricesNone Oil price Options Loan indexed to oil prices: for oil importers, if oil prices rise, the cost of the debt diminishes Providing TA to Chile, Morocco, and Dominican Republic; initiating advisory with Panama and Ghana Natural disasters - CAT-SWAP (if certain conditions occur, e.g. natural disaster) can stop debt payments during a predetermined period - CAT-Bond - CAT-DDO -for short term liquidity for disasters - Pacific Island and Caribbean and currently working with Colombia - Mexico - Costa Rica, Colombia, Guatemala, Peru, El Salvador, Philippines, Panama Climate change Weather derivativeMalawi, Mongolia Guarantees for PPPs? Extend control guarantees. Ideally, not give any, in any case not give blanket guarantees. If do give guarantees, identify, quantify, budget and monitor them. None

Key questions for countries trying to assess national priorities We want to invest in risk management, but where will we get the biggest bang for the buck? What should we optimize– reduced uncertainty, reduced volatility, reduced costs/impacts, improved price stability, more targeted social protection? Should we allocate more for hurricanes, earthquakes, droughts, import commodity price shocks, export commodity price shocks, flawed PPP projections, contractual liabilities? How should we compare the marginal benefits of expenditures for infrastructure investments, price hedging instruments, insurance programs, catastrophe reconstruction bonds, or building retro-fitting?”

Key questions for the World Bank How can we help improve household level resilience, highly correlated with poverty and vulnerability? How can we improve the countries’ capacity to respond while protecting the budget and long term fiscal balance of the state? How can we reduce the financial exposure (contingent liability of the state)? How can we ensure funds are spend effectively in the aftermath of a disaster?

Requires multi-prong analysis The economic impacts of physical impacts, on built assets, economic output, and employment The explicit and implicit impact on fiscal expenditures of physical impacts, e.g., constructing and maintaining public assets, subsidies, public insurance programs, support of state- owned enterprises, social safety nets, and the need to respond to emergencies and help rebuild damaged communities: – Explicit contingent liabilities from contracts and regulations, credit guarantees, public-private partnerships in infrastructure – Implicit contingent liabilities from political commitments (financial bailouts), humanitarian grounds (disaster relief), or to finance public goods (environmental clean-up). Projected impact on government revenues, via tracing the impacts on reduced economic activity on direct and indirect taxes.

Requires multi-prong analysis of impacts Type of Risk Type of Impact Economy- wide Budget Expenditures Fiscal Revenues Physical Risks Asset loss: Output loss: Contingent liabilities: Implicit liabilities: Tariffs on imports and exports Commodity-related royalties Income, value- added, and property taxes Economic Risks Financial Sector Risks Direct damages to public and private sector assets Incapacitation of other sectors, interrupted services, disruption of economic flows Social programs e.g. subsidies, safety net payout Recovery and reconstruction costs not explicitly budgeted

How much do we know? Type of Risk Type of Impact Economy- wide Budget Expenditures Fiscal Revenues Natural Disasters Asset Loss: A LOT Output loss: LESS Explicit contingent liabilities: A LOT Implicit contingent liabilities: LESS LESS Commodity output and price shocks Historical know- ledge: A LOT Forecast specific to sector/area: LESS Explicit contingent liabilities: A LOT If government royalty payments, export taxes are involved: A LOT If not involved: LESS Under- funded state financial guarantees LESS Explicit costs of guarantees: A LOT Implicit demand- side risks assoc. with PPPs: LESS LESS

Key knowledge gaps Natural disasters: economic impacts of natural disasters on direct and indirect output loss (esp. short- and medium-term employment) and public and private assets; the magnitude of contingent liabilities; and medium-term revenue implications. Trends and probabilities over time. Commodity output and price shocks: economic and fiscal dimensions of price movements in commodity sectors, expressed as deviations from expected expenditure and revenue streams. Needed for commodity price hedging or insurance schemes (for import-dependent countries). Probabilities but less clear trends unless climate-related. Under-funded state contractual guarantees (primarily PPPs and project- specific guarantees): explicit and implicit risks associated with state financial guarantees in the infrastructure sectors. Impact, effectiveness, and efficiency of risk management instruments, such as rate of return/value for money on risk management expenditures. Sequencing and trade-offs between key dimensions of a sovereign risk management program.

Conclusions/Next Steps Do country case-studies, starting with a small, high risk economy (e.g., Jamaica, a Central American country) Refine methodologies to assess the economic and fiscal impacts of risk Develop a tool-kit for countries to better address exogenous risks and use market-based approaches Expand/adapt the offerings of financial instruments, inc. CAT bonds, CAT DDO’s, CAT SWAPs, indexed loans, hedging instruments, weather derivatives, guarantees