Rethinking adaptation funding for a fairer, smarter future

When a country or community lacks sufficient, predictable, timely and accessible funding to minimise the physical impacts of climate change, it can become trapped in a vicious cycle. Without resilient infrastructure, countries face greater economic losses following a climate disaster. Ending up with a weaker fiscal position in the aftermath means that the ability to spend on strengthening resilience would worsen, creating a downward spiral for the country’s people and economy. 

To avoid such an outcome, sustained international support is needed for emerging and developing countries to access financing to build resilience. Targeting that support requires new analytical approaches to guide those investments where they are truly needed most. 

Limited funding from governments and
private sources

International public flows to emerging economies for financing adaptation are lagging significantly, amounting to only $28 billion in 2022. The first global stocktake in 2023 warned about the widening adaptation financing gap, which the United Nations Environment Programme estimates to be up to $359 billion per year. With Earth set to exhaust its carbon budget to limit temperature rise to 1.5°C in the next few years, the need to ramp up investments in climate adaptation will only rise. 

More companies are realising the threat to supply chains and physical assets from climate hazards, but private sector–led funding remains limited due to inadequate immediate financial returns. The lack of revenue streams from resilience-strengthening projects makes financing a challenge, even though these investments are good for economies. The World Economic Forum estimates that investing 1% of gross domestic product in climate adaptation measures can help avoid economic losses of up to 4% of GDP in the same timeframe. 

The primary dependence on public sources exposes other problems. For developing countries, the desire to strain their already weak fiscal position by spending now to avoid future losses is generally not politically palatable. 

Grants and concessional loans from multilateral development banks, development finance institutions, philanthropic organisations and other donors are thus necessary to help close the adaptation investment gap. 

The need to target
financing better

Historically, aid was disbursed by focusing primarily on a country’s income level or GDP per capita. This approach has helped reduce poverty worldwide, but does not work well when addressing the climate crisis. Many middle- or high-income emerging and developing economies, especially small island developing states, may be one climate disaster away from getting downgraded to a low income. This is because they may be highly indebted or have limited access to financial markets.

The approach of international financial institutions has been changing in recent years as the climate crisis has become apparent. To help donors allocate funding to countries, many approaches have been proposed that rank countries based on climate vulnerability and the capacity to cope with climate shocks. Others have looked to include poverty indicators that reflect the ability to pay. But these may not accurately reflect a country’s ability to access capital to mitigate disaster and strengthen resilience.

A new approach

We propose a new approach, embodied in the Climate Finance Vulnerability Index, created as a composite of the climate risk each country faces and its ability to access funding. Moreover, the approaches to computing climate and financial vulnerabilities are also unique.

In assessing a country’s susceptibility to climate hazards, it is important to consider the risk not just retrospectively but also prospectively – that is, incorporating the future risk of loss from disasters. Similarly, to assess a country’s ability to access financing, the focus should be on the sustainability of its debt, financial integration with the rest of the world and the level of sophistication of its capital markets. Of course, central to all this are indicators relating to governance and the capacity to manage complex financial and disaster risk reduction portfolios. 

In having a more robust understanding of risk across multiple dimensions – as this index does – better programmes and interventions can be designed to meet climate adaptation needs.

Donors interested in funding climate adaptation and resilience want their contribution to have the maximum impact possible. By adding a separate dimension on a country’s ease of access to finance, the index can help donors pick between two countries facing similar climate disaster risks: based on where the funds can go further, they can pick the one in more dire need. 

Many countries that need adaptation funding the most are not the ones receiving it, as underscored by the Brookings Institution. A more holistic approach to understanding climate adaptation financing risk can support closing this gap by highlighting the compounding effects of high climate risk and low access to capital to inform adaptation and financing strategies of countries so that aid, grants and concessional loans can be prioritised within existing and future resources to help prevent the worst impacts of climate change.