Storms and sustainability: Assessing the impact of natural disasters on debt sustainability in the Caribbean

Abstract

The Caribbean remains one of the most vulnerable regions in the world, facing a plethora of issues including the increasing intensity and frequency of natural disasters, limited fiscal space, difficulty in accessing financing, and elevated debt levels. We formally assess the impact of natural disasters such as storms and flooding on debt sustainability using the fiscal reaction function. Our results show that debt remains sustainable when we account for natural disasters, albeit weakly. The results remain robust when we assess natural disasters with higher intensity. We attribute the favourable movement in the primary balance to the implementation of austerity measures, obtaining external aid payouts from catastrophe insurance after natural disasters, or having restricted fiscal space. For robustness, we investigate the impact of natural disasters on the debt-to-GDP ratio and find that the overall results remain consistent with the fiscal reaction function. Policy recommendations include greater adoption of credible and flexible fiscal rules, catastrophe bonds, and climate disaster clauses on financial instruments.