There are many examples of countries that have defaulted because of climate conditions. Moldova and Suriname experienced defaults in 1992 and 1998, respectively, due to severe droughts that negatively impacted the production of agricultural goods intended for export (IMF, 1999; van Dijck and others, 2000). El Niño floods in Ecuador in late 1997 and early 1998 led to thousands of deaths, loss of household assets and crops, and caused extensive damage to vital infrastructure. The floods destroyed large agricultural areas, reducing exports, and impairing several banks’ assets mainly from the country’s coastal region. Ecuador defaulted several months after severe floods caused widespread power outages (Sturzenegger and Zettelmeyer, 2007).

Natural disaster risk also reduces the government’s ability to issue debt. In Pakistan, the 2022 floods worsened the country’s risk of defaulting on external debt. The floods affected 33 million people, causing substantial damage across 81 districts, and exacerbated existing vulnerabilities. Health systems were strained, with over 1,460 facilities impacted, while waterborne diseases surged (ReliefWeb, 2022). The floods led to a 2.2 percent direct GDP loss, with indirect effects causing GDP growth to fall from 6 percent to below 2 percent for 2022-23. Inflation reached 24 percent in 2023, worsening poverty. Damaged infrastructure, reduced agricultural output, and increased unemployment further hit key sectors, pushing the fiscal deficit to 5.5 percent of GDP. By late 2023, Pakistan faced insolvency, with foreign exchange reserves critically low and the value of sovereign bonds falling by over 60 percent (EIU, 2023).

<mark>Whether climate/disaster related or not, financial crises lead to s</mark> ubstantial <mark>and enduring costs. These costs may manifest as elevated levels of unemployment, decreased economic growth, and heightened social and political instability. Reinhard and Rogoff (2009) document how during the financial crisis-induced downturn phase, which lasts an average of more than four years, the unemployment rate tends to rise by around 7 percentage points. Output also declines</mark> substantiall <mark>y, falling by, on average, more than 9 percent from peak to trough. Public debt tends to increase substantially, driven largely by the sharp decline in tax revenues that governments experience as a result of deep and long-lasting output contractions.</mark> In more recent analysis, Laeven and Valencia (2020) systematically show that banking crises impose large costs on the sovereign and find that sovereign debt and currency crises tend to follow banking crises.

<mark>The external shocks described in this paper could be sufficient to trigger a financial crisis, under certain conditions, with potential losses of around 15 percent of GDP. Typically, the root causes of financial crises are initially small; for example, in July 2008 the value of defaulting sub-prime mortgages was valued at $273 billion, which led to $8 trillion of equity losses.</mark><sup>3</sup> <mark>The ensuing bank failures and loan pullbacks exacerbate the recession, leading to more loan defaults and further bank failures. Given the crucial role that financial systems play in modern economies, including Cambodia, a freeze-up in the banking system could exacerbate or even multiply the direct effects of the crises.</mark> <mark>Although Cambodia was relatively unaffected by the Asian Financial Crisis in 1998, Thailand and Malaysia recorded GDP losses above 7 percent, while Indonesian GDP fell by more than 13 percent. A higher share of agriculture in the economy means that the impacts in Cambodia could be smaller than those in other ASEAN countries, but the high rate of dollarization could increase potential costs. If we include the lost baseline growth and subsequent weaker growth, net losses</mark>

> 3 Mayer and others (2008) reported that 21 percent of the reported $1.3 trillion of sub-prime loans was delinquent.