rapid investment growth of the past decade.<sup>11</sup> Although it has recently declined, high corporate leverage, particularly in state-owned enterprises, has been associated with declining corporate profitability and financial performance (Molnar and Lu 2019; World Bank 2018b). In view of the size of China’s economy, adverse spillovers to other EMDEs would be likely to be significant, including through portfolio reallocation among asset classes (Ahmed et al. 2019; World Bank 2016).

Sixth, LICs have accumulated debt rapidly and increasingly from non-concessional and less transparent sources of finance (Essl et al. 2019). These developments have increased LICs’ vulnerability to financing shocks and to the revelation of previously undisclosed debt obligations.<sup>12</sup> Transparency about contingent liabilities in LICs, such as those stemming from state-owned enterprise debt and public-private partnership transactions, as well as government asset holdings is also limited. These data limitations are especially acute for debt owed to commercial and non-Paris Club creditors. Poor data coverage can give rise to sudden increases in disclosed debt, for example when debt of loss-making stateowned enterprises migrates to the books of the central government.<sup>13</sup> Seventh, for some EMDEs, risks related to climate change are substantial. Climate-related risks are particularly pronounced for economies where physical capital and infrastructure is located in high risk areas, and smaller EMDEs that rely heavily on climate-sensitive industries (such as agriculture and tourism) but have limited scope for economic diversification. The experience of several economies in LAC, in particular, shows that debt crises can be triggered by natural disasters. Furthermore, the move to a low-carbon economy could have a material effect for energy-exporting EMDEs. A shift away from the use of carbon-intensive fuels could leave the assets of fossil fuel companies, including stateowned companies, stranded by rules to curb climate change (Carney 2015). This could have critical implications for debt sustainability both at the firm and the country level.

To the extent that natural disasters are becoming more frequent and persistent as a result of climate change, they are likely to increase macroeconomic volatility and reduce longterm growth prospects, posing a growing risk to debt sustainability in vulnerable EMDEs (Nakatani 2019). EMDEs tend to adopt pro-cyclical policies in the aftermath of natural disasters, which may further deepen the macroeconomic costs of these events (Noy and Nualsri 2011). Political unrest after climate shocks or additional investment needed for climate adaptation may lift government borrowing cost, further increasing the likelihood of debt distress (Klomp 2015). Finally, extreme weather events can lead to a significant deterioration of fiscal and trade balances which in turn may trigger financial distress and debt crises.<sup>14</sup> Finally, elevated debt increases an economy’s vulnerability to domestic financing and political shocks even in an environment of benign global financing conditions. Domestic

> 11 For details, see Maliszewski et al. (2016), Yu and Shen (2019), and Wang, Wan and Song (2018).

> 12 For details, see Bova et al. (2016), Horn, Reinhart, and Trebesch (2019), and Lee and Bachmair (2019). 13 For example, in Mozambique and the Republic of Congo, the revelation of unreported debt led to large upward revisions to official debt figures, which resulted in debt distress (IMF 2018a). Only a third of the 59 countries eligible for International Development Association borrowing report private sector external debt statistics (World Bank and IMF 2018).

> 14 For details, see Acevedo (2016), Lee, Zhang, and Nguyen (2018), and Lis and Nickel (2010).

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