# **I. Introduction**

The Covid-19 pandemic has led to unprecedented human suffering and economic decline on a global scale. While many countries are now recovering, others are still in the grip of the pandemic and most find themselves debt-ridden and facing an uncertain future with new waves of infections, rising geopolitical challenges and mounting concern over how to tackle the impending climate crisis. It is therefore urgent that every country utilize its limited fiscal resources in the most efficient way possible relying on rigorous analysis to assess the best course of action. This paper contributes to this debate by assessing the effectiveness of different fiscal policy instruments – carbon pricing, fiscal incentives for private green investments, and public green investment – in supporting a green recovery that is also fiscally sustainable. Fiscal sustainability in this context is defined broadly as a country’s ability to keep its debt-to-GDP ratio on a non-explosive path.<sup>2</sup>

# **Despite deterioration of fiscal position, green investment is needed**

The fiscal position of most countries has deteriorated due to the Covid-19 crisis. Both advanced and developing economies have responded to the crisis with relief measures on an unprecedented scale. General government debt to GDP has grown from about 104 percent in 2019 to about 120 percent in 2020 for the average of advanced economies, and from about 55 percent to 64 percent for emerging economies. At the same time, the low level of interest rates has allowed interest spending to remain contained in advanced economies and to grow moderately in emerging ones. Public deficits in 2021 are projected to fall as economies recover but will remain at elevated levels for the foreseeable future, according to recent World bank projections.<sup>3</sup> Notwithstanding growing public debt, countries face many competing fiscal demands: (i) providing support to vulnerable population segments while recovery strengthens; (ii) rebuilding fiscal buffers at a pace contingent with recovery in order to ensure debt sustainability; and (iii) pursuing a green and inclusive transformation of the economy. The urgency of transitioning towards a green economy may not be acknowledged by all countries, which is one reason that there is considerable uncertainty over how the transition will proceed. Countries can facilitate the transition by adopting a price for carbon that reflects the true social cost of emissions. Carbon pricing will inevitably lead to an increase in energy and production costs necessary to induce a reallocation of investment toward green processes and less energy-intensive activities. Moreover, other production practices that are energy intensive and entail high greenhouse gas emissions in sectors such as agriculture, transport and building construction and management will be affected. The increase in energy prices could be eased if firms are able to improve energy efficiency. Supply-side shocks coming from higher production costs will diminish as new investment opportunities in green activities arise. While the private sector will undertake a large share of investment, public investment will be required where there are market failures such as in network and transportation infrastructures.

> 2 A country is fiscally sustainable if it has a fiscal balance in the present and in the future that is able to keep the debt as a ratio to GDP on a non-explosive path.

> 3 See the June 2021 edition of the World Bank **_<u>Global Economic Prospects</u>_** .

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