# **1. Introduction**

Small island developing states (SIDS) are a group of 39 member states of the United Nations and 18 other dependent territories. Although they are a heterogenous group, most of them face similar challenges. Most are relatively small economies which are not well diversified and so are vulnerable to macroeconomic shocks. This was starkly illustrated by the economic impact of the COVID-19 pandemic; the real GDP of SIDS contracted on average by 7.4 percent in 2020, and only partially rebounded by 4.1 percent in the following year. This was mainly driven by the collapse of tourism, on which the economies of many SIDS depend.<sup>1</sup> Moreover, because of their geographical characteristics, many of them are much more vulnerable to climateshocks—especially damages from tropical cyclones—than are most other Emerging Markets and Developing Economies (EMDEs). Climate change is exacerbating their vulnerability, making extreme climate-related shocks more frequent and damaging over the long term.

Alongside other socio-economic challenges, such as raising real income levels, reducing poverty and enhancing human development, most SIDS also face the urgent need to implement adaptation to climate change. Small island states must adapt to tropical cyclones, floods, droughts, rising sea levels and other extreme weather events. Investment in climate-resilient infrastructure could produce long term benefits in terms of higher GDP (Cevik, 2022). Climate change adaptation investments are, in large part, public goods and thus require public investment.<sup>2</sup> Moreover, because of the comparatively smaller sizes of small islands (both in terms of population and economy), it is very difficult to realize economies of scale in public investments, making such investments relatively more expensive than in larger countries. The magnitude of investments required for effective climate change adaptation, combined with the lack of economies of scale for many of these investments, unavoidably presents fiscal challenges, with most SIDS having limited fiscal space (if any) for expanding public investments.

Fiscal space in many SIDS is constrained by high public debt ratios. More than a third of the SIDS which are independent UN member states have relatively high public debt ratios (above 60 percent of GDP). In their most recent Debt Sustainability Analysis (DSA), 14 SIDS were assessed as being at high risk of debt distress, mainly because their debt ratios breach sustainability thresholds in DSA stress tests (see section 4 for more details). Consequently, some researchers and policy advocates argue that debt relief measures, alongside other reforms to the global financial architecture, are essential to restore debt sustainability and to enable SIDS to undertake the investments needed to strengthen their resilience (Fresnillio and Crotti, 2022; Rustomjee, 2017). This is the motivation for the SIDS Strengthening Resilience by Alleviating Debt (SRAD) program, which advocates for policy measures to improve climate resilience and increase fiscal space in SIDS. It focuses on debt alleviation measures such as: i)

> 1 For comparison, the average unweighted real GDP of all EMDEs which are not SIDS contracted by 1.8 percent in 2020 but then increased by 6.9 percent in 2021. The source of the data is the WEO database. The data for the SIDS includes the 36 states which are UN members and which are classified as EMDEs (all SIDS except for Singapore), except Cuba and the Cook Islands for which there are no data in the WEO database.

> 2 There are some types of adaptation investments which are private goods, such as strengthening privately owned buildings to make them more resilient to storms, but even these may require some form of public subsidy, either because private property owners do not have sufficient resources for the necessary investments (as may be the case for houses owned by low income households which often bear the brunt of damage from tropical cyclones) or because private property owners do not fully understand the magnitude of the risks that they face over the long term and therefore require a subsidy to incentivise them to invest optimally in adaptation.

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