Pakistani Prime Minister Shehbaz Sharif warned world leaders at the COP27 climate talks last November that developing nations risk falling into a “financial debt trap” if they're forced to turn to the markets to cover the mounting costs of climate change. Six months on, with rates and temperatures rising, his prediction looks prescient.So far this year cyclones have battered southeast Africa, floods have killed hundreds in Rwanda, Congo and Uganda and the worst drought in four decades parched crops in the Horn of Africa. Record temperatures are currently being recorded across southeast Asia, Cyclone Mocha has just ripped through Bangladesh and Myanmar and agricultural regions have dried up in Argentina.

Those events often become humanitarian crises; they’re also expensive and getting more so. The average cost of capital for a select group of 58 climate-vulnerable countries is 10.5% according to report published in April by the Boston University Global Development Policy Center. That compares to a sovereign bond yield of 4.3% over the past decade for a Bloomberg Barclays emerging markets index.

Many borrowed heavily when interest rates were much lower, meaning they are often already struggling to pay back debt when a natural disaster strikes. The shift in borrowing costs has also been transferred to small businesses such as farmers, exacerbating the problem for governments.

One such farmer is Thobani Lubisi. In February he was just beginning preparations for the annual harvest on Dwaleni Farm, a cooperative in eastern South Africa, when heavy raindrops began pounding his neat rows of sugarcane plants. Over two days almost half a year’s worth of rain gushed onto the fields, waterlogging crops and turning the dirt tracks used to deliver the harvest to the nearest mill to sludge. The nearby Mlumati River burst its banks, completely submerging the farm’s pump house.

In the weeks that followed, as work began to repair the damage from the worst flood locals had ever seen, Thobani and his colleagues were forced to face up to a new reality. The damaged harvest had blown a hole in household budgets and the repair work quickly drained savings. Ordinarily the farmers, who were uninsured, could tap the local agricultural bank, but the surge in global interest rates means loans now come with crippling monthly payments.

Lubisi, 43, whose father was one of the first Black farmers to start growing sugarcane in the area 40 years ago, has managed to keep going for now, but he is one of the lucky ones. Some in the region have sold their plots. Others are renting out their fields because they can’t afford the repairs.

“You work the whole year for zero because there will be no income,” said Lubisi, holding an umbrella to shield himself from the sun in an interview earlier this month as a four-foot Nile monitor lizard slithered into the Mlumati, now a languid stream just a few feet across. “This kind of damage for me looks like it’s a first.”

Lubisi’s story is one that’s being increasingly repeated across the developing world. Munich Re calculated the losses from global natural disasters in 2022 at $270 billion and estimates that roughly 55% of that total wasn’t insured. Weather-related natural disasters are already being influenced by climate change, and this influence is likely to grow stronger as temperatures rise.

Alvario Lario, president of the United Nations International Fund for Agricultural Development, said he’s seen farmers driven out of business due to extreme weather in Ivory Coast, Madagascar, Kenya and Indonesia. “The depth or the intensity of these shocks is very clearly much more acute than what it was five or ten years ago. That’s the reality,” he said.

Almost 3,500 miles north east of Dwaleni Farm is an archipelago that faces a similar financing problem on a national scale. The Maldives, a nation of 1,200 islands that are rapidly sinking into the sea, is spending 30% of its annual budget on seawalls, land reclamation and desalination plants. The country’s borrowing costs have surged since it sold a $500 million bond in early 2021, with the yield on the notes due in 2026 now trading at close to 19%.

To meet its coastal adaptation needs the Maldives would need to spend $8.8 billion, about four times its national budget, according to Aminath Shauna, the nation’s Minister for Environment, Climate Change and Technology. Already 64% of its islands are experiencing erosion as a result of rising sea levels, she said.

“It is a horrible twist of irony that our climate vulnerability makes us risky, and because we are risky, we can’t borrow the money needed to protect us from climate change,” Shauna said in an emailed response to questions.

As natural disasters intensify and become more frequent, investors are increasing the interest rate they charge vulnerable countries, adding to the debt burden, according to the Boston University report. The elevated risk premium could trap countries into a “vicious cycle” of higher debt costs and a decreased capacity to invest in climate resilience, the researchers including Luma Ramos and Rebecca Ray wrote.

That’s a state of affairs already playing out on the southeastern coast of Africa, an area that’s been ravaged by a spate of violent storms in recent years, events that the World Weather Attribution initiative has linked to climate change. Mozambique’s finances were already in poor shape after the so-called tuna bonds scandal shut it out of international debt markets when Cyclone Idai hit in 2019, destroying crops and fueling inflation. The nation’s outstanding domestic debt has surged more than 100% to 301 billion meticais ($4.7 billion) since 2019 and a series of late debt payments earlier this year led Moody’s Investor Service to classify the nation as technically in default to local lenders. “Liquidity pressures emerged in the context of unusually high debt repayments and higher than foreseen spending” exacerbated by Cyclone Freddy, a storm that ripped through the region earlier this year, analysts at Moody’s wrote in a report. “Recent events also highlight the credit effects of Mozambique's susceptibility to increasingly recurrent and severe climate shocks.”

The growing frequency of natural disasters has spurred governments in climate-vulnerable countries to step up calls for increased aid from rich nations that have historically contributed the bulk of emissions. A breakthrough agreement was reached at COP27 to create a loss-and-damage facility to pay poorer countries for the harm caused by climate change, but it’s not clear how the fund will be financed or structured and wealthy nations have historically handed over much less climate aid than they’ve promised.

Others have called for measures that would encourage more private sector funding of climate adaptation measures. Green finance has been successful in channeling money into climate mitigation projects such as solar farms, but investors are less inclined to allocate funds to adaptation schemes like building sea walls because the future revenue stream is harder to calculate. The UN’s Lario estimates that for every $10-$12 invested in climate mitigation, just one dollar is currently invested in adaptation.One option would be for multilateral organizations such as the International Monetary Fund and World Bank to step in as guarantors of projects to allow private investors to get involved without taking on so much risk.

“We need to focus on how to drive more private sector climate finance mobilization,” said Norbert Ling, ESG Credit Portfolio Manager at Invesco Asset Management in Singapore. “The role of multilateral development banks in scaling up climate finance is strong, they can de-risk projects for the private sector.”In Nkomazi, cane growers can access loans from Akwandze Agricultural Finance, a venture between 1,200 small farmers and mill owner RCL Foods Ltd. Akwandze doesn’t require land as collateral for its loans because the sugar is grown in communal areas where there are no title deeds. Instead the borrowings are secured against the farmers’ income from their crops.

But that isn’t much help when flooding has destroyed the sugar cane or prevented it from getting to the mill on time. Members of the cooperative that helped establish the bank can borrow at a reduced rate of 2% above the so-called prime rate, used by banks to lend to their most creditworthy clients. Currently the prime rate is 11.75%, the highest since mid-2009.

“We had to dig down into our pockets, I think some they did take loans,” since the flood, said Sabelo Shabangu, a farmer at Khanyangwane sugarcane project, a few miles from Dwaleni Farm, who has borrowed from Akwandze in the past and is still paying off the debt. “It gives farmers a huge burden. Once that money starts to be insufficient that loan will carry on and on and on.”

--With assistance from Matthew Hill and Janet Paskin.

Author: Antony Sguazzin, Ronojoy Mazumdar and Prinesha Naidoo