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July 09, 2018

How to Manage the Fiscal Costs of Natural Disasters

Posted by Serhan Cevik, Guohua Huang, and Alexander Tieman[1]

The world is a dangerous place. The frequency and severity of natural disasters, including extreme weather events, have exacerbated across the world over the past few decades, with significant adverse effects on socioeconomic conditions. Myriad studies find negative effects of natural disasters on the fiscal front because of the damage to human and physical capital and post-disaster relief and recovery efforts. Between 1950 and 2015, 40 countries have been hit by a natural disaster that caused economic damage in excess of 10 percent of GDP, while for small island states about one in ten natural disasters involves economic damage of more than 30 percent of GDP (see chart below). 

Natural Disasters: Maximum Damage (Click on the map for a better image resolution)

(Maximum Annual Impact, 1950-2015, in percent of GDP)

Natural disasters present a unique challenge to fiscal management because of their exogenous nature and the potentially overwhelming scale of fiscal costs. They worsen a government’s fiscal position—directly and indirectly—by eroding the revenue base and increasing expenditures on disaster relief, recovery and reconstruction. An example from Japan was discussed in a recent blog article. Without a robust PFM framework governments may face fiscal crisis in the aftermath of natural disasters.

A new paper on “How to Manage the Fiscal Costs of Natural Disasters” has been published by the IMF. The paper focuses on how governments can build fiscal resilience against natural hazards and strengthen fiscal management after a disaster. It discusses both budgeting frameworks and other fiscal policies.

Three questions lie at the center of the fiscal management of natural disasters: How large should fiscal buffers be? How should fiscal buffers be built up? And how should fiscal buffers be used efficiently and transparently once a natural disaster has struck? To address these questions, this paper discusses fiscal strategies for financing the recovery effort – including by building up natural disaster funds - and considers various fiscal approaches for mitigating disaster impact. It also provides guidance on how to conduct regular risk analysis of potential fiscal effects of natural disasters, and outlines best practices in defining and accounting for contingent liabilities related to natural disasters in budgeting frameworks. In addition, approaches for risk reduction, disaster risk financing strategies, and risk transfer mechanisms – such as different insurance instruments – are also discussed in the paper.

[1] Serhan Cevik and Guohua Huang are Senior Economists with the IMF’s Fiscal Affairs Department (FAD). Alexander Tieman is a Deputy Division Chief in the same department.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.


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