Work-in-Progress: Economic Analysis for Integrated Risk Management Carter Brandon, Latin America Region, World Bank.

Work-in-Progress: Economic Analysis for Integrated Risk Management

Carter Brandon, Latin America Region, World Bank

Average losses from extreme weather events for selected Latin America and Caribbean countries from 1992-2011

Source: Harmeling, S. and Eckstein D. “Global Climate Risk Index 2013”. Germanwatch, November 2012. http://germanwatch.org/fr/download/7170.pdf

• () indicate Global Rank of 183 countries or territories evaluated. Showing the top 12 for the region.• Sorted by Losses per GDP (%)

Average Annual Losses per GDP (%) Deaths per 100,000 inhabitants

Grenada

Dominica

St. Kitts & Nevis

Belize

AB

Honduras

St. Lucia

Nicaragua

Guyana

Haiti

Paraguay

El Salvador

0510

(26)

(1)

(4)

(5)

(10)

(15)

(16)

(23)

(29)

(20)

(8)

(7)

0 2.5 5

(8)

(52)

(43)

(2)

(26)

(4)

(3)

(90)

(28)

(128)

(14)

(19)

Select Damages from Disasters as a % of GDP

Belize - 1961

Nicaragua - 1972

Dominica - 1979

St Lucia - 1980

Jamaica - 1988

AB - 1995

Dominica - 1995

St. Kitts & Nevis - 1995

Honduras - 1998

St. Kitts & Nevis - 1998

Grenada - 2004

Guyana - 2005

Haiti - 2010

St Lucia - 2010

0%

100%

200%

Hurricanes:David & Frederick

Hurricane:Allen

Hurricane:Hattie

Hurricane:Luis

Hurricane:Georges

Hurricane:Ivan

Flood

Earthquake

Hurricane:Tomas

Hurricanes:Luis & Mari-

lynHurricane:

Luis

Hurricane:Gilbert

EarthquakeHurricane:

Mitch

Disaster events are increasing as are disaster losses

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

0

40

80

Count of Disasters

Source: EM-DAT

1961 - 1970 1971 - 1980 1981 - 1990 1991 - 2000 2001 - 20100

300

600

Count of Disasters

Source: EM-DAT1961 - 1970 1971 - 1980 1981 - 1990 1991 - 2000 2001 - 2010

$0

$25,000

$50,000

Damages from Disasters (US$ millions)

Source: EM-DAT. Truncated for the 2010 losses.

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

$0

$8,000

$16,000

Damages from Disasters (US$ millions)

Source: EM-DAT. Truncated for the 2010 losses.

Source: Planning Institute of Jmaica

Honduras – Growth impacts of Hurricane Mitch after 1998

The economic cost of disasters

• Negative economic impacts, especially on the poor:– Households sell assets– Children drop-out from school– Production systems/supply chains disrupted, sometimes for years

• Disasters are exogenous shocks to the budget and impact growth and development prospects:

– Direct financial losses through damage to public assets and spending for emergency response and recovery;

– Indirect costs through loss of growth and revenue generation

But countries face many sources of exogenous risk:

Many advances, but still most risks are analyzed and managed sectorally, e.g., disaster risk management (DRM) investments and

insurance, agricultural insurance, commodity price hedging

Physical Risks

• Natural Disasters• Climate Change

Economic Risks

• Commodity price fluctuations

Financial Sector Risks

• Liabilities from guarantees, PPPs

Physical Risks• Natural Disasters• Climate Change

Economic Risks• Commodity price

fluctuations

Financial Sector Risks• Liabilities from

guarantees, PPPs

Needed, a common economic and fiscal framework to better quantify, compare, and prioritize risk

Integrated Risk Management:

These types of risks can be grouped and addressed with different instruments

TYPE OF RISK

FINANCIAL TOOLS COUNTRIES THAT HAVE USED THIS TOOL

Food price Loan indexed to food prices NoneOil price Options

Loan indexed to oil prices: for oil importers, if oil prices rise, the cost of the debt diminishes

Providing TA to Chile, Morocco, and Dominican Republic; initiating advisory with Panama and Ghana

Natural disasters

- CAT-SWAP (if certain conditions occur, e.g. natural disaster) can stop debt payments during a predetermined period - CAT-Bond - CAT-DDO -for short term liquidity for disasters

- Pacific Island and Caribbean and currently working with Colombia - Mexico - Costa Rica, Colombia, Guatemala, Peru, El Salvador, Philippines, Panama

Climate change

Weather derivative Malawi, Mongolia

Guarantees for PPPs?

Extend control guarantees. Ideally, not give any, in any case not give blanket guarantees. If do give guarantees, identify, quantify, budget and monitor them.

None

Key questions for countries trying to assess national priorities

We want to invest in risk management, but where will we get the biggest bang for the buck?What should we optimize– reduced uncertainty, reduced volatility, reduced costs/impacts, improved price stability, more targeted social protection?

Should we allocate more for hurricanes, earthquakes, droughts, import commodity price shocks, export commodity price shocks, flawed PPP projections, contractual liabilities?

How should we compare the marginal benefits of expenditures for infrastructure investments, price hedging instruments, insurance programs, catastrophe reconstruction bonds, or building retro-fitting?”

Key questions for the World Bank

How can we help improve household level resilience, highly correlated with poverty and vulnerability?

How can we improve the countries’ capacity to respond while protecting the budget and long term fiscal balance of the state?

How can we reduce the financial exposure (contingent liability of the state)?

How can we ensure funds are spend effectively in the aftermath of a disaster?

Requires multi-prong analysis• The economic impacts of physical impacts, on built assets,

economic output, and employment

• The explicit and implicit impact on fiscal expenditures of physical impacts, e.g., constructing and maintaining public assets, subsidies, public insurance programs, support of state-owned enterprises, social safety nets, and the need to respond to emergencies and help rebuild damaged communities:– Explicit contingent liabilities from contracts and regulations, credit

guarantees, public-private partnerships in infrastructure – Implicit contingent liabilities from political commitments (financial

bailouts), humanitarian grounds (disaster relief), or to finance public goods (environmental clean-up).

• Projected impact on government revenues, via tracing the impacts on reduced economic activity on direct and indirect taxes.

Requires multi-prong analysis of impacts

Type of Risk

Type of Impact

Economy-wide

Budget Expenditures

Fiscal Revenues

• Physical Risks

• Asset loss:

• Output loss:

• Contingent liabilities:

• Implicit liabilities:

• Tariffs on imports and exports

• Commodity-related royalties

• Income, value-added, and property taxes

• Economic Risks

• Financial Sector Risks

Direct damages to public and private sector assets

Incapacitation of other sectors, interrupted services, disruption of economic flows

Social programs e.g. subsidies, safety net payout

Recovery and reconstruction costs not explicitly budgeted

How much do we know?

Type of RiskType of Impact

Economy-wide

Budget Expenditures

Fiscal Revenues

• Natural Disasters

• Asset Loss: A LOT • Output loss:

LESS

• Explicit contingent liabilities: A LOT• Implicit contingent

liabilities: LESS• LESS

• Commodity output and price shocks

• Historical know-ledge: A LOT• Forecast specific

to sector/area: LESS

• Explicit contingent liabilities: A LOT

• If government royalty payments, export taxes are involved: A LOT• If not involved: LESS

• Under-funded state financial guarantees • LESS

• Explicit costs of guarantees: A LOT• Implicit demand-

side risks assoc. with PPPs: LESS

• LESS

Key knowledge gaps• Natural disasters: economic impacts of natural disasters on direct and indirect

output loss (esp. short- and medium-term employment) and public and private assets; the magnitude of contingent liabilities; and medium-term revenue implications. Trends and probabilities over time.

• Commodity output and price shocks: economic and fiscal dimensions of price movements in commodity sectors, expressed as deviations from expected expenditure and revenue streams. Needed for commodity price hedging or insurance schemes (for import-dependent countries). Probabilities but less clear trends unless climate-related.

• Under-funded state contractual guarantees (primarily PPPs and project-specific guarantees): explicit and implicit risks associated with state financial guarantees in the infrastructure sectors.

• Impact, effectiveness, and efficiency of risk management instruments, such as rate of return/value for money on risk management expenditures.

• Sequencing and trade-offs between key dimensions of a sovereign risk management program.

Conclusions/Next Steps

• Do country case-studies, starting with a small, high risk economy (e.g., Jamaica, a Central American country)

• Refine methodologies to assess the economic and fiscal impacts of risk

• Develop a tool-kit for countries to better address exogenous risks and use market-based approaches

• Expand/adapt the offerings of financial instruments, inc. CAT bonds, CAT DDO’s, CAT SWAPs, indexed loans, hedging instruments, weather derivatives, guarantees