Can fiscal policy help countries face extreme-weather shocks?

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When extreme weather events strike, economies feel the impact too. The financial fallout can be devastating, especially for countries without strong fiscal defenses. With storms, floods, and droughts becoming more frequent and severe, the question is: How can governments better prepare? In this blog we emphasize the critical role of fiscal policy in helping countries prepare for, respond to, and recover from extreme weather events.

The urgency is clear. In 2022, Pakistan’s catastrophic floods displaced millions and submerged a third of the country underwater. In Mozambique, cyclones Idai and Kenneth hit in quick succession, leaving devastation and billions in damages. Across the Horn of Africa, relentless droughts have pushed millions to the brink of famine.  

These shocks disproportionately impact emerging market and developing economies, where limited risk-management capacity and weaker economic resilience often deepen the long-term damage, perpetuating a vicious cycle. One critical challenge is that these risks are not fully integrated into countries’ broader macroeconomic and fiscal policies—with can lead to negative impacts on debt sustainability and growth.
 

Fiscal Policy: A Critical Tool for Resilience

Fiscal policy—or the use of government spending and taxation to support the economy—can be a powerful tool in disaster preparedness, emergency response, and long-term recovery from extreme weather shocks. Fiscal policy can be used to build long-term economic resilience, by incentivizing investment in climate-smart infrastructure, investing in early-warning systems and contingent funds, transferring risks from the private to the public sector, and preventing economic downturns. Well-planned fiscal policies help nations respond swiftly to disasters, minimizing economic shocks and enabling a stronger recovery.

A World Bank working paper explored the crucial role that fiscal policy can play in climate change mitigation and enhancing economic resilience.

Governments with prudent fiscal policies, including with sufficient fiscal buffers, and manageable debt levels suffer less long-term damage from extreme weather-related shocks. Our research found that countries with public debt over 50% of GDP face greater economic losses after disasters than those with lower debt. Likewise, countries that consistently implement countercyclical policies (that is, supported households and firms during recessions) see little or no losses to the level of output relative to significant losses for those who implement procyclical policy.

Domestic revenue mobilization is a cornerstone for building fiscal resilience against weather-related shocks, enabling governments to respond effectively and invest in long-term adaptation. By raising more revenues in times of stability, countries can build fiscal buffers to quickly respond to disasters, support emergency relief, and invest in long-term adaptation—without derailing economic progress.

Studies suggest that developing economies could unlock up to 9% of GDP through targeted tax and institutional reforms, which are essential for mitigating the economic impact of shocks. Weather-related disasters often result in substantial income losses, averaging 2.9% of income losses in middle-income countries. By raising additional revenue, countries can better absorb, respond to, and recover from these shocks, safeguarding economic stability.

This dual benefit of revenue mobilization—ensuring fiscal sustainability while securing economic resilience—makes it a powerful tool for addressing the growing volatility caused by extreme weather events.
 

Protecting Budgets from Shocks

Complementary policies, such as medium-term expenditure frameworks and fiscal risk statements, can ensure that spending is aligned with resilience goals. This can help governments strategically allocate resources to address risks and quantify these risks, so the financial implication of a shock is properly acknowledged. When disasters strike, governments often need to increase spending in reconstruction while facing lower revenues due to income losses and tax relief measures.

To build financial buffers, governments can adopt practical strategies such as:

• Creating contingency reserves within the annual budget, which provide flexibility to adapt to changing conditions.
• Establishing natural disaster funds, which are dedicated pools of funds governed by specific rules for their use. The size of these funds is often determined by estimated liabilities from previous disasters, considering the increasing severity and frequency of such events.

These measures can help governments respond faster, recover more effectively, and maintain economic stability in the face of growing risks. The World Bank is working with countries to strengthen fiscal resilience, protect livelihoods, and promote sustainable development in an era of increasing extreme weather events.

^{The authors are grateful to Joseph Eloi and Emilia Skrok for comments and input. This paper was funded by the KDI School of Public Policy and Management.}