India’s next fiscal challenge is climate risk

Climate change in India has been looked upon more as an environmental issue for decades. This then turned into a development challenge and now to a fiscal risk. Transport networks and supply chains can be paralysed during a flood. Heatwaves may decrease productivity from work and increase electricity consumption. During drought, the real purchasing power gets affected and farm incomes. Cyclones can cause damage to public infrastructure, disrupt activities of businesses and affect the provision of essential services.

The expenses continue after these uncertainties. Governments need to fund relief, reconstruction, social protection and the restoration of public assets, which may occur at a time when economies are already strained, and public revenues are already limited. Beyond the standard budget debates, a critical question remains unaddressed: what is the true fiscal cost of climate change for India?"

The costs of activities aimed at addressing climate change and its impacts are already significant in India. But the difficulty is that this is distributed across ministries, sectors and programmes and the fiscal exposure is not clear.

The National Institute of Public Finance and Policy did a study in 2020 that estimated the expenditure related to climate programmes accounts for about 5–6 per cent of all national budgetary expenditure, of which a significant portion is specifically targeted.

A threat to the financial stability

A study of climate change and fiscal deficits in India in 2026 finds that compared to the overall government expenditure the coefficient of variation of the climate-related expenditure is very high, at 26.4 per cent. It also detects higher budget differences in sectors vulnerable to climate change. The figures must be taken with a pinch of salt as they are based on how climate-related spending is categorized.

The relevance is not just on the side of increased spending by governments due to climate change. It could increase the uncertainty of public expenditure. In India, IAC projects total adaptation needs of `56.68 trillion up to 2030 in a business-as-usual (BAU) scenario. Further, NITI Aayog has also pointed out that the potential climate-damage cost to India by 2030 will be `15.5 trillion. These are scenario-based estimates, rather than obligations which have to show up in government accounts.

The establishment of another independent Indian climate fund is not necessarily required in India. It requires a Union Budget’s Climate Fiscal Risk Statement. The statement needs to stipulate five areas: What are the most flood, drought, heatwave, cyclone and water-stress-exposed sectors, states and public assets? What contingencies might be the risks that governments would be exposed to following a severe climate event?

There are models from other countries to be learned:  The UK’s Office for Budget Responsibility (OBR) looks at the impact of physical climate impact, adaptation and transition to a low-carbon economy on borrowing and public debt. The Treasury has also added climate change and adverse weather response considerations to its long-term economic and fiscal analysis of New Zealand. In the Philippines, the Climate Change Expenditure Tagging (CCET) method is employed to identify, monitor and report on climate-related expenditure in the budget process. India requires both aspects: knowing the amount of spending it is doing on climate action, and what climate change could do to the public finances.

Fiscal reviews typically focus on lower growth, higher interest rates, and lower revenues. Climate shocks should be incorporated into the same exercise. If a big flood does the damage, what will happen to a state’s finances? What occurs following successive droughts to agricultural and rural-support expenditure?

The IMF’s Quantitative Climate Change Risk Assessment Fiscal Tool (Q-CRAFT) is a tool that can be used by governments to analyse the implications of climate scenarios for a country’s macroeconomic and fiscal indicators, including government debt. These should be adopted systematically throughout India, starting at the Union level and gradually moving on to make climate-fiscal assessments at the state level. States have to be included.

They carry the brunt of the initial expense of wrecked roads, drainage, water systems, agriculture, health services and disaster response. But they have different financial means. The fiscal federalism aspect of climate risk is therefore also a question. Efforts of the 16th Finance Commission provide a useful context for understanding how intergovernmental transfers can help address variations in climate exposure, climate resilience requirements and fiscal capacity.

Fiscal insurance as resilience

Often, a resilient drainage system or heat-resistant public infrastructure and drought-resilient agriculture are regarded as extra costs. It should instead be seen as some future expenditure that is not incurred. The value of an investment can’t just be based on its initial cost if it lowers reconstruction expenses the next day. Public investment appraisal should also take into account losses and liabilities that resilience can avoid. The same principle goes for insurance. If a loss is not covered by insurance, then governments fill the gap as insurers of last resort. By using appropriate catastrophe insurance, parametric insurance and other risk-transfer mechanisms, a more manageable share of losses for governments can be reduced following disasters. The transition to the lower-carbon economy is also a part of climate-risk accounting. The fuel-tax revenues and subsidies could be impacted by changes in the consumption of fossil fuels, and the transition to renewable energy, electricity grids, storage, green mobility and worker adjustment will involve investments.

Progress has been made in India with regard to monitoring climate investment and bolstering disaster management. It is now time to reflect climate risk in fiscal policy. The impacts of climate change can build up over time – from repeated floods, crop failures, “heat-stressed” cities, damaged infrastructure, increased reconstruction costs, and the increased need for public support. These pressures, when clearly apparent in government accounts, come on the back of fiscal space having been restricted. India is facing a new hurdle of budget administration: not only is there a question of how much it spends, but also of how well India’s public finances will withstand a changing climate. Rather than being reshaped by climate change, its budgets have to anticipate the risks of climate change.

The writer is Professor, Department of Commerce, CHRIST University; Views presented are personal.