Overlooking nature is no longer an option for fiscal policy and debt sustainability analyses

Environmental degradation is a structural economic risk rather than a peripheral concern. Nicola Ranger, Carlo Pasqua and Christopher Adam explain why, as international financial institutions review the IMF-World Bank Debt Sustainability Framework, integrating nature must be a core priority.

Integrating nature into fiscal policy is a critical priority for economic stability and we have the data and tools needed to do this – as our new report from the Grantham Research Institute and University of Oxford shows. Across the globe, more than half of GDP depends in whole or in part on the ecosystem services delivered by our natural capital (or stock of productive natural assets). This dependency is particularly pronounced in low-income countries (LICs). Economic activity in these countries is closely tied to ecosystem services such as water availability, soil fertility, pollination and protection from natural hazards – but these services are increasingly under threat due to environmental degradation.

Despite this evidence, the primary international instrument used to assess debt risks and inform international finance and fiscal policies in LICs – the IMF-World Bank Debt Sustainability Framework for Low-Income Countries (LIC-DSF) – has yet to systematically integrate nature-related risks. We were commissioned to assess the implications for LICs and international finance and concluded that this omission risks producing unrealistic macroeconomic baselines, overlooking latent vulnerabilities and disincentivising investments that would otherwise enhance long-term economic resilience and growth.

Nature as a macro-critical factor

The adverse economic impacts of environmental degradation are increasingly evident. In Pakistan for instance, degraded natural systems contribute significantly to health burdens, with the costs of environment-related health impacts estimated at 6.5% of GDP in 2015. In Malawi, agriculture accounts for more than 20% of GDP and 80% of employment, yet research by the World Bank shows that approximately 80% of Malawi’s land is degraded, resulting in declining agricultural productivity and threatening long-term economic output and fiscal stability. In Honduras deforestation has worsened landslide and flood risk, increasing reconstruction costs and trade disruptions.

These effects are not isolated events: rather, the degradation of natural capital represents a systemic threat that is already undermining growth, disrupting fiscal sustainability and impairing sovereign creditworthiness across many LICs. Empirical evidence indicates that environmental degradation materially affects economic fundamentals:

• Disasters, aggravated by ecosystem degradation, cause significant GDP contractions, reduce fiscal space, and impair recovery. For example, in many small island developing states (SIDS) and fragile states these problems are causing GDP to decline by more than 10%.
• Depletion of natural capital undermines productivity, particularly in agriculture and raw materials, but also in related sectors such as manufacturing, which accounts for a large share of GDP and employment in LICs. It adds to volatility in global prices.
• Nature-related stresses and shocks, such as water crises due to overextraction of groundwater, disease outbreaks, wildfires and land degradation, affect public spending, fiscal balances and sovereign debt trajectories, especially when vulnerability to environmental disasters is high. There is clear evidence of existing shocks affecting large sectors such as energy, mining and agriculture linked to domestic environmental degradation, particularly through links to water provision, but also to vulnerabilities to international nature-related transition shocks (where economic actors are misaligned with the transition to a nature-positive economy) and physical shocks.

According to the IMF’s own guidance, any factor that could undermine fiscal sustainability, impair financial system resilience or reduce market confidence qualifies as “macro-critical” and ought to be integrated into debt sustainability analysis. The degradation of natural capital is now demonstrably macro-critical. In many LICs, environmental shocks are occurring with increasing frequency, and their impacts are magnified by the long-term degradation of ecosystems.

World Bank research we cite in our report shows that a partial collapse in key ecosystem services (such as pollination, fisheries and forest regulation) could lead to GDP losses exceeding 10% in LICs by 2030. If realised, such nature-related shocks would pose as great a threat to debt sustainability in LICs as those routinely considered by the IMF and World Bank. Failure to account for these risks may therefore result in unsustainable borrowing, underestimation of associated fiscal stress, and increased debt distress.

Nature as an investment in stability and growth

Our report concludes that nature must be recognised not only as a source of risk but also as a strategic investment opportunity; the economic benefits from its sustainable management could be significant. For example, in the Democratic Republic of Congo, sustainable management of forests and landscapes could yield benefits 15 times greater than investment costs by 2050. Ecosystem restoration – such as reforestation, wetland rehabilitation and sustainable land management – can enhance agricultural productivity, protect infrastructure, reduce disaster vulnerability and support job creation.

When treated as public investment in productive capital, nature-based solutions can contribute to economic diversification and long-term stability. Yet under the current approach to debt sustainability analyses, such expenditure is often treated as a fiscal liability, rather than investment that reduces risk and improves macroeconomic fundamentals.

Integrating nature into the LIC-DSF: feasible and necessary

Our report concludes that the integration of nature into the LIC-DSF is both technically feasible and policy-relevant. The concrete, near-term recommendations for fiscal and debt sustainability analyses we set out are:

• Stress–test for nature-related shocks
• Incorporate nature in baseline growth scenarios
• Reclassify nature-based investments as growth-enhancing
• Leverage existing tools and data
• Strengthen institutional capacity.

For policymakers, creditors and financial institutions operating in LICs, the message is clear: overlooking nature is no longer an option. Environmental degradation is a material and growing driver of macroeconomic instability. At the same time, nature represents one of the most cost-effective and under-utilised tools for fostering stability, resilience and long-term growth.

As international financial institutions review the Debt Sustainability Framework, integrating nature must be a core priority. Doing so is not only analytically sound: it is economically prudent and fiscally responsible.

Read the authors’ report, Integrating nature into the IMF-World Bank’s Debt Sustainability Framework for Low Income Countries. The report was commissioned by the Foreign, Commonwealth and Development Office (FCDO) and published by the CLimate, Environment, and Nature (CLEAN) Helpdesk.