The papers in this series aim to providea vehicle for publishing preliminary results onMacroeconomics and Fiscal Management (MFM) topics toencourage discussion and debate. This paper explores two newfinancing mechanisms that multilateral and bilateraldevelopment agencies could consider deploying to addressproblems of debt sustainability in small states. In thispaper the authors provide an initial assessment of theseproposals, informed by analysis of small state indebtednessand recent debt dynamics. Proposed financing instruments arepredicated on assumptions that small states face high levelsof indebtedness, and that reducing debt levels whileincreasing climate resilience could sustainably reduce suchvulnerabilities. The authors find that levels ofindebtedness vary widely across small states. Analysis ofsmall state debt dynamics shows that small state debtaccumulation has been driven by large primary and currentaccount deficits and slow economic growth. Debt reductionfrom new mechanisms can only be expected to be sustainable,therefore, if countries simultaneously address themacroeconomic imbalances driving debt accumulation. Theauthors demonstrate that, while exposure to naturaldisasters is likely to have exacerbated economic managementchallenges in some small states, such exposures are unlikelyto be the only important cause of indebtedness. The authorsconclude that proposed new financing instruments canpotentially help reduce small state debt burdens and gainfiscal space for climate adaptation but will not present asustainable solution to problems of small state debt risksunless they involve macroeconomic and structural reforms toaddress the underlying imbalances driving rapid debt accumulation.
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