A. Identify Risks and Vulnerabilities

2. The recognition and inclusion of climate change and natural disaster risks in the country’s statement of fiscal risks is an emerging international best practice. This demonstrates that the authorities have considered the potential impact of these risks on government finances and are preparing to address them should they materialize.

3. Risks are well-identified in Seychelles, although work remains to be done to determine how they will affect the public finances. While Seychelles is not among the hardest hit by natural disasters, it is very vulnerable to climate change. The Seychelles archipelago appears to lie outside of the regular Indian ocean cyclonic zone. However, in recent years the country has been affected by tsunami, floods and occasional cyclones without catastrophic impacts (see Chapter I). Climate change can significantly increase the frequency and intensity of storms and change their patterns over the long term. Another significant vulnerability is periodic coral bleaching, the last of which occurred during 2015/16. Meanwhile, sea level rise in Seychelles will affect both tourism and fisheries over the long term as hotel infrastructure could be destroyed or have to be relocated in the absence of strengthening of coastal defenses. Climate change may also affect the migration pattern of some species of fish reducing the size of catches.

4. Seychelles plans to prepare a fiscal risk statement as part of the 2018 budget, that would be presented as part of the budgetary proposals. It would be useful if initial steps to quantify the fiscal risks emanating from natural disaster and climate change are included in the fiscal risk statement.

B. Invest in Risk Reduction

5. Seychelles has already begun to integrate risks into its medium-term investment program. In their NDC, the authorities have identified priority climate mitigation and adaption expenditure amounting to about 40 percent of GDP. On the mitigation side, these investments include diversifying the electricity generation infrastructure to achieve 15 percent of renewable energy by 2030 and shifting land transport to renewable sources of energy. Regarding adaption, significant investment will be for critical infrastructure including the port, coastal management and tourism.³

6. Strengthening the public investment management framework is a priority for effective risk reduction. Integrating climate change investment into the government investment program and the scale-up of such spending would require capacity development in investment planning and regulation including the management of PPPs; and in investment implementation. Preliminary results of the recently concluded PEFA assessment suggest that the authorities receive high grades for expenditure control, financing and transparency, but implementation capacity needs to be strengthened as reflected in under-execution of the capital budget in recent years.

The authorities could also benefit from the IMF Public Investment Management Assessment (PIMA) tool, which provides a comprehensive diagnostic of a country’s institutional capacity.⁴

C. Have A Clear Contingency Plan for Disasters

7. Risk assessment should inform comprehensive contingency plans for natural disasters. For example, country risk profiles and hazard maps should be an integral part of the design of contingency plans.⁵ They should also be developed in conjunction with incentives for households and business to adopt risk reduction behaviors. Delays in agreeing intervention priorities, lack of clarity in leadership and coordination roles between different levels of government and the responsible foreign counterparts, among others, have been cited as impediments to good planning by Clarke and Dercon (2016), based on historical events. To avoid such delays, contingency plans should carefully assign roles, spell out essential procedures and identify the critical resources that would be needed for a given response. Seychelles has set up a Division of Disaster Risk Management, which oversees contingency planning and has collaborated with the World Bank (under the CAT DDO—see below) to expand the coverage of plans.

8. Budget flexibility is essential for agile response. Even the best laid contingency plans could fail because of budget inflexibility to provide short-term financing. At the macroeconomic level, medium-term budgets with contingencies for natural disasters are regarded as best-practice. At the micro level, the budget law should permit rapid reallocation of expenditure to take care of the most pressing needs. Recently two Caribbean small states, in the context of IMF supported programs, have adopted fiscal responsibility laws that allow them to create fiscal space and to accommodate natural disasters though escape clauses.⁶

D. Arrange Contingency Financing

9. The World Bank proposes a risk-layering framework based on the frequency and severity of natural disasters in relation to the cost-effectiveness of risk transfer (see Table below). Specifically, for smaller/more frequent disasters governments should be able to cover the costs from their own resources more cheaply than taking out insurance. Governments may also be able to mobilize emergency grants or loans on a concessional basis in the immediate wake of the disaster. Events of intermediate frequency and severity could be covered by a combination of risk transfer instruments (insurance, catastrophe bonds etc.) and their own resources. Very low-frequency (above 1 in 200 years), very high-damage events are not cost-effective to insure and damage from such events is likely to be coverable only with aid from the international community

Disaster Financing Risk Layering Matrix

Disaster Financing Risk Layering Matrix

Probability of event or return period	Ex ante Financing	Ex post Financing
5 percent or up to 20 years Up to 3 percent of GDP	Budgetary reserves	Emergency budget allocations
3.33 percent or 20 to 30 years Up to 5 percent of GDP	Contingent loans	Emergency loans
1 percent or 30 to 100 years Above 5 percent of GDP	Insurance & Reinsurance	…
0.5 percent or 100 to 200 years Above 5 percent of GDP	Catastrophe bonds	Grants & humanitarian aid
Below 0.5 percent or above 200 years Above 5 percent of GDP	Global partnerships exogenous shocks and pandemics

View Table

Disaster Financing Risk Layering Matrix

Probability of event or return period	Ex ante Financing	Ex post Financing
5 percent or up to 20 years Up to 3 percent of GDP	Budgetary reserves	Emergency budget allocations
3.33 percent or 20 to 30 years Up to 5 percent of GDP	Contingent loans	Emergency loans
1 percent or 30 to 100 years Above 5 percent of GDP	Insurance & Reinsurance	…
0.5 percent or 100 to 200 years Above 5 percent of GDP	Catastrophe bonds	Grants & humanitarian aid
Below 0.5 percent or above 200 years Above 5 percent of GDP	Global partnerships exogenous shocks and pandemics

E. Self-Insurance

10. Small states should try to establish natural disaster financing ahead of time. Post-disaster increases in public expenditure in the context of economic dislocation, which lead to stagnant or falling revenues, frequently result in the need to contract public debt. At the same time, a significantly reduced debt service capacity could limit the countries’ ability to borrow or even cause them to default on existing debt, as Grenada did in 2008. Countries with high public debt ratios could find it challenging to raise debt in these circumstances. Accordingly, small states should try to create more fiscal space in the form of lower debt levels to facilitate a post-disaster scale up in public expenditure. Still, disbursements would lag post-disaster spending needs despite best efforts of the creditors to respond to an emergency, because the entire process, from application to disbursement, must be completed after the event.

F. Risk Transfer

11. Contingent loans and grants could be an indispensable part of small states’ disaster safety nets. Contingent loans like the World Bank Catastrophe deferred drawdown options (CAT DDO) can be fast-disbursing because the loan is pre-approved and ready to disburse ahead of time. This instrument is currently only available for middle income countries, and Seychelles is the only small state that has negotiated one. In a similar vein, Clarke and Dercon (2016) make a strong case for pre-financing humanitarian grants to avoid delays and dislocation following a disaster.

12. Small states should be willing to pay more than the expected loss to transfer some of their risks through insurance and other financial instruments (Cummins and Mahul, (2009)). In the face of small states’ size disadvantages and in many cases their low capacity, there is a case for assistance from the international community (both technical and possibly financial) to help them find and operationalize risk-transfer mechanisms—which are a logical supplement to current inadequate, and often late, ex-post financing.

13. Among small states, Seychelles appears be one of the most advanced in adopting an ‘optimal’ risk-layering financing model. Preliminary findings from a survey of 12 countries with the most severe disasters among small states suggest that use of risk transfer instruments is in its infancy. Further expansion may be constrained even in the long run by cost and diseconomies of scale. Our current evidence suggests that following options would be possible for Seychelles:

• Ex post Own financing. Seychelles’ most recent disasters were largely financed by ex post own financing (emergency budget allocations and emergency loans).

• Ex-ante Own-financing. Like most other small states, Seychelles provides very little budgetary resources in advance of disasters in the form of dedicated natural disaster contingency or reserve funds. Among small states, only Tuvalu used a reserve fund financing to offset part of its damage from natural disaster and Grenada has established a Hurricane contingency fund under its fiscal responsibility law. Seychelles, however, has a general contingency line in the budget which may be used in the event of a natural disaster.

• Contingent loans. Seychelles is the only small state that has accessed contingent loans. It currently subscribes to a World Bank CAT DDO under which it pays a commitment fee for the right to draw down pre-arranged financing if it is struck by a cyclone. Apart from this, Grenada’s inclusion of the hurricane clause in its restructured bond is the only instance of a small state with ex ante disaster-related provisions in state-contingent debt.

• Indemnity Insurance. Like most small states, Seychelles has traditional indemnity insurance, but its scope is limited. Traditional indemnity insurance is the costliest ex-ante financing options due to high risk premia as well as nascent or non-existing domestic insurance markets. Although Seychelles has some indemnity insurance, especially among state-owned enterprises, it might be useful for the government to consider broader coverage of strategic government assets to facilitate post disaster recovery⁷ .

• Parametric Insurance. With the assistance of the World Bank, parametric insurance appears to be gaining a foothold, especially in small-state risk-pooling arrangements. These include the CCRIF in the Caribbean, PCRFI in the Pacific island states, Africa Risk Capacity (ARC) in Africa. Parametric insurance costs less and disbursement is faster because payouts are triggered by objective parameters like wind speed and severity of earthquake as measured by Richter scale. This avoids need for costly and time-consuming assessment of the damage, and reduces moral hazard arising from incomplete information. Extension of ARC to Indian Ocean states (Madagascar is already a member) could provide the external benefit of the development of country risk profiles which could be useful for contingency planning and price discovery in insurance markets.

• Other Financial Instruments. No small state has yet issued a catastrophe bond: The World Bank issued one to finance CCRIF, the parametric insurance facility for Caribbean countries. The small size of Seychelles limits its ability to access this type of risk transfer.

G. Monetary Policy and Financial Sector Issues

14. The destruction of productive capacity in natural disasters creates huge supply shocks and the consequent shortages of food and other necessities can push up inflation for extended periods. While non-monetary disaster relief could help alleviate shortages the are usually insufficient to offset the shortfalls. In addition, inflows of monetary disaster relief, remittances and insurance payments push up demand for goods and services, while the need for urgent reconstruction of damaged infrastructure, homes and business could force increases wages and raw materials. Accordingly, inflation in general, and more specifically food price inflation can spike. Most studies have treated post disaster food price spikes as a food security issue. While this is valid focus in many instances, post disaster inflation can also be viewed as traditional macroeconomic problem. The usual policy recommendation is to accommodate the first-round effects of a supply shock and offset the second round effects. The policy advice is likely to remain true small to moderate natural disasters where the effects can be offset by conventional monetary policy. However, for large disasters in small states that causes significant dislocation less orthodox measures may have to be employed including temporary price controls and direct efforts to contain the exchange rate depreciation.

16. Following a disaster it is important that banks and other elements of the national payments system be up and running with minimum delay. Hence the central bank should ensure that robust business continuity plans are in place. Moreover, stress testing of banks could include scenarios for more extreme natural disasters to ensure that they would remain viable after a natural disaster. Over the medium term, strengthening financial access through mobile banking and microfinance networks would help to make the financial sector more responsive to the needs of more vulnerable members of the society.