Abstract
Selected Issues
Coping with Natural Disaster Risks in Sri Lanka1
Sri Lanka has been prone to weather-related natural disasters, possibly reflecting climate change. While the government has started to build up resiliency against disasters by introducing disaster insurance schemes and increasing mitigation spending, it can further improve disaster preparedness by undertaking policy measures in the near term. First, a contingency budget for emergency cash support and infrastructure rehabilitation can be introduced within the budget. Second, the planned introduction of an automatic pricing mechanism for electricity, combined with well-targeted safety nets, can contain fiscal risks from droughts. Third, the risk management of disaster insurance schemes can be improved to maximize its effectiveness for post-disaster reconstruction while minimizing costs. Beyond the near term, there is a need to develop a comprehensive disaster risk financing strategy that is consistent with Sri Lanka’s debt sustainability, and build up capacity for innovative risk transfer approaches such as parametric insurance.
A. Introduction
1. Sri Lanka is prone to natural disasters. Weather-related natural disasters, from severe floods to extreme droughts, are recurrent events in Sri Lanka, with greater frequency than in other countries (see chart). Large-scale flooding took place in May 2016 and was followed by a historically severe drought across the country in late 2016. The monsoon in May 2017 then triggered devastating floods and landslides in the southwest regions, claiming more than 200 lives and damaging more than 9,000 houses. Climate change would be a possible culprit for this erratic weather pattern—as global warming is projected to make monsoon rainfall more variable in South Asia, with greater frequency of devastating floods and droughts (World Bank, 2013).
Weather-Related Natural Disasters
(Number of occurrences, 2000–17, advanced & developing economies)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Sources: International Disaster Database (EM-DAT); and IMF staff calculations.Weather-Related Natural Disasters
(Number of occurrences, 2000–17, advanced & developing economies)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Sources: International Disaster Database (EM-DAT); and IMF staff calculations.Weather-Related Natural Disasters
(Number of occurrences, 2000–17, advanced & developing economies)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Sources: International Disaster Database (EM-DAT); and IMF staff calculations.2. The recent floods and drought impacted economic growth, raised inflation, and worsened the trade deficit in 2017. With two rice cultivation cycles disrupted since fall 2016, agriculture GDP contracted by 3.8 percent and 0.8 percent in 2016 and 2017, respectively. The food shortage contributed to food inflation accelerating to 14.4 percent y/y in December 2017 and an increase in food imports by about US$200 million in 2017 (0.2 percent of annual GDP). Moreover, the drought forced a shift in power generation from hydro to more expensive thermal sources, raising oil imports by about US$900 million (1 percent of GDP) in 2017. The impact has been felt disproportionately by the poor: while more than 2 million people have been affected by the floods and drought, the number of food-insecure households was estimated at 277,000 in August 2017, with 30 percent of them possibly consuming less than the daily minimum calorie intake (World Food Program, 2017). The property damage from the floods is also more difficult for poor households to overcome.
3. The authorities’ long-run economic strategy (Vision 2025) pledges to prioritize environmental protection and disaster management. It acknowledges that weak environment and disaster management have raised Sri Lanka’s vulnerability to natural disasters. The government thus commits to take steps to improve disaster management, including a national disaster reserve fund for post-disaster reconstruction. This would require assessment of Sri Lanka’s disaster risk profile, development of a risk management framework, and identification and refinement of policy toolkits.
4. Against this backdrop, this note discusses policy options to cope with natural disaster risks in Sri Lanka. Section B reviews general principles for disaster mitigation policies and discusses their application to Sri Lanka. Section C discusses policy options including contingency budgeting, electricity pricing reforms to mitigate the fiscal risks of droughts, as well as disaster-linked insurance schemes. Section D concludes.
B. Developing National Disaster Risk Management Framework
5. Enhancing resilience to natural disasters and climate change requires a comprehensive, multi-pillar risk management framework (IMF, 2016). Key elements of such a framework include: (1) identifying and assessing natural disaster risks; (2) developing self-insurance through fiscal and external buffers; (3) risk reduction through structural reforms and targeted investments in infrastructure; and (4) risk transfer through disaster risk insurance, multilateral risk pools and precautionary instruments.
6. Once identified, disaster risks could be financed through a combination of financial instruments. World Bank (2012) proposes a three-tiered approach, based on the return period of natural disasters (see figure).2
Low-risk layer (for disasters with return periods of about 5 years or less): The annual budget allocation or contingency budget could finance recurrent disaster losses such as localized floods or landslides. Disaster-linked social protection can also be used to protect vulnerable households.
Medium-risk layer (for disasters with return periods of about 5–20 years): Contingent credit could allow governments to draw down funds quickly after a natural disaster. This could finance losses from disasters that are more severe but less frequent.
High-risk layer (for disasters with return periods greater than 20 years): For low-frequency, high severity risks, governments could transfer risks to the international capital and insurance markets for example through catastrophe bonds and catastrophe derivatives.
Disaster Risk Management: Three-Tiered Approach
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Sources: World Bank (2016); and IMF and World Bank staff.Disaster Risk Management: Three-Tiered Approach
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Sources: World Bank (2016); and IMF and World Bank staff.Disaster Risk Management: Three-Tiered Approach
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Sources: World Bank (2016); and IMF and World Bank staff.7. Sri Lanka’s natural disaster risk profile is characterized by a mixture of high-frequency, low-severity events and a few single large-loss events. World Bank (2016) assessed the country’s risk profile based on historical data for 1998–2012 on ex-post disaster spending for relief assistance as well as housing and road reconstruction (the 2004 Indian Ocean earthquake and tsunami is not included in the analysis). It found that floods were relatively frequent and less variable in terms of impact severity, and that cyclones and droughts were infrequent and typically had more severe impacts. Over the long term, the combined average annual loss from natural disasters is estimated at about 0.5 percent of GDP, comprising 0.32 percent of GD P for floods, 0.05 percent of GDP for droughts, and the remainder for landslides and cyclones. For high-risk layer events, Sri Lanka is estimated to face disaster costs of about 2.4 percent of GDP once every 100 years.
8. A comprehensive natural disaster risk financing strategy should be developed, taking account of Sri Lanka’s natural disaster risk profile and public debt sustainability. As near-term policy options, contingency budgeting and well-designed disaster insurance could address risks, including for low-risk layer disasters within available fiscal space. An automatic pricing mechanism for electricity would also help to contain contingent fiscal liabilities arising from droughts. The next section will elaborate on these areas. Beyond the near term, use of contingent credit for medium-risk layer disasters should be informed by the experience with the World Bank Development Policy Loan with Catastrophe Deferred Drawdown Option (Cat-DDO), with its size and trigger optimized to safeguard public debt sustainability.3 Further, introducing innovative risk transfer options such as parametric disaster insurance, catastrophe risk pools, and catastrophe bonds (box below) would require further buildup of infrastructure and regulatory and implementation capacity.
Innovative Transfer Options
Innovative approaches for sharing natural disaster risks have emerged over the past decade.
Parametric disaster insurance. Unlike a conventional insurance scheme where a payout would be assessed against actual incurred costs, parametric insurance pays out as soon as third-party data confirm a disaster event based on pre-defined parameters. Insurance contracts can be tailored to key risks and vulnerabilities in each country, such as hurricane wind speed or earthquake intensity. While this scheme has an advantage of fast post-disaster payouts, implementation is data intensive and requires detailed databases on assets including property values and locations as well as the development of a model to estimate losses incurred following a disaster. Furthermore, cost can be high because the market for parametric insurance is still developing with only a few players developing models that are accepted by the financial markets.
Catastrophe risk pools. Disaster risks can be pooled across regions, generating economies of scale by reducing costs of operation, capital, and information required to develop parametric insurance products. Risk can be pooled within a country (e.g., Turkey’s Catastrophe Insurance Pool) or across countries (e.g., sovereign catastrophe risk pools that cover the Caribbean and Latin America, Africa, and the Pacific). By putting a price tag on risk, risk pools also increase the value of risk information and create incentives to invest in risk reduction.
Catastrophe (CAT) bonds. CAT bonds offer institutional investors high coupons, but in the event of a disaster, the principal is forgiven, freeing the resources for disaster response. Principal forgiveness depends on the chosen parametric trigger, based upon scientifically measurable characteristics of a hazard. This facilitates rapid response in the event of a disaster, while at the same time protecting investors from moral hazard arising from asymmetric information. Mexico became the first sovereign to issue CAT bonds in 2006 and subsequently issued in 2009 and 2012 using the World Bank’s MultiCat Program, a catastrophe bond issuance platform that allows governments to use a standard framework to buy insurance on affordable terms through the capital markets. The World Bank has also issued a CAT bond for the CCRIF, the parametric insurance facility for Caribbean countries.
Sources: IMF (2016), Annex IV; World Bank (2016); and World Bank (2017).C. Near-Term Options to Mitigate Disaster Financing Risks
9. Weather-related natural disasters can result in large ex-post fiscal costs often requiring budget reallocation. The table below tabulates the central government’s disaster-related spending for 2017 (actual) and 2018 (budgeted). Spending is categorized into mitigation (e.g., early weather warning system, relocation of vulnerable houses), rehabilitation (reconstruction of roads and water supply facilities damaged by the disasters), cash support (income support for farmers affected by the drought), insurance (premiums for disaster-linked insurance schemes), and others. In 2017, the central government spent Rs 54 billion (0.4 percent of GDP) to cope with the floods and drought, with rehabilitation spending comprising about two thirds of total. It also spent Rs 5 billion (0.04 percent of GDP) for cash support. Because spending for rehabilitation and cash support had not been appropriated in the original budget, the government had to revise and realign the budget by mid-year to create space for such spending. In contrast, the 2018 budget includes mitigation projects amounting to Rs 15 billion (0.1 percent of GDP), but does not appropriate spending for rehabilitation and cash support. Therefore, if severe weather calamities were to reoccur in 2018, a budget realignment exercise might again be necessary, which can delay the response to disasters.
Sri Lanka: Government Spending on Natural Disasters, 2017–18
Sri Lanka: Government Spending on Natural Disasters, 2017–18
| 2017 Actual | 2018 Budget | |||
|---|---|---|---|---|
| Rs bn | % GDP | Rs bn | % GDP | |
| Total | 53.5 | 0.41 | 21.0 | 0.15 |
| 1. Mitigation | 0.4 | 0.00 | 15.2 | 0.11 |
| 2. Rehabilitation | 34.4 | 0.26 | 0.6 | 0.00 |
| 3. Cash support | 5.2 | 0.04 | 0.0 | 0.00 |
| 4. Insurance | 5.5 | 0.04 | 3.5 | 0.02 |
| 5. Other | 8.0 | 0.06 | 1.7 | 0.01 |
Sri Lanka: Government Spending on Natural Disasters, 2017–18
| 2017 Actual | 2018 Budget | |||
|---|---|---|---|---|
| Rs bn | % GDP | Rs bn | % GDP | |
| Total | 53.5 | 0.41 | 21.0 | 0.15 |
| 1. Mitigation | 0.4 | 0.00 | 15.2 | 0.11 |
| 2. Rehabilitation | 34.4 | 0.26 | 0.6 | 0.00 |
| 3. Cash support | 5.2 | 0.04 | 0.0 | 0.00 |
| 4. Insurance | 5.5 | 0.04 | 3.5 | 0.02 |
| 5. Other | 8.0 | 0.06 | 1.7 | 0.01 |
Contingency Budgeting
10. Contingency budgeting can strengthen fiscal resiliency to natural disasters. Incorporating a contingency budget for emergency cash support and infrastructure rehabilitation in the central government budget would facilitate and speed up, if needed, ex-post assistance for families and communities damaged by natural disasters. The size of the contingency budget should be determined within the total spending envelope, in line with the fiscal balance target, to help mitigate the impact of disaster-related spending on public debt sustainability. If the fund for contingency appropriations is unused, it can be channeled to build up reserves for future disasters, with stringent governance and transparency requirements (box below). Over the medium term, the framework can be developed into a natural disaster reserve fund as used in Mexico (box below).
Use of Dedicated Contingency Funds
Countries building up budgetary reserves to address natural disaster risks may choose to utilize a dedicated fund. The main characteristics of such funds are that they have a dedicated financing source, specific governance and investment rules, and very restrictive rules regarding the way the resources are to be utilized. They are attractive for building up reserves because they provide considerable flexibility in timing expenditures across years, and can hold money in reserve, away from the demands placed on the general budget funds, until it is needed.
However, many of these funds are extra-budgetary (EBFs), meaning that they are kept outside of the usual budget process and follow different allocation rules. EBFs are less transparent and, by not being part of the regular budget process, allocate resources without taking account of alternative budget needs. A well-designed framework should have the following characteristics:
The fund should be consolidated with budget information to allow assessment of the overall fiscal situation; at a minimum, the fund balance should appear in financial statements, and drawdowns from the fund should appear in budget execution reports.
There should be a standing appropriation that allows for spending immediately after certain trigger event (such as a declaration of a disaster emergency by the executive).
It should have clear rules governing the use of the resources; follow normal government accounting standards; prepare and publish audited financial statements; define governance rules; and adopt prudent and transparent investment policies. In general, normal PFM rules should apply, but procurement rules for immediate disaster response should be adjusted to allow for quicker procurement.
It should be limited to respond to disasters with large fiscal impacts: hence, drawdowns should only start above a threshold size, or a minimum total cost estimate. Smaller expenditure needs should be covered through budget contingencies.
The size of the fund should be determined by taking into account (i) expected damages, (ii) likely available support from the international community (incl. IMF support), (iii) ability to borrow in an emergency, and (iv) opportunity costs for building up buffers. The fund should not get too large because (i) its primary purpose is to “buy time” by covering immediate expenses during which time longer-term financing can be arranged, and (ii) a large fund will generate pressures to tap it for other purposes.
The fund is a funding source, not an implementing agency. Hence, spending authority should rest with implementing agencies who decide and execute post-disaster spending. The fund typically should not have staff dedicated to it.
Mexico’s Natural Disaster Fund (FONDEN)
The Government of Mexico created the Natural Disaster Fund (FONDEN) in 1996 in response to the delays faced in the post-disaster financing of emergency and recovery activities. FONDEN is a financial mechanism to provide the federal agencies and the Mexican states with post-disaster financial resources. FONDEN’s mandate is to (a) finance post-disaster emergency assistance (through a revolving fund), and (b) provide the 32 Mexican states and the line ministries (for example, the Ministry of Infrastructure, Ministry of Health, Ministry of Education, and Ministry of Human Development) with financial resources in the case that losses from natural disasters exceed their budget capacity.
FONDEN provides finance towards post-disaster recovery and reconstruction of public assets (100 percent of federal assets and 50 percent of state and municipal assets) and low-income houses. In 1999, the FONDEN Trust Fund was established to help finance the FONDEN program through a catastrophe reserve fund that accumulates the unspent disaster budget of each year.
Source: World Bank (2012).Drought and Electricity Costs: Fiscal Risk Mitigation
11. Droughts pose a significant fiscal risk due to Sri Lanka’s reliance on hydro electricity generation and administered tariffs. Hydropower generation accounts for 30 percent of the total electricity generation capacity in Sri Lanka. Thus, droughts result in low hydro utilization and boost need for thermal generation (coal and oil), raising the cost of supplying electricity—the 2017 drought raised the average electricity cost to about Rs 20 per kWh (see chart). Unless end-user tariffs are adjusted to cost-recovery levels, elevated electricity costs result in quasi-fiscal losses for the Ceylon Electricity Board (CEB). In fact, as end-user tariffs have not been adjusted since 2014, CEB incurred losses of 0.4 percent of GDP in 2017.
Electricity Cost & Rainfall in Sri Lanka
(Rupees per kilowatt hour & milimeteres)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Source: Ministry of Finance & IMF Staff CalculationsElectricity Cost & Rainfall in Sri Lanka
(Rupees per kilowatt hour & milimeteres)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Source: Ministry of Finance & IMF Staff CalculationsElectricity Cost & Rainfall in Sri Lanka
(Rupees per kilowatt hour & milimeteres)
Citation: IMF Staff Country Reports 2018, 176; 10.5089/9781484362358.002.A003
Source: Ministry of Finance & IMF Staff Calculations12. Cost-reflective tariff adjustments, together with well-targeted cash transfers, can help mitigate these risks. Electricity subsidies should be contained because they tend to benefit the rich more than the poor. An automatic tariff adjustment mechanism under the 2015 tariff methodology—cabinet approval is expected by September 2018—would minimize such subsidies. The 2015 tariff methodology introduces price stability by fixing tariffs over a period of six months, protecting end-users from volatility in the exchange rate, international prices of fuel and coal, and weather conditions. Tariffs also reflect a forecast of likely developments in supply and cost for the forthcoming six months, ensuring that discrepancies between cost and price are eliminated over time. To mitigate the distributional impact of higher end-user electricity tariffs on the poorer segments of the population, lifeline tariffs4 and/or targeted cash transfers can be used. Ongoing reforms on social safety nets to improve targeting and coverage of existing social assistance programs are critical to support these efforts.
Improving Natural Disaster Risk Insurance
13. Public insurance schemes are currently in place to cover the population against disaster risks. The National Natural Disaster Insurance Scheme (NNDIS) was introduced in April 2016, administered by the state-owned National Insurance Trust Fund (NITF).5 It covers all households and small- and medium-sized enterprises for property losses up to Rs 2.5 million caused by disasters including cyclones, floods, and earthquakes (droughts are excluded), with premium paid by the government. The NITF then purchases reinsurance from the international reinsurance market to provide financial protection to their capital. In addition, crop insurance schemes administered by state-owned insurers cover farmers against crop losses due to natural disasters including droughts and floods.
14. There is scope to improve the risk management of the NNDIS. The flooding in 2016 and 2017 resulted in net losses for the NNDIS, estimated at about Rs 2 billion for 2016–17 (0.02 percent of GDP). This reflects relatively high costs for reinsurance (about Rs 800 million for 2017), which was not fully offset by the premium paid by the government (Rs 500 million). Improving risk management for the NNDIS would help to keep contingent liabilities at bay. Options include thoroughly assessing the risk exposure of the NNDIS, based on asset values and average payouts to households; minimizing reinsurance costs by carefully choosing risk layers to be covered, deductibles, and coverage limits; and transitioning to a targeted scheme to focus on poor and vulnerable households (e.g., reducing the maximum property losses for richer households and encouraging them to buy insurance from private insurers). The new Social Registry being developed by the Welfare Benefits Board can collect data on assets to be insured and target poor households in a way that is consistent with other welfare programs operated by the government. Further, the NITF should clearly demarcate risk exposure by insurance schemes and functions (e.g., separating accounts between the NNDIS and the reinsurance). The World Bank is providing technical assistance in this area.
15. Disaster insurance schemes can be further strengthened. The government should consider introducing a catastrophe insurance program for public assets, which can facilitate post-disaster reconstruction of damaged infrastructure such as roads and bridges. Standardizing insurance cover across key public assets would generate economies of scale and diversification benefits, thereby lowering premiums. The effectiveness of existing crop insurance schemes can be improved by assessing risk exposure, reviewing the payment trigger, and evaluating the potential benefits of risk pooling. In this context, the 2018 Budget announced establishment of a weather-indexed crop insurance scheme for rice paddies and other crops such as maize and soya, under a contributory scheme with the premium paid by both farmers and the government.
D. Conclusions
16. Given its exposure to frequent weather calamities, Sri Lanka could greatly benefit from a comprehensive disaster risk financing framework. The country has been prone to weather-related natural disasters, possibly reflecting climate change, with recent floods and droughts taking a heavy toll on Sri Lankan people and the economy. The government started to build up resiliency against disasters by introducing disaster insurance schemes and increasing mitigation spending. This note highlights three near-term policy measures to improve disaster preparedness. First, a contingency budget for emergency cash support and infrastructure rehabilitation can be introduced in the government budget within the total spending envelope consistent with the fiscal balance target. Second, the planned introduction of an automatic pricing mechanism for electricity, combined with well-targeted safety nets, can contain fiscal risks from droughts. Third, the risk management of disaster insurance schemes can be improved to maximize its effectiveness for post-disaster reconstruction while minimizing costs. Beyond the near term, there is a need to develop a comprehensive disaster risk financing strategy that is consistent with Sri Lanka’s debt sustainability, and build up infrastructure and implementation capacity that are necessary for innovative risk transfer approaches such as parametric insurance, catastrophe risk pools, and catastrophic bonds.
References
International Monetary Fund (2016). After Paris: Fiscal, Macroeconomic, and Financial Implications of Climate Change, M. Farid, M. Keen, M. Papaioannou, I. Parry, C. Pattillo, A. Ter-Martirosyan, and other IMF Staff, IMF Staff Discussion Note 16/1. https://www.imf.org/en/Publications/Staff-DiscussionNotes/Issues/2016/12/31/After-Paris-Fiscal-Macroeconomic-and-Financial-Implications-of-Global-Climate-Change-43484.
World Bank (2012). FONDEN: Mexico’s Natural Disaster Fund—A Review, Washington, DC: World Bank. http://documents.worldbank.org/curated/en/408711468286527149/FONDEN-Mexicos-natural-disaster-fund-a-review.
World Bank (2013). Turn Down the Heat: Climate Extremes, Regional Impacts, and the Case for Resilience, Washington, DC: World Bank. http://documents.worldbank.org/curated/en/975911468163736818/Turn-down-the-heat-climate-extremes-regional-impacts-and-the-case-for-resilience-full-report.
World Bank (2016). Fiscal Disaster Risk Assessment and Risk Financing Options: Sri Lanka, Washington, DC: World Bank. https://openknowledge.worldbank.org/handle/10986/24689.
World Bank (2017). Sovereign Climate and Disaster Risk Pooling: World Bank Technical Contribution to the G20, Washington, DC: World Bank. https://openknowledge.worldbank.org/handle/10986/28311.
World Food Program (2017). Sri Lanka: Drought Impact Assessment and Monitoring using Computer Assisted Telephone Interviewing (CATI) Services, August 2017. https://www.wfp.org/content/2017-sri-lanka-maps.
Prepared by Masahiro Nozaki (IMF) and Samantha Cook (World Bank, Senior Financial Sector Specialist, Disaster Risk Finance and Insurance Program, Finance, Competitiveness and Innovation).
When a natural disaster has a 10-year return period, it means the probability of its occurrence is 10 percent per year. A 100-year disaster has a probability of occurrence of 1 percent per year. This means that over a long period of time, a disaster of that magnitude will, on average, occur once every 100 years (it does not mean it occurs exactly once every 100 years).
The Cat-DDO became effective in August 2014, with the total amount of $102 million (0.13 percent of the 2014 GDP), allowing the government to draw down, upon declaring a state of emergency, following an adverse natural event. The full amount was drawn in August 2016 to finance disaster-related spending for the May 2016 flooding.
Lifeline tariffs are subsidized tariffs to support low income households. For example, in Kenya, a lifeline tariff was introduced for households that consume less than 50kWh per month, a threshold commonly used in Africa as a subsistence-level benchmark.
Established in 2006, the NITF is an insurance and reinsurance institution fully-owned by the government. Aiming at providing a safety-net and protection for all needy sectors, the NITF is mandated to provide affordable insurance coverage against riot and terrorism; crop insurance; and health and general insurance. It provides reinsurance to the domestic insurance industry.
