The leading framework assessing low-income countries’ economic health has enhanced its coverage of climate vulnerability and now rewards adaptation investments.
The recently concluded review by the IMF and World Bank of the low-income countries’ debt sustainability framework (LIC-DSF) makes important progress on adaptation. Changes to methodologies will now enhance the realism of debt outlooks to better reflect growing physical damages linked to climate change and incorporate benefits of proactive investments in adaptation and resilience. Following successive climate shocks, such as Nepal’s catastrophic glacier melt, the IMF and World Bank’s adjustments mark an important and welcomed step toward providing early warnings of climate vulnerability in economic frameworks and incentivising investment in resilience.
What is the LIC-DSF and who uses it?
The debt sustainability framework (DSF) is the main tool for multilateral institutions and other creditors to assess risks to debt sustainability in low-income countries (LICs). Simply put, it captures a country’s economic health. Its forward-looking approach is designed to send early signals about borrowing capacity and strengthen resilience to shocks. Its results determine countries’ eligibility for grants and other concessional support. Official and private creditors, as well as other participants such as credit rating agencies, also use LIC-DSF results to inform their analysis of a country’s economic and financial health and, by extension, their lending terms.
Why does this review matter?
Policy frameworks at the IMF and World Bank are periodically reviewed to maintain agility and effectiveness. The review of the LIC-DSF comes at a time of significant debt pressures worldwide and compounding risks, including physical shocks and geopolitical turmoil. 58 countries are already experiencing or at high risk of debt distress, and prolonged conflict in the Middle East could increase pressure.
At the same time, low-income countries are more vulnerable to rising climate impacts, with many facing a “debt–climate nexus” where debt pressures crowd out adaptation and resilience investments and physical shocks in turn worsen debt pressures.
Record-breaking heatwaves and wildfires in much of the Northern Hemisphere, the catastrophic glacier melts in Nepal, and a turbocharged El Niño in the equatorial Pacific are some of the latest examples of what a warming planet means for people and their livelihoods. In 2025 alone, direct economic losses from extreme weather events topped US$220 billion according to Swiss RE.
E3G has called for more rigorous analysis of climate change impacts in the LIC-DSF to provide early warnings and incentivise investment in resilience
Over the course of the LIC-DSF review, E3G identified opportunities to consolidate progress made at the country-level into institutional frameworks, enabling more realistic and even-handed analysis. Areas of concern included:
- The shortcomings of a reliance on historical data to identify vulnerability when greater frequency and intensity of extreme weather events make past data less reliable;
- The likelihood that current outlooks underappreciate risks associated with the current warming trajectory; and
- The risk that restrictive triggers for natural disaster stress testing may overlook a growing list of vulnerable countries.
Key climate reforms to the LIC-DSF and what they address
E3G’s recommendations in the LIC-DSF reforms
| Feature | E3G recommendation | LIC-DSF reform |
| Climate risk adjustment | Use climate-adjusted scenarios to enhance outlook realism | Uses three warming scenarios in long-term module: Current policies (+2.7 °C), Optimistic (+1.8 °C), and Hot (+3.6–4.4 °C) |
| Reward adaptation | Model economic benefits of adaptation investments | Models “payoffs” and “avoided income losses” from adaptation investments |
| Stress test triggers | Lower thresholds to increase coverage of natural disaster stress-test | Revised metric and data; automatic for Small Island Developing States; coverage increased from 22 to 40 countries |
What are the implications of these reforms?
These reforms demonstrate the institutions’ commitment to analytical rigor and responsiveness to the growing challenges members face. The main implications are:
- Greater realism in the wake of growing climate vulnerabilities.
- Investments in adaptation and resilience are better rewarded, incentivising action.
- The new distinction between liquidity and sustainability pressures has the potential to free up fiscal space if met with additional financing on attractive terms to invest in policies that promote durable growth and development gains.
What should we look out for next?
The new framework is expected to become operational in the second half of 2027, with an upcoming operational guidance note for staff.
- Looking ahead, we strongly urge the use of the climate risk adjusted projections, found in the long-term model, on a broad set of countries given heightened impacts of climate change worldwide.
- We support efforts to better model and enhance macroeconomic gains linked to adaptation investments.
- We encourage credit rating agencies to follow suit in rewarding countries that proactively invest in adaptation and resilience.
Looking at the bigger picture, greater realism on future losses should bolster current efforts to invest in mitigation and adaptation to support the most vulnerable
As some countries may see elevated risk of debt pressures due to greater realism on mounting physical risks, such results should:
- Reinvigorate delivery of mitigation policies given the long-held knowledge that the cost of inaction and associated warming surpasses the cost of lowering emissions, and that some impacts cannot be adapted for.
- Heighten discussions on financing options and ways to support countries and communities most vulnerable to acute physical shocks and gradual changes like sea level rise.
