Climate Change Could Lead to Increased Debt Costs for Over 50 Nations in Next Decade
A recent study has warned that failing to address climate change will have severe financial consequences for 59 nations, potentially leading to rising debt-servicing costs within the next ten years. The study, published in the Management Science journal, simulated the economic impact of climate change on current sovereign credit ratings and found that countries such as China, India, the United States, and Canada could expect higher costs as their credit scores decline by two notches under a climate-adjusted ratings system.
The research, conducted by the University of East Anglia (UEA) and the University of Cambridge, emphasized that deferring green investments will result in increased borrowing costs for nations, thereby elevating the costs of corporate debt. These rising debt expenses will further exacerbate the economic damage caused by climate change, which has already impacted global output. Insurance giant Allianz estimates that recent heatwaves alone have already shaved off 0.6% points from global output this year.
While climate change vulnerability is acknowledged by ratings agencies, they have been cautious in quantifying the risks in their ratings exercises due to uncertainties surrounding the potential extent of damage. However, the study from UEA and Cambridge utilized artificial intelligence models trained on existing ratings from S&P Global. By combining these ratings with climate economic models and S&P’s natural disaster risk assessments, the study created new ratings for various climate scenarios.
Under a scenario that assumes emissions continue to rise, the study revealed that 59 nations would experience credit downgrades. In comparison, during the COVID-19 pandemic, a total of 48 sovereigns faced downgrades between January 2020 and February 2021. On the other hand, if the planet successfully adheres to the Paris Climate Agreement’s goal of limiting temperature rise to two degrees Celsius, the simulation indicates no short-term impact and limited long-term effects on sovereign credit ratings.
However, if emissions continue to increase throughout the century, the study warns that global debt-servicing costs could rise to the hundreds of billions of dollars. Developing nations with lower credit scores would be particularly hard-hit by the physical effects of climate change. Interestingly, the highest-ranking credit score nations would also face severe downgrades, primarily because they have the most significant potential fall from their current positions.
These findings coincide with a global push to better understand the potential economic and financial risks from climate change. A European Central Bank paper from last year urged clearer incorporation of these risks into credit ratings. S&P Global Ratings has already published its principles for environmental, social, and governance (ESG) factors in credit ratings, including a mention of the economic damage risks associated with climate change and the costs of mitigating it.
While these rating agencies have acknowledged the need to consider the ESG factors, there is an ongoing effort to refine and enhance their assessments. Fitch Ratings, for example, includes exposure to environmental impacts as a component in its assessments through its ESG Relevance Scores.
It is clear that the consequences of climate change reach far beyond environmental impact. The financial implications are significant, and nations must take necessary steps to address this global crisis. From reducing greenhouse gas emissions to investing in sustainable initiatives, countries must integrate climate considerations into their economic plans to safeguard their financial stability in the face of mounting debt costs.
