A study on the economic impacts of climate change on current sovereign credit ratings found that the global failure to control carbon emissions will lead to increased debt service costs for 59 countries over the next decade. This is because their credit ratings may fall, leading them to pay more in interest and debt costs.
According to the study published in the Journal of Management Science this Monday, countries such as China, India, the United States, and Canada could face higher debt service costs due to a two-notch downgrade in their credit ratings.
In this study led by the University of East Anglia (UEA) and Cambridge University, researcher Patricia Krusac pointed out, "Countries delaying green and sustainable investments will see their borrowing costs rise. Failure to invest timely in green energy and environmental projects might lead to downgraded credit ratings, thereby incurring higher interest on their debt. This would further impact corporate debt costs."
Rising debt service costs are just one of many negative impacts of climate change on the overall economy. Climate change can also lead to an increase in natural disasters, resource shortages, and ecosystem destruction, all of which can have a broader and more profound impact on the economy. The insurance giant Allianz estimates that the recent hot weather has already reduced global output by 0.6 percentage points this year, further affecting global economic growth.
Rating agencies maintain a cautious stance when considering climate change risks. While these agencies acknowledge the economic damage caused by climate change, its complex and variable impact makes it difficult to accurately predict the potential damage extent and scope.
This study uses artificial intelligence models to train on existing Standard & Poor’s Global ratings, understanding and capturing different nations' credit statuses, then combines them with climate economic models and S&P's natural disaster risk assessments, creating new credit ratings for various climate scenarios. This will help better understand the potential impacts of climate change on the economy and credit ratings, providing more accurate assessments and predictions.
The potential impact of climate change on national credit ratings is closely related to significant events. Under rising carbon emissions, the deterioration of climate issues has led to downgrades for 59 sovereign nations. However, the worst-case scenario of high emissions could lead to a rise in global debt service costs to tens of billions of dollars in cash. In contrast, during the COVID-19 pandemic from January 2020 to February 2021, 48 sovereign nations were downgraded due to its economic impact.
If the global community adheres to the goals of the Paris Climate Agreement, keeping temperature rise within two degrees, sovereign credit ratings will not be affected in the short term but may face limited impact in the long term.
While lower-rated developing countries suffer actual physical impacts of climate change, damaging their credit ratings, higher-rated countries may experience larger falls due to their already high credit standings once downgraded.
These findings come as global regulators strive to better understand the potential damage climate change could inflict on the economy and the global financial system. Last year, a report from the European Central Bank called for clearer incorporation of these risks into credit ratings.
Standard & Poor’s Global Ratings has released its environmental, social, and governance principles used in credit ratings, which include risks related to the potential economic damage caused by climate change and the costs needed to mitigate these risks. Meanwhile, the agency has declined to comment on the UEA/Cambridge study.
Fitch Ratings' "ESG Relevance Scores" system considers environmental, social, and governance factors, with environmental impact seen as a crucial part of the assessment. This means Fitch Ratings takes into account the performance and risks in environmental aspects when rating bond issuers, corporations, or countries.
Fitch Ratings states that environmental, social, and governance factors are long-standing and increasingly important influences on credit ratings. They will continue to weigh these factors in their analysis and frequently publish relevant research and commentary.
