Climate Risk Threatens Credit Ratings for Dozens of Countries

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(Bloomberg) — Nations that pollute the least are among the most vulnerable to disasters and face the highest barriers to the financing they need to protect themselves. As climate impacts worsen, already towering debt loads, finance costs and poor sovereign credit ratings could enforce a “vicious cycle” for developing countries, according to new research. 

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Fitch Ratings this month published an analysis suggesting that small countries prone to extreme weather and fossil-fuel exporters may face the highest sovereign risks from climate change in coming years. 

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A new tool for analysis — called Climate Vulnerability Signals — scores sovereign credit on a 100-point scale, based on both physical risks and “transition risks,” or economic sensitivity to declining fossil-fuel use and high clean-tech costs. Of 119 countries analyzed through 2050, 60 had scores high enough to suggest that they were at risk of a credit downgrade by 2050, according to the report. That would make it harder for them to borrow to finance projects that protect against climate change and speed the energy transition.

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All countries may face some added costs associated with the clean energy transition and physical impacts, the authors write. “We believe this is consistent with the general scientific view that climate risk is an issue of significant global concern,” the Fitch authors write.

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Several countries, including the Bahamas, Jamaica and the Philippines, face among the highest physical risk pressure on credit by 2050, according to the Fitch analysis. Those three nations were hit by devastating cyclones in recent years.

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Fitch’s new tool “represents an important advancement in the disclosure of climate risk factors monitored by rating agencies,” said June Choi, a PhD candidate at Stanford University and lead author of separate, preliminary research about the relationship between extreme weather and sovereign credit risk. 

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Identifying future risks is essential, she said, but it’s equally important for agencies to spell out what kind of adaptations reduce risks.

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Choi and Stanford colleagues late last month published a working draft that looks backward through time and finds a strong association between countries’ exposure to tropical storms and likelihood to have a speculative sovereign rating. The paper has yet to be submitted for peer review, but it adds to growing evidence linking climate impacts to sovereign credit risk.

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More and more extreme weather shocks make it harder to service debt, raising the cost of capital and consequently the bar for resilience investments. 

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Storms and heat are already exacerbating finance risks. The Stanford researchers’ early results show that countries exposed to tropical cyclones since 1990 have debt-to-GDP ratios 30% higher than they would have been without the storms. The combined effects of cyclones and higher temperatures are linked to GDP that is roughly 10% lower than it otherwise might have been. 

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“A lot of these most exposed countries are really in this gray zone where they’re always hit, never fully recovered, even back to baseline, and they’re just being slammed again,” Choi said.