## Why Climate Change Vulnerability Is Bad for Sovereign Credit Ratings

_IMF Blog, February 17, 2021_

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## Bibliographic details
- Authors: Serhan Cevik, Joo Tovar Jalles
- Published: February 17, 2021

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### Key findings on climate vulnerability and sovereign credit
- Climate change vulnerability and resilience affect sovereign creditworthiness, borrowing costs, and default risk.
- Financial risks created by climate change are felt more acutely by developing economies, especially those lacking policy space to address climate shocks.
- Empirical analysis uses the Notre Dame Global Adaptation Initiative dataset to measure country-level climate vulnerability and resilience.

### Evidence from sovereign bond spreads (sample and method)
- Sample: a panel of 67 countries over a period of 1995–2017.
- Outcome: climate change vulnerability has adverse effects on sovereign credit ratings and bond spreads even after controlling for conventional macroeconomic determinants.

### Quantified effects on long-term (10-year) government bond spreads
- An increase of 10 percentage points in climate change vulnerability is associated with an increase of about 30 basis points in long-term (10-year) government bond spreads relative to the U.S. benchmark in the sample of 67 countries.
- An improvement of 10 percentage points in climate change resilience is associated with a decrease of 7.5 basis points in long-term government bond spreads.

### Heterogeneity by country group (advanced vs. emerging and developing)
- Climate change vulnerability has no significant impact on bond spreads and credit ratings in advanced economies.
- Effects are much greater for emerging markets and developing economies, reflecting weaker capacity to adapt and mitigate climate consequences:
  - An increase of 10 percentage points in climate change vulnerability is associated with an increase of over 150 basis points in long-term government bond spreads of emerging markets and developing economies.
  - An improvement of 10 percentage points in climate change resilience is associated with a decrease of 37.5 basis points in bond spreads for emerging markets and developing economies.
  - On average, the effect in emerging markets and developing economies is five times larger than when all countries are counted.
  - The difference between countries in the 25th and 75th quintile amounts to 233 basis points for climate change vulnerability and 56 basis points for climate change resilience.

### Link to sovereign default risk
- Sample: a panel of 116 countries over the period 1995–2017.
- Finding: countries with greater vulnerability to climate change face a higher likelihood of sovereign debt default compared to more climate-resilient countries.
- Climate change resilience can decrease the probability of sovereign debt default after controlling for conventional determinants.

### Policy implications and recommendations (building resilience)
- Benefits of climate resilience are especially pertinent as countries pursue sustainable recovery from the COVID-19 pandemic.
- Developing economies with limited fiscal capacity could benefit from alternative instruments, including catastrophe insurance and debt-for-nature swaps, to mobilize resources for resilient infrastructure and environmental conservation while reducing the debt burden.
- Recommended actions to ease climate-related strain on public finances and lower borrowing costs:
  - Pursue cost-effective climate change mitigation and adaptation strategies.
  - Build structural resilience to climate risks, including through resilient infrastructure.
  - Strengthen financial resilience through fiscal buffers and insurance schemes.
  - Improve economic diversification to reduce excessive reliance on climate-sensitive sectors.

*Source: Why Climate Change Vulnerability Is Bad for Sovereign Credit Ratings (IMF blog, Serhan Cevik and João Tovar Jalles, February 17, 2021).*

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## References

- [IMF staff research](https://www.imf.org/en/Publications/WP/Issues/2020/12/18/Feeling-the-Heat-Climate-Shocks-and-Credit-Ratings-49945)
- [similar analysis](https://www.imf.org/en/Publications/WP/Issues/2020/11/08/An-Apocalypse-Foretold-Climate-Shocks-and-Sovereign-Defaults-49784)
- [climate shocks and sovereign bond yields](https://www.imf.org/en/Publications/WP/Issues/2020/06/05/This-Changes-Everything-Climate-Shocks-and-Sovereign-Bonds-49476)

_Source: https://www.imf.org/en/blogs/articles/2021/02/17/blog-why-climate-change-vulnerability-is-bad-for-sovereign-credit-ratings_