Sovereign issuers with the greatest level of exposure to climate risk are 18.5% more likely to default, according to research from ICE.
The stock exchange and data specialist published a report last week, in which it assigned scores to more than 200 sovereigns based on how vulnerable they are to climate-related fatalities, water stress, changes in productivity and temperature.
ICE’s report – The link between physical climate risk and sovereign default – showed the assessments were based on a combination of historical estimates and future projections.
Each issuer was graded from 1 to 5 according to their financial exposure to physical climate risk, with 5 representing the highest level of exposure.
ICE then looked at sovereign defaults between 1995 and 2020 and found that – after controlling for certain development and economic indicators – countries with higher scores had higher default probabilities than those with low scores.
“Holding all else constant, a country with an ICE Physical Risk Score of 5 is associated with a 18.5% higher probability of default on average than a country with an ICE Physical Risk Score of 0,” the report said.
“Said another way, after accounting for economic indicators, sovereign default probability increases by 3.7% on average for each one unit increase in the ICE Physical Risk Score.”
All of the seven countries that ICE rated above 3.5 in its ranking had defaulted at least once in the past, it noted.
Climate change is expected to affect national financial stability in numerous ways, including health, migration, food security and natural capital.
Many countries have already experienced significant economic losses as a result of rising temperatures and extreme weather events. Wildfires in 2019 and 2020 are estimated to have cost Australia some $100bn, for example.
ICE noted that “under realistic emissions scenarios” the impacts of climate change are likely to worsen and have a “profound” effect on sovereign nations’ fiscal stability and economic security.
“Our goal is to inform market participants and stakeholders about the implications of climate risk for international debt markets, with a particular focus on the challenges facing the world’s most climate-vulnerable countries,” it explained.
Some of the world’s least economically developed countries are also the most vulnerable to the physical effects of climate change, and are already overloaded with interest payments to creditors.
The UN estimates that at least 45 and 19 countries currently spend more on interest payments than healthcare and education, respectively.
Potential ratings downgrades as a result of climate risk are expected to exacerbate this situation for some governments over coming years, and well as increasing their need for finance.
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