Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness

52 Pages Posted: 26 Mar 2021

See all articles by Patrycja Klusak

Patrycja Klusak

Norwich Business School; Bennett Institute for Public Policy, University of Cambridge

Matthew Agarwala

University of Cambridge - Bennett Institute for Public Policy

Matt Burke

University of East Anglia, UK; Bennett Institute for Public Policy, University of Cambridge, UK; Sheffield Hallam University - Sheffield Business School

Moritz Kraemer

Senior Fellow

Kamiar Mohaddes

University of Cambridge - Judge Business School; University of Cambridge - King's College, Cambridge

Date Written: March 25, 2021

Abstract

Enthusiasm for ‘greening the financial system’ is welcome, but a fundamental challenge remains: financial decision makers lack the necessary information. It is not enough to know that climate change is bad. Markets need credible, digestible information on how climate change translates into material risks. To bridge the gap between climate science and real-world financial indicators, we simulate the effect of climate change on sovereign credit ratings for 108 countries, creating the world’s first climate-adjusted sovereign credit rating. Under various warming scenarios, we find evidence of climate-induced sovereign downgrades as early as 2030, increasing in intensity and across more countries over the century. We find strong evidence that stringent climate policy consistent with limiting warming to below 2°C, honouring the Paris Climate Agreement, and following RCP 2.6 could nearly eliminate the effect of climate change on ratings. In contrast, under higher emissions scenarios (i.e., RCP 8.5), 63 sovereigns experience climate-induced downgrades by 2030, with an average reduction of 1.02 notches, rising to 80 sovereigns facing an average downgrade of 2.48 notches by 2100. We calculate the effect of climate-induced sovereign downgrades on the cost of corporate and sovereign debt. Across the sample, climate change could increase the annual interest payments on sovereign debt by US$ 22–33 billion under RCP 2.6, rising to US$ 137–205 billion under RCP 8.5. The additional cost to corporates is US$ 7.2–12.6 billion under RCP 2.6, and US$ 35.8–62.6 billion under RCP 8.5.

Keywords: Sovereign credit rating, climate change, counterfactual analysis, climate-economy models, corporate debt, sovereign debt

Suggested Citation

Klusak, Patrycja and Klusak, Patrycja and Agarwala, Matthew and Burke, Matt and Burke, Matt and Kraemer, Moritz and Mohaddes, Kamiar, Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness (March 25, 2021). CAMA Working Paper No. 34/2021, Available at SSRN: https://ssrn.com/abstract=3811958 or http://dx.doi.org/10.2139/ssrn.3811958

Patrycja Klusak

Norwich Business School ( email )

Norwich Research Park
Norwich, Norfolk NR4 7TJ
United Kingdom

HOME PAGE: http://https://www.uea.ac.uk/norwich-business-school/people/profile/p-klusak

Bennett Institute for Public Policy, University of Cambridge ( email )

First Floor
17 Mill Lane
Cambridge, CB2 1RX
Great Britain

Matthew Agarwala

University of Cambridge - Bennett Institute for Public Policy ( email )

First Floor, 17 Mill Lane
Cambridge, CB2 1RX
Great Britain

Matt Burke

University of East Anglia, UK; Bennett Institute for Public Policy, University of Cambridge, UK ( email )

Norwich Research Park
Norwich, Norfolk NR4 7TJ
United Kingdom

Sheffield Hallam University - Sheffield Business School ( email )

City Campus
Howard Street
Sheffield, S1 1WB
United Kingdom

Moritz Kraemer

Senior Fellow

SOAS - University of London
School of Finance and Management, Thornhaugh Stree
London,, WC1H 0XG
United Kingdom

Kamiar Mohaddes (Contact Author)

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom
+44 (0)1223 766933 (Phone)

HOME PAGE: http://https://www.mohaddes.org/

University of Cambridge - King's College, Cambridge ( email )

King's Parade
Cambridge, CB2 1ST
United Kingdom
+44 (0)1223 766933 (Phone)

HOME PAGE: http://https://www.mohaddes.org/

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