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 109 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), 59 sovereigns experience climate-induced downgrades by 2030, with an average reduction of 0.68 notches, rising to 81 sovereigns facing an average downgrade of 2.18 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$ 45-67 billion under RCP 2.6, rising to US$ 135-203 billion under RCP 8.5. The additional cost to corporates is US$ 10-17 billion under RCP 2.6, and US$ 35-61 billion under RCP 8.5.
Klusak, P. & Agarwala, M. & Burke, M. & Kraemer, M. & Mohaddes, K., 2021. "Rising Temperatures, Falling Ratings: The Effect of Climate Change on Sovereign Creditworthiness," Cambridge Working Papers in Economics 2127, Faculty of Economics, University of Cambridge.
About the speaker
Dr. Matthew Agarwala leads the Bennett Institute for Public Policy’s Wealth Economy project at the University of Cambridge and is a member of The Productivity Institute. His research interests include wealth accounting, natural and social capital, economic measurement, green finance, productivity, and the economics of wellbeing. Matthew’s work spans sectors and disciplines, with co-authors including ecologists, conservationists, social anthropologists, civil servants, members of UK Parliament, and Nobel Laureates in peace, medicine, physics, and chemistry. Matthew works closely with the UN, World Bank, central banks, finance ministries, hedge funds, and investor groups to highlight nature-related financial risks. He is a sought-after public speaker and regular media contributor (BBC Radio, Bloomberg, Channel 4 News, Financial Times, Guardian, New York Times, Reuters, and The Times).
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