TY - JOUR
T1 - Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness
AU - Klusak, Patrycja
AU - Agarwala, Matthew
AU - Burke, Matt
AU - Kraemer, Moritz
AU - Mohaddes, Kamiar
N1 - Funding Information: M. Agarwala, P. Klusak, and M. Burke acknowledge funding from the International Network for Sustainable Financial Policy Insights, Research and Exchange (INSPIRE). M. Agarwala also acknowledges funding from The Wealth Economy Project. Supplemental Material:The data files and online appendix are available at https:/ /doi.org/10.1287/mnsc. 2023.4869.
PY - 2023/12
Y1 - 2023/12
N2 - 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, honoring the Paris Climate Agreement and following representative concentration pathway (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 corporations is US$10–$17 billion under RCP 2.6 and US$35–$61 billion under RCP 8.5.
AB - 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, honoring the Paris Climate Agreement and following representative concentration pathway (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 corporations is US$10–$17 billion under RCP 2.6 and US$35–$61 billion under RCP 8.5.
KW - climate change
KW - climate-economy models
KW - corporate debt
KW - counterfactual analysis
KW - sovereign credit rating
KW - sovereign debt
UR - http://www.scopus.com/inward/record.url?scp=85182017665&partnerID=8YFLogxK
U2 - 10.1287/mnsc.2023.4869
DO - 10.1287/mnsc.2023.4869
M3 - Article
SN - 0025-1909
VL - 69
SP - 7468
EP - 7491
JO - Management Science
JF - Management Science
IS - 12
ER -