Feeling the Heat: Climate Risks and the Cost of Sovereign Borrowing

Abstract

This paper empirically examines the link between the cost of sovereign borrowing and climate risk for 40 advanced and emerging economies. Controlling for a large set of domestic and global factors, the paper shows that both vulnerability and resilience to climate risk are important factors driving the cost of sovereign borrowing at the global level. Overall, we find that vulnerability to the direct effects of climate change matter substantially more than climate risk resilience in terms of the implications for sovereign borrowing costs. Moreover, the magnitude of the effect on bond yields is progressively higher for countries deemed highly vulnerable to climate change. Impulse response analysis from a set of panel structural VAR models indicates that the reaction of bond yields to shocks imposed on climate vulnerability and resilience become permanent after around 12 quarters, with high risk economies experiencing larger permanent effects on yields than other country groups.

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

“…18 One important concern is whether predicting climate-induced downgrades in the future may increase the cost of debt today. This is particularly concerning for low-income countries where evidence suggests that climaterelated natural disasters are already hitting bond yields (Beirne et al, 2020;Buhr et al, 2018;Kling et al, 2018). If investors believed that e.g., India is not a climate-safe investment, the perverse result could be to starve India of the access to capital it needs to increase resilience.…”

“…Most of the literature on climate and sovereign risk focuses on bond yields rather than ratings (Beirne et al, 2020;Buhr et al, 2018;Capelle-Blancard et al, 2017;Cevik & Jalles 2020b,c;Crifo et al, 2015;Kling et al, 2018). An increasingly common finding is that high climate vulnerability and low resilience increases sovereign borrowing costs, especially for lower income countries (Beirne et al, 2020;Kling et al, 2018).…”

“…Most of the literature on climate and sovereign risk focuses on bond yields rather than ratings (Beirne et al, 2020;Buhr et al, 2018;Capelle-Blancard et al, 2017;Cevik & Jalles 2020b,c;Crifo et al, 2015;Kling et al, 2018). An increasingly common finding is that high climate vulnerability and low resilience increases sovereign borrowing costs, especially for lower income countries (Beirne et al, 2020;Kling et al, 2018). Calculating the impact of climate risk on bond yields for 46 countries from 1996 to 2016, Buhr et al (2018) find that climate related vulnerability increased the cost of debt of developing countries by 117 basis points, which translates into USD 40 billion in additional interest payments on government debt over the period of past 10 years.…”

Asian Development Outlook 2021: Financing a Green and Inclusive Recovery

“…From the supply side, public and private financing entities can signal their commitment to the Sustainable Development Goals by tapping green and social finance, thereby attracting positive investor recognition and broadening their investor base (Ghoul et al 2011;Chava 2014). The literature shows that firms beset by environmental issues have less diversified investor bases and pay higher costs for capital (Seltzer, Starks, and Zhu 2020;Painter 2020;Battiston and Monasterolo 2020;de Greiff, Delis, and Ongena 2018;Ng and Rezaee 2015;Beirne, Renzhi, and Volz 2020). By contrast, firms that tap green and social finance can signal to investors their awareness of positive green and social outcomes and their commitment to achieving them.…”

Asia Bond Monitor June 2021

“…Rating agencies and financial markets are increasingly paying attention to these risks. Empirical evidence shows that climate vulnerability raises the cost of capital for countries (Buhr et al 2018;Beirne, Renzhi, and Volz 2020) and that macrofinancial risks from climate change may also amplify sovereign risk (Volz et al 2020). Moreover, climate vulnerability is also affecting firms' cost of capital and access to finance (Kling et al 2021).…”