Climate Change and Sovereign Risk

This analysis examines 40 developed and emerging economies, and demonstrates that higher climate risk vulnerability leads to significant rises in the cost of sovereign borrowing.

Co-published by SOAS University of London, the Asian Development Bank Institute, the World Wide Fund for Nature and Four Twenty Seven, the study finds that premia on sovereign bond yields were around 275 basis points for economies highly exposed to climate risk, compared to 113 basis points for emerging market economies overall.

“Impulse response analysis suggests that shocks imposed on climate vulnerability and resilience have permanent effects on bond yields,” the analysis finds. “Economies highly exposed to climate risks experience larger permanent effects on yields than economies with lower exposure.”

The research outlines six transmission channels through which climate change affects sovereign risk. These include:

1. Fiscal impacts of climate-related natural disasters 
2. Fiscal impacts of adaptation and mitigation policies 
3. Macroeconomic impacts of climate change 
4. Impacts on international trade and capital flows 
5. Impacts of financial sector stability
6. Impacts of political stability 

These interconnected transmission channels amplify sovereign risk and are explored and illustrated using examples from south-east Asia.

The report concludes with five policy recommendations:

• Comprehensive sectoral and national vulnerability assessments
• Mainstreaming climate risk analysis into public financial management
• Climate-informed monetary and prudential frameworks and operations 
• Financial sector policies to scale-up investment in climate adaptation
• Policies to develop insurance solutions

It also recommends that international financial institutions provide technical assistance and training, support risk monitoring, provide finance for adaptation and resilience investment and offer emergency lending and crisis support.