Integrating Nature Into Debt Sustainability Analysis

Multilateral organisations would be making a “grave omission” if they fail to include biodiversity-related financial risks in debt sustainability analyses, according to this report. Authors Moritz Kraemer and Ulrich Volz say that ignoring the financial risk posed by nature loss misdiagnoses the state of debt sustainability and increases the risk of sovereign debt crises and ecosystem collapse.

Natural infrastructure is essential for economic and social productivity as well as resilience and adaptability, according to the authors, yet it is disappearing at an accelerating rate. This report, published by the Finance for Biodiversity Initiative in partnership with the SOAS Centre for Sustainable Finance, documents the “disastrous economic consequences” of ecosystem loss.

The report highlights World Bank estimates that ecosystem collapse could cost upwards of USD$2.7tn and calls for a precautionary approach to protect financial stability.

The authors also say the crisis of unsustainable sovereign debt is exacerbating biodiversity risks, with 90% of key natural resources located across just 39% of land. Much of this is in developing and emerging economies which are already facing unsustainable levels of sovereign debt.

Many developing economies are rich in biodiversity but disproportionately exposed to the financial risks of nature loss, as natural capital makes up a higher share of their total wealth. Unsustainable debt burdens create an incentive to deplete their natural resources, which can create a reinforcing cycle of accelerating nature loss and rising financial risk.

The report outlines a four-step methodology for integrating nature risks into debt sustainability stress testing using the scenario of a partial collapse of ecosystem services:

1. identify the impact of biodiversity loss using forward-looking World Bank estimates
2. determine the resulting size and structure of government borrowing requirements
3. adjust funding costs and estimate interest increases by calculating output loss, resilience, and growth
4. implement the assessment by estimating gross financing needs and GDP-to-debt ratio

The authors then apply this process to six countries: Bangladesh, Brazil, Canada, Indonesia, Nigeria and Vietnam.

The results confirm that biodiversity loss poses a serious threat to financial stability. Under a scenario of partial nature collapse, the debt-to-GDP ratio could rise steeply in Bangladesh (15%), Nigeria (13%), Indonesia (11%) and Brazil (7%). In Bangladesh and Vietnam, partial ecosystem collapse would eclipse all other IMF stress scenarios in severity.

The report highlights challenges in integrating nature risks, such as non-linearities and tipping points, as well as a lack of data and common metrics. But the authors also note developments in data quality due to the ongoing work of the Taskforce on Nature-related Financial Disclosures.