Climate change could hit the credit rating of sovereign and corporate issuers before the end of the decade, with the US, Canada, Indonesia, China, India and Chile facing some of the biggest cuts to their credit rating, according to a new study.
The research, led by the University of East Anglia (UEA) and the University of Cambridge, warned that 59 nations could experience a drop in their credit rating unless they took drastic action to reduce their emissions.
Emissions cut could eliminate effects
In contrast, researchers argued that “stringent climate policy consistent with limiting warming below 2°C and honouring the Paris Climate Agreement could nearly eliminate the effect of climate change on ratings."
The study is the first climate-adjusted sovereign credit rating using artificial intelligence to simulate the economic effects of climate change on S&P ratings for 108 countries over the next 10, 30 and 50 years, and by the end of the century. It was published in the journal Management Science.
Researchers warned that in the event of an representative concentration pathway (RCP) of 8.5°, a very high concentration of greenhouse gasses, the Chinese economy could be hardest hit by these downgrades, facing a reduction of more 7.11 notches in its S&P credit rating by the end of the century.
The surge in borrowing costs could vary significantly depending on how successful nations are in cutting back on their emissions, researchers said. If nations succeeded in drastically scaling back their emissions to a 2.6°RCP scenario, the G7 and China could face increased borrowing costs of $44 to $66 billion by 2100. But this figure could rise to more than $200bn in an 8.5°RCP scenario.
Policy implications
The findings had direct policy implications, argued lead researcher Dr Patrycja Klusak, from UEA’s Norwich Business School, and an affiliated researcher at Cambridge’s Bennett Institute for Public Policy.
“From a policy perspective, our results support the idea that deferring green investments will increase costs of borrowing for nations, which will translate into higher costs of corporate debt.”
“Ratings agencies took a reputational hit for failing to anticipate the 2008 financial crisis. It is imperative that they are proactive in reflecting the much larger consequences of climate change now” Klusak added.
Investors split on bond market outlook
The study comes a week after US rating agency Fitch has downgraded US sovereign debt to AA+ amid ongoing political uncertainty over the extension of the debt ceiling.
With the global inflation and rates outlook uncertain, a war is wagering among some of the world’s largest investors whether to go big on US sovereign debt or to short it. While Warren Buffett’s Berkshire Hathaway has snapped up $10 billion in US treasuries right after the announcement of the credit downgrade, Pershing Square Capital Management’s founder Bill Ackman said he was now shorting 30 year US treasuries.
For institutional investors who own sovereign bonds, a rise in borrowing costs could make these assets relatively more attractive, yet these returns could be undermined if inflation remains high.
The size of global sovereign debt market has surged after more than a decade of quantitative easing. The global bond market has risen to more than $140 trillion in assets by the end of 2022, compared to around $60 trillion in 2005, according to the Bank for International Settlements. About half of these bonds in circulation today are sovereign bonds, a fact which could make the rise in sovereign borrowing costs even more explosive.
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