This report provides a comprehensive analysis of the ways in which climate risks affect sovereign risk.
The report demonstrates new empirical evidence of how climate risk and resilience influence the costs of capital, informing an increasingly critical conversation around the financial implications of climate change and how countries can prepare for these impacts. Using a sample of 40 developed and emerging economies, econometric analysis shows that higher climate risk vulnerability leads to significant rises in the cost of sovereign borrowing. Premia on sovereign bond yields amount to around 275 basis points for economies highly exposed to climate risk. This risk premium is estimated at 113 basis points for emerging market economies overall, and 155 basis points for Southeast Asian economies.
The report provides a closer look at Southeast Asia, a region with significant exposure to climate hazards such as storms, floods, sea level rise, heat waves and water stress. Physical risks are expected to considerably affect economic activity, international commerce, employment, and public finances across Southeast Asian countries. Transition risks will be prominent as exports and economies become affected by international climate policies, technological change, and changing consumption patterns. The implications of climate change for macrofinancial stability and sovereign risk are likely to be material for most if not all countries in Southeast Asia.
The report highlights the need for governments to climate-proof their economies and public finances or potentially face an ever-worsening spiral of climate vulnerability and unsustainable debt burdens. It outlines five policy recommendations, emphasising the importance for financial authorities to integrate climate risk into their risk management processes and for governments to prioritize comprehensive climate vulnerability assessments and work with the financial sector to promote investment in climate adaptation.