Climate disasters increase debt costs for vulnerable nations
New research from the European Central Bank reveals that climate-related disasters can significantly increase sovereign bond yields. This effect is particularly pronounced for highly indebted and developing countries, impacting their borrowing costs.
Mapping climate risk to sovereign debt
The ECB's new evidence on climate risk's impact on sovereign bonds utilizes a detailed dataset spanning two decades across 52 developed and developing countries.
The analysis distinguishes between transition risk, measured by carbon emissions intensity, and physical risk, categorized as chronic (long-term temperature changes) or acute (frequency and impact of natural disasters).
Findings indicate that sovereign debt investors are increasingly pricing in transition risks, with higher emissions correlating to higher yields, especially in emerging economies.
Chronic physical risks, however, do not appear to influence yields.
The study also examines yield changes up to five years post-disaster, revealing that specific climate-related events can increase borrowing costs in the medium term, with effects varying by event type and a country's debt level.
This systematic cross-country analysis offers novel insights for fiscal and climate policy.
Fiscal buffers cushion climate blows
Climate shocks impact public finances through direct costs for emergency aid and reconstruction, and indirect effects like reduced tax revenues.
The research highlights that a country's fiscal position significantly influences the magnitude and persistence of climate shock impacts on sovereign yields.
Low-debt countries generally experience smaller, more temporary increases in borrowing costs, as their governments possess the fiscal capacity to implement mitigation strategies.
In contrast, high-debt countries face larger and more persistent effects, particularly from severe events like storms and droughts.
This is because fiscal vulnerabilities amplify perceived risks, making it harder for these nations to absorb economic disruptions and maintain debt sustainability.
Debt burden meets climate reality
Climate change poses a significant and growing risk, particularly for high-debt, fiscally vulnerable countries.
Their limited capacity to manage both severe weather impacts and green transition demands is a critical challenge.
Policymakers must deepen their understanding of these climate-debt linkages and intensify international efforts to address them.