Scientists may debate the implications of climate change, but weather events and trends in climate can affect not only the environment, but sovereign credit as well.
Moody’s Investors Service recently described how it incorporates climate risk in its credit analyses and ratings. In the new report Environmental Risks – Sovereigns: How Moody’s Assesses the Physical Effects of Climate Change on Sovereign Issuers, the agency outlined its key rating factors for climate events that, when taken together, have an impact on a country’s ability and willingness to repay its debts. These include economic, institutional and fiscal strength, as well as susceptibility to event risk.
Moody’s classifies climate risk under two categories: climate trends and climate shocks.
Climate trends include such phenomena as global warming and ocean acidification. They span multiple decades and are less likely to have a discernible impact on credit, since a country will have time to either adapt to the change or take steps to lessen its effects. Due to its nature, however, a climate trend can result in irreversible conditions and can bring about long-term changes in economic and social spheres. They also increase the probability of climate shocks.
Climate shocks, though they are one-time events, can cause significant disruption to economic activity. These include droughts, floods, hurricanes and wildfires.
A country’s susceptibility to climate on its sovereign credit depends on its exposure and resilience to such events. Higher-rated sovereigns are better able to endure such shocks through their diversified economies and stronger infrastructure. They also can carry a higher debt burden at more affordable interest rates. A sovereign that is dependent on agriculture and possesses a weaker infrastructure and smaller fiscal capacity has greater susceptibility to the effects of climate.
– Adam Fusco, editorial associate