Rising Temperatures, Falling Ratings: The Effect of Climate Change on Sovereign Creditworthiness

Patrycja Klusak (), Matthew Agarwala (), Matt Burke (), Moritz Kraemer () and Kamiar Mohaddes
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Patrycja Klusak: Norwich Business School, University of East Anglia, Norwich NR4 7TJ, United Kingdom; Bennett Institute for Public Policy, University of Cambridge, Cambridge CB3 9DT, United Kingdom
Matthew Agarwala: Bennett Institute for Public Policy, University of Cambridge, Cambridge CB3 9DT, United Kingdom; Centre for Social and Economic Research on the Global Environment, University of East Anglia, Norwich NR4 7TJ, United Kingdom; Tobin Center for Economic Policy, Yale University, New Haven, Connecticut 06511
Matt Burke: Smith School of Enterprise and the Environment, University of Oxford, Oxford OX1 3QY, United Kingdom
Moritz Kraemer: Chief Economist, LBBW (Landesbank Baden-Württemberg), 70173 Stuttgart, Germany; Centre for Sustainable Finance, SOAS University, London WC1H 0XG, United Kingdom; House of Finance, Goethe University, 60323 Frankfurt, Germany

Management Science, 2023, vol. 69, issue 12, 7468-7491

Abstract: Enthusiasm for “greening the financial system” is welcome, but a fundamental challenge remains: financial decision makers lack the necessary information. It is not enough to know that climate change is bad. Markets need credible, digestible information on how climate change translates into material risks. To bridge the gap between climate science and real-world financial indicators, we simulate the effect of climate change on sovereign credit ratings for 109 countries, creating the world’s first climate-adjusted sovereign credit rating. Under various warming scenarios, we find evidence of climate-induced sovereign downgrades as early as 2030, increasing in intensity and across more countries over the century. We find strong evidence that stringent climate policy consistent with limiting warming to below 2 °C, honoring the Paris Climate Agreement and following representative concentration pathway (RCP) 2.6, could nearly eliminate the effect of climate change on ratings. In contrast, under higher emissions scenarios (i.e., RCP 8.5), 59 sovereigns experience climate-induced downgrades by 2030, with an average reduction of 0.68 notches, rising to 81 sovereigns facing an average downgrade of 2.18 notches by 2100. We calculate the effect of climate-induced sovereign downgrades on the cost of corporate and sovereign debt. Across the sample, climate change could increase the annual interest payments on sovereign debt by US$45–$67 billion under RCP 2.6, rising to US$135–$203 billion under RCP 8.5. The additional cost to corporations is US$10–$17 billion under RCP 2.6 and US$35–$61 billion under RCP 8.5.

Keywords: sovereign credit rating; climate change; counterfactual analysis; climate-economy models; corporate debt; sovereign debt (search for similar items in EconPapers)
Date: 2023
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http://dx.doi.org/10.1287/mnsc.2023.4869 (application/pdf)

Related works:
Working Paper: Rising Temperatures, Falling Ratings: The Effect of Climate Change on Sovereign Creditworthiness (2021)
Working Paper: Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness (2021)
Working Paper: Rising Temperatures, Falling Ratings: The Effect of Climate Change on Sovereign Creditworthiness (2021)
Working Paper: Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness (2021)
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