Research by Senior Fellow Moritz Kraemer on “The Effect of Climate Change on Sovereign ...

19 January 2022

Research by Moritz Kraemer , Senior Fellow at the SOAS Centre for Sustainable Finance , with colleagues at the University of Cambridge was shortlisted for the Financial Time’s Responsible Business Education Awards 2022 .

The study, “ Rising Temperatures, Falling Ratings: The Effect of Climate Change on Sovereign Creditworthiness ”, was conducted by Moritz Kraemer jointly with Patrycja Klusak, Matthew Agarwala, Matt Burke and Kamiar Mohaddes. It simulates the effect of climate change on sovereign credit ratings for 108 countries, creating the world’s first climate-adjusted sovereign credit rating. Under various warming scenarios, the research finds evidence of climate-induced sovereign downgrades as early as 2030, increasing in intensity and across more countries over the century. It also finds strong evidence that stringent climate policy consistent with limiting warming to below 2°C, honouring the Paris Climate Agreement, and following RCP 2.6 could nearly eliminate the effect of climate change on ratings. In contrast, under higher emissions scenarios (i.e., RCP 8.5), 63 sovereigns experience climate-induced downgrades by 2030, with an average reduction of 1.02 notches, rising to 80 sovereigns facing an average downgrade of 2.48 notches by 2100. The study calculates 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$ 22–33 billion under RCP 2.6, rising to US$ 137– 205 billion under RCP 8.5. The additional cost to corporates is US$ 7.2–12.6 billion under RCP 2.6, and US$ 35.8–62.6 billion under RCP 8.5.

The study builds on previous, ground-breaking research conducted at the SOAS Centre for Sustainable Finance highlighting the impact of climate vulnerability on the cost of capital and sovereign risk. In a 2018 UN report , SOAS researchers showed for the first time that countries with higher exposure to climate vulnerability incur a risk premium on their sovereign debt. Subsequent studies ( Climate Change and Sovereign Risk , Feeling the heat: Climate risks and the cost of sovereign borrowing , and Bracing for the Typhoon: Climate change and sovereign risk in Southeast Asia ) with the Asian Development Bank Institute have corroborated the positive effect of physical climate vulnerability on the cost of government debt. Using panel data of 15,265 firms in 71 countries, SOAS researchers were able to show in a study that climate vulnerability also increases the cost of corporate debt directly and indirectly through its impact on restricting access to finance.

The Financial Times has an article on the awards: “ Academic research award: smart ideas with real-world impact ”.