SOAS economists contribute to new report on ‘Nature Loss and Sovereign Credit Ratings’

23 June 2022

The world’s first biodiversity-adjusted sovereign credit rating shows how ecological destruction affects public finances – driving downgrades, debt crises and soaring borrowing costs, according to a team of economists from SOAS University of London, the University of Cambridge, the University of East Anglia, and Sheffield Hallam University.

A new report on ‘ Nature Loss and Sovereign Credit Ratings ’ published with the Finance for Biodiversity Initiative shows that a loss of plant and animal species may already be set to cause major sovereign downgrades. If parts of the world see a “partial ecosystems collapse” of fisheries, tropical timber production and wild pollination – as simulated by the World Bank – then more than half the 26 nations studied would face downgrades, with India falling four notches and China plummeting by six on the 20-notch scale.

Building on research published last year by the World Bank , the report charts the credit ratings of 26 nations across three different scenarios. If the struggling ecosystems in the analysis actually start to collapse, more than half the study’s countries will experience a drop of their credit ratings by at least one notch, with a third falling by three or more notches.

Across the 26 countries, these downgrades would increase the annual interest payment on debt by up to US$53 billion a year, leaving many developing nations at significant risk of sovereign debt default.

China’s credit rating falls by six notches, creating added annual interest payments of up to $18 billion, while an already indebted corporate sector incurs an extra $20-30 billion of debt. Malaysia falls by almost seven notches, with up to $2.6 billion in additional interest payments every year.

Downgrades of four notches would hit India, Bangladesh and Indonesia, along with billions in interest, and 12 countries of the 26 in the study increase their risk of bankruptcy by more than 10%, most dramatically for Bangladesh (41%), Ethiopia (38%) and India (29%). Six countries in the study, including Pakistan and Madagascar, would become more likely than not to default if hit by a sudden collapse of natural ecosystems.

The report argues that countries protecting “biological assets” could see creditworthiness improve. The report highlights that the AI-driven simulations are cautious – only covering fisheries, timber and pollinators, while in reality nature loss degrades everything from human health to farmable soil – as risk from biodiversity loss is extremely difficult to quantify.

Sovereign ratings assess the creditworthiness of nations, covering over US$66 trillion in sovereign debt. The agencies behind these ratings act as gatekeepers to global capital. Currently, credit rating agencies assess difficult-to-quantify financial risks such as possible geopolitical events, but largely ignore the economic consequences of ecological degradation. “Nature-blind” investors cannot manage risk effectively, and omitting biodiversity loss from calculations could undermine market stability.

“As everywhere, the laws of demand and supply apply here as well. Diminished supply elsewhere will increase the scarcity and consequently the value of conserved natural assets,” said co-author Dr Moritz Kraemer , a former S&P chief sovereign credit officer now a Senior Fellow at the the SOAS Centre for Sustainable Finance. “Incorporating nature risk into sovereign credit ratings would create a strong incentive for governments to enhance environmental protection,” he said.

Co-author Pr ofessor Ulrich Volz, Director of the SOAS Centre for Sustainable Finance, added: “Biodiversity-related risks are a material risk to economic activity and public finances. Protecting the natural habitat is not just important for nature’s sake but also crucial for safeguarding macroeconomic stability.”

The report is available for download.