New research highlights relationship between climate risk and sovereign risk, and outlines steps governments can take to avoid ‘ever-worsening’ spiral of climate vulnerability and unsustainable debt burdens
Governments and their central banks must take urgent action to address climate-related risk if they want to protect the overall financial stability of their nations, fresh research has warned.
A report published today by the SOAS’ Centre for Sustainable Finance, the Asian Development Bank Institute, Four Twenty Seven, and the World Wide Fund for Nature Singapore sets out the the myriad ways climate risks can amplify sovereign risk and harm macro financial stability.
Identified risks range from the direct fiscal impacts of climate-related natural disasters and adaptation and mitigation programmes to the more indirect impacts climate change can have on trade, capital flows, and a region’s political stability. The report also highlights the negative impacts climate-related risks can have on the stability of a country’s financial sector.
After analysing a sample of 40 developed and emerging economies, the researchers concluded that higher climate risk vulnerability leads to significant increases in the cost of sovereign borrowing.
As such, they urge governments to “climate-proof” their economies and public finances to avoid an “ever-worsening spiral of climate vulnerability and unsustainable debt burdens”.
“There is an urgent need to boost investment in climate adaptation and resilience. At the same time, governments must climate-proof their finances and debt management strategies,” said Dr Ulrich Volz, lead report author and director of SOAS’ centre for sustainable finance. “Central banks and supervisors will have to play crucial roles in analysing and mitigating macrofinancial risks and making sure that the financial sector is not only prepared to weather this storm, but that it also supports the economy and society in becoming more resilient to the impacts of climate change.”
The report recommends that financial authorities integrate climate risk into their risk management processes and calls on governments to prioritise comprehensive climate vulnerability assessments, while also working with the financial sector to promote climate adaptation investment.
It predicts that the implications of climate change for macro financial stability and sovereign risk is likely to be material for most, if not all, countries in Southeast Asia, a region with significant exposure to climate hazards such as storms, floods, sea level rise, heat waves, and water stress.
ASEAN economic community deputy secretary-general Aladdin D Rillo urged policymakers to heed the recommendations in the report. “Without taking appropriate measures to address vulnerability to climate risks, the implications for sovereign risk can have substantial negative ramifications for financial stability, sovereign financing cost, and, indeed, economic growth,” he said. “We urgently need to scale up our collective efforts to climate-proof our economies and societies.”