Report Finds Increasing Cost of Capital in Developing Countries Due to Climate Change
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A report commissioned by the UN Environment Programme and authored by researchers from Imperial College Business School and SOAS University of London examines the relationship between climate change, sovereign credit profiles and cost of capital in developing countries.

The report defines and distinguishes between climate impacts, climate vulnerability and climate risks.

Country case studies identify economic and climate vulnerabilities, and summarize adaptation initiatives to increase resilience.

3 July 2018: Researchers from Imperial College Business School and the School of Oriental and African Studies (SOAS) University of London, UK, published a report assessing the physical impacts of climate change on countries’ borrowing costs. The study finds that the cost of borrowing will increase over time, and identifies measures to mitigate climate risk.

Commissioned by the UN Environment Programme (UNEP, or UN Environment), the report is the first systematic effort to study the relationship between climate vulnerability, sovereign credit profiles and cost of capital in developing countries. Titled ‘Climate Change and the Cost of Capital in Developing Countries,’ the research focuses on impacts in the 48 members of the Climate Vulnerable Forum (CVF) and the Vulnerable 20 Group (V20), using case studies from Bangladesh, Barbados, Guatemala, Kenya and Viet Nam.

The authors distinguish between climate impacts, climate vulnerability and climate risks. While climate impacts are “the physical manifestations of man-made climate change,” such as rising sea levels and coastal flooding, a country’s climate vulnerability is a measure of its sensitivity to these impacts, and is determined by geographic factors as well as its ability to adapt to climate change. Climate risks are the negative financial outcomes due to climate change impacts, and are defined as “the marginal increase in the rate of interest on sovereign debt that is attributable to national climate vulnerability.”

Credit ratings, determined by rating agencies, represent a borrower’s credit risk. The report finds that although no country’s sovereign credit rating has been downgraded by a major credit rating agency due to climate risk alone, these ratings are likely to incorporate climate risks in other ways. The authors identify four ways that climate change can be captured in countries’ sovereign credit profiles: through economic impacts, damage to infrastructure, rising social costs, and population shifts due to forced displacement.

In the past ten years, climate vulnerability has cost V20 countries an additional US$62 billion in interest payments.

The report highlights that for every US$10 in interest paid by developing countries, an additional dollar will be spent due to climate vulnerability, adding to these countries’ financial burden and exacerbating their economic challenges. The report’s underlying models find that, in the past ten years, climate vulnerability has cost V20 countries an additional US$62 billion in interest payments, including US$40 billion in additional interest payments on government debt alone. Future additional interest payments due to climate vulnerability are projected to increase, up to US$168 billion over the next decade. These payments, the authors note, are separate from economic losses suffered as a result of climate change, which compound the issue by reducing countries’ ability to invest in climate change mitigation and adaptation measures.

To offset increasing costs, the report emphasizes the importance of building climate risks into decision making, in recognition that climate change negatively affects returns on investment and long-term economic stability. Pursuant to this, each country case study identifies unique physical climate risks and impacts, translates them into economic indicators, and identifies how they might affect a country’s credit profile. The authors summarize the countries’ recent adaptation and resilience initiatives, identifying entry points to mitigate climate risk and reduce added costs.

Country actions include the establishment of a dedicated national climate change fund in Guatemala, strengthening coastal defense through investments in natural capital in Barbados, improving the effectiveness of salt-tolerant rice grains in Bangladesh and subsidizing insurance fees for farmers and poor households in Viet Nam. In addition to quelling overall economic costs associated with climate change, the authors note that these market and policy initiatives can increase the speed of economic recovery following climate events, and/or transfer climate-related financial risks. [Publication: Climate Change and the Cost of Capital in Developing Countries] [Imperial College London Press Release] [UNFCCC Press Release]

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