Does climate change affect sovereign credit ratings? evidence from tropical and non-tropical countries
Date
2022-06
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Abstract
This study investigates how climate change vulnerability and readiness affect
the sovereign credit ratings of countries in tropical and non-tropical regions. The study
explores the composite indices developed by the Notre Dame Global Adaptation
Initiative (ND-GAIN) which measure a country’s overall susceptibility to climate
change (i.e., vulnerability) and its capacity to adapt with the consequences of climate
change (i.e., readiness). Using a panel dataset of 60 countries observed over the period
2011 to 2019, we estimate a baseline panel-fixed effects model to analyze the impact
of climate change vulnerability and readiness on the sovereign credit ratings issued by
Moody’s, Fitch, and Standard and Poor’s. The econometric results show that climate
change vulnerability has no significant effect on sovereign credit ratings after
controlling for readiness and other macroeconomic variables. On the other hand,
climate change readiness has a positive and significant effect on sovereign
creditworthiness. However, our results show that better climate change readiness
benefits the sovereign credit ratings of non-tropical countries more than tropical
countries. The results of the baseline panel-fixed effects regressions are robust when
tested across various specifications using subsamples (i.e., tropical and non-tropical);
across credit rating agencies (i.e., Fitch, Moody's, and S&P); and alternative
econometric models (i.e., ordered probit). Overall, the econometric results suggest a
vicious cycle where tropical countries end up with low sovereign creditworthiness due
to the difficulty of getting ratings upgrade, which can be traced to low climate change
readiness. This highlights the urgency for countries to start mainstreaming climate
change factors in their future fiscal and financial planning and policymaking.
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Keywords
sovereign credit ratings, climate change, climate change readiness