A recent study led by researchers from the University of East Anglia (UEA) and the University of Cambridge in the UK has raised concerns about the potential impact of climate change on India’s sovereign credit rating. The study suggests that if steps are not taken to address climate change, India’s credit rating could face a downgrade as early as the 2030s due to the increasing volatility of temperatures and its associated consequences. Published in the journal Management Science, this study is groundbreaking as it combines climate science with real-world financial indicators, shedding light on the interconnectedness of these two domains.
The researchers employed artificial intelligence (AI) techniques to model the economic implications of climate change on the sovereign credit ratings provided by Standard and Poor’s (S&P) for 108 countries. They projected the effects over different time horizons—10, 30, and 50 years, as well as by the end of the century.
Patrycja Klusak from UEA’s Norwich Business School, who is also affiliated with Cambridge’s Bennett Institute for Public Policy, highlighted the study’s significance in bridging the gap between climate science and financial indicators. The research underscores that the repercussions of climate change could start manifesting as early as 2030, resulting in more substantial downgrades across nations as temperatures continue to rise and volatility increases.
The study underscores the importance of making green investments promptly. Delaying such investments could lead to higher borrowing costs for nations, subsequently raising corporate debt costs. The findings lend weight to the notion that credit rating agencies should proactively factor in the considerable implications of climate change, a lesson learned from their reputational setbacks during the 2008 financial crisis.
Despite the growing prominence of green finance indicators, such as Environmental, Social, and Governance (ESG) ratings, and the increasing number of corporate disclosures, the researchers emphasize that these mechanisms need to be grounded in scientific realities. Matthew Agarwala, a co-author from Cambridge’s Bennett Institute for Public Policy, highlighted the necessity for markets to have credible and comprehensible information about how climate change translates into tangible risks.
The study projects potential sovereign credit rating downgrades for various countries under different scenarios. Without emissions reduction efforts, 59 nations could face an average downgrade of more than one notch by 2030. Countries like Chile, Indonesia, China, and India might experience a two-notch downgrade, with the US, Canada, and the UK also being impacted to varying degrees. To put this into perspective, the economic turmoil caused by the Covid-19 pandemic led to 48 sovereigns experiencing downgrades between January 2020 and February 2021.
The study indicates that adhering to the goals of the Paris Climate Agreement, including limiting global temperature rise to two degrees Celsius, could mitigate short-term effects on sovereign credit ratings. However, without substantial emissions reduction, around 81 nations could witness an average downgrade of over two notches by the end of the century. India, Canada, Chile, and China could face even more significant downgrades.
The researchers’ projections are conservative, focusing solely on a linear temperature increase. When accounting for climate volatility and extreme weather events, the downgrades and associated costs could rise substantially.
The study also highlights the potential impact of sovereign downgrades on corporate ratings and debt in 28 countries. Under the Paris Agreement’s conditions, corporations might face additional costs of up to $17 billion by 2100. Without sufficient emissions reduction measures, this figure could rise to $61 billion.
The research team aimed to remain grounded in both climate science and financial practices. They used AI models trained on S&P’s ratings from 2015-2020, incorporating climate economic models and S&P’s assessments of natural disaster risks to create “climate-smart” credit ratings under different global warming scenarios.
The study also suggests that while developing nations with lower credit scores might be more vulnerable to the direct physical impacts of climate change, nations with higher credit ratings, like AAA, might face more severe downgrades due to their greater exposure to economic risks.
