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Climate change 'a growing trend to sovereign risk'

Climate change, specifically global warming, will be the second global mega-trend to affect sovereign credit risk through this century, according to a new report by Standard & Poor's Ratings Services.

Alongside the effects on societies due to their ageing populations, the impact of climate change will put downward pressure on sovereign ratings, warns "Climate Change Is a Global Mega-Trend for Sovereign Risk". In S&P's ranking, all of the 20 most vulnerable nations are emerging markets, and many of them are in the Asia-Pacific region - with Vietnam, Bangladesh, Fiji, the Philippines, Papua New Guinea and Indonesia among the list of nations in the bottom 10 places.

Their vulnerability is in part due to their reliance on agricultural production and employment, which can be vulnerable to shifting climate patterns and extreme weather events, but also to their weaker capacity to absorb the financial cost.

The other key points from the report, authored by S&P's chief sovereign credit risk officer Moritz Kraemer, include.

The impact on creditworthiness will probably be felt through various channels, including economic growth, external performance, and public finances.

Sovereigns will probably be unevenly affected by climate change, with poorer and lower-rated sovereigns typically hit hardest, which could contribute to rising global rating inequality.

Extreme weather events such as tropical storms and floods seem to have been on the rise since the early 1980s. Data collected by MunichRe, a reinsurer, suggest that weather-related loss-events have risen in all continents, most significantly in Asia and North America, where they increased more than fourfold.

In East Asia, overall losses (insured and non-insured) used to be below US$10 billion per year, but have regularly surpassed $20 billion during the past decade, with a peak of more than $50 billion.

Typhoon Haiyan hitting the Philippines last November has been a powerful and hugely destructive reminder of this trend.

So far, S&P has not revised the rating of a sovereign as a consequence of an extreme weather event. It has taken a view that the size of devastation, while large in absolute terms, has not been sufficient to affect a overall rating. However, assuming that extreme weather events are on the rise in terms of frequency and destruction, how this trend could feed through to its ratings on sovereign states bears consideration.

To measure the degree to which economies are exposed to the risks, S&P has created a composite of three different variables and arrived at a vulnerability ranking for the 116 sovereigns it rates.

The three variables are: share of the population living in coastal areas below 5 metres of altitude; share of agriculture in gross domestic product; and US-based Notre Dame University's vulnerability index, the Global Adaptation Index, which measures the degree to which a system is susceptible to and unable to cope with adverse effects of climate change. In its ranking, most of the 20 least vulnerable nations are advanced economies, with Luxembourg, Switzerland and Austria at the top.


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