Feeling the Heat: Climate Shocks and Credit Ratings

WP/20/286

Feeling the Heat: Climate Shocks and Credit Ratings

by Serhan Cevik and João Tovar Jalles

©International Monetary Fund. Not for Redistribution

© 2020 International Monetary Fund

WP/20/286

IMF Working Paper

Western Hemisphere Department

Feeling the Heat: Climate Shocks and Credit Ratings

Prepared by Serhan Cevik and João Tovar Jalles1

Authorized for distribution by Bert van Selm

December 2020

IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the

author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Abstract

Climate change is an existential threat to the world economy like no other, with complex, evolving and nonlinear dynamics that remain a source of great uncertainty. There is a bourgeoning literature on the economic impact of climate change, but research on how climate change affects sovereign risks is limited. Building on our previous research focusing on the impact of climate change on sovereign risks, this paper empirically investigates how climate change may affect sovereign credit ratings. By means of binary-choice models, we find that climate change vulnerability has adverse effects on sovereign credit ratings, after controlling for conventional macroeconomic determinants of credit worthiness. On the other hand, with regards to climate change resilience, we find that countries with greater climate change resilience benefit from higher (better) credit ratings. These findings, robust to a battery of sensitivity checks, also show that impact of climate change is disproportionately greater in developing countries due largely to weaker capacity to adapt to and mitigate the consequences of climate change.

JEL Classification Numbers: C23; C35; C36; G24; Q54; Q56

Keywords: Climate change; vulnerability; resilience; credit ratings

Author's E-MailAddress: [e-mail]; [e-mail]

1 The authors acknowledge helpful comments and suggestions from Edgar Buckley, Karina Manasseh, Samuel Mann, and William Murray. The opinions expressed herein solely belong to the authors and should not be attributed to the IMF, its Executive Board, or its management (Cevik) and the University of Lisbon´s School of Economics and Management (Jalles).

©International Monetary Fund. Not for Redistribution

2

Contents	Page
Abstract .................................................................................................................................................................................	2
I.I ntroduction .....................................................................................................................................................................	3
II. A Brief Overview of the Literature..........................................................................................................................	5
III. Data Overview...............................................................................................................................................................	6
IV. Econometric Methodology...................................................................................................................................	11
V. Empirical Results........................................................................................................................................................	12
VI. Conclusion ..................................................................................................................................................................	17
References.........................................................................................................................................................................	20

©International Monetary Fund. Not for Redistribution