The world’s first biodiversity-adjusted government bond ratings show how environmental degradation is affecting public finances – leading to downgrades, debt crises and rising borrowing costs, according to a team of economists led by the University of Cambridge.
The loss of plant and animal species could already result in significant government bond downgrades, with China and Indonesia falling two notches as early as 2030 under a business-as-usual scenario.
If parts of the world experience “partial ecosystem collapse” of fisheries, tropical timber production and wild pollination – as simulated by the World Bank – then more than half of the 26 nations surveyed face downgrades, with India down four notches and China down six crashes on the 20s scale.
Across the 26 countries, these downgrades would increase annual interest payments on debt by as much as $53 billion a year, putting many developing countries at significant risk of sovereign debt default — effectively bankruptcy.
Economists say their AI-driven simulations are cautious – they only cover fisheries, timber and pollinators, when in reality the loss of nature is worsening everything from human health to agricultural soil – as the risk of biodiversity loss is extremely grave is to be quantified.
Government ratings assess the creditworthiness of nations and include more than $66 trillion in government debt. The agencies behind these ratings act as gatekeepers to global capital.
Currently, agencies such as Moody’s and Standard & Poor’s assess financial risks that are difficult to quantify, such as possible geopolitical events, but largely ignore the economic consequences of environmental degradation.
A team of economists from the Universities of Cambridge, East Anglia, Sheffield Hallam and SOAS University of London argue that “naturally blind” investors cannot manage risk effectively and omitting biodiversity loss from calculations “could undermine market stability”.
“Not only the financiers are the losers,” said lead author Dr. Matthew Agarwala of the University of Cambridge’s Bennett Institute for Public Policy. “The increased sovereign risk is causing markets to charge higher risk premia, which means governments – and ultimately taxpayers – are paying more for credit.”
“As nature loss reduces economic output, countries become more difficult to service their debts, straining government budgets and forcing them to raise taxes, cut spending or increase inflation. This will have dire consequences for ordinary people.”
The report, supported by the Finance for Biodiversity Initiative, is published today.
Nature and biodiversity provide ecosystem services – from bees that pollinate crops to plants that prevent flooding – the loss of which comes with high economic costs.
“Economies that rely on ecosystems face a choice: pay now by investing in nature, or pay later through higher borrowing costs and rising debt,” said study co-author Dr. Matt Burke, Senior Lecturer at Sheffield Hallam University.
“The ‘Pay Now’ option generates long-term returns for people, business and nature. The pay later option carries significant downside risks with little to no upside.”
Building on research published by the World Bank last year, the latest report presents the credit ratings of 26 nations under three different scenarios.
These are a halt to biodiversity loss as well as a business-as-usual scenario in which nature declines at current rates, including the loss of 46 million hectares of wilderness by 2030.
The team also studied a “tipping point” scenario in which ecosystems partially collapse, resulting in a 90 percent reduction in marine fisheries, wild pollination and timber provision services from tropical regions where natural forest loss is most acute .
Even without turning points, current trends alone see four nations facing credit rating downgrades over the next eight years: India and Bangladesh by one notch and China and Indonesia by two notches.
If the struggling ecosystems in the analysis do begin to collapse, more than half of the countries in the study will fall by at least one notch, and a third by three or more notches.
China’s credit rating falls six notches, resulting in up to $18 billion in additional annual interest payments, while an already indebted corporate sector incurs an additional $20 billion to $30 billion in debt. Malaysia falls nearly seven notches, with up to $2.6 billion in additional interest payments a year.
Four-notch downgrades would hit India, Bangladesh and Indonesia, along with billions in interest rates, and 12 of the 26 countries in the study increase their risk of default by more than 10%, most dramatically for Bangladesh (41%), Ethiopia (38%) and India (29%).
Six countries in the study, including Pakistan and Madagascar, would be more likely to default if hit by a sudden collapse in natural ecosystems.
“Developing countries are already burdened with crippling debt burdens caused by Covid-19 and rising prices, and the loss of nature will push these nations closer to the brink,” said co-author Dr. Patrycja Klusak, Associate Researcher at the Bennett Institute in Cambridge and Associate Professor at the University of East Anglia.
“There is an urgent need for innovation in the government bond markets. Priorities include incorporating science into forward-looking risk assessments, providing immediate support to developing countries to avoid sovereign defaults, and using debt markets to support conservation investment.”
The researchers argue that countries that protect “biological assets” could improve their creditworthiness.
“As everywhere else, the laws of supply and demand apply here. Reduced supply elsewhere will increase scarcity and consequently value of protected natural assets,” said co-author Dr. Moritz Kraemer, former Chief Sovereign Credit Officer of S&P, now Senior Fellow at the Center for Sustainable Finance at SOAS University of London.
“Including natural hazards in sovereign credit ratings would create a strong incentive for governments to improve environmental protection,” he said.
Co-author Prof. Ulrich Volz, Director of the SOAS Center for Sustainable Finance, added: “Risks related to biodiversity are a significant risk to economic activity and public finances. Protecting natural habitat is important not only for nature’s sake, but also critical to maintaining macroeconomic stability.”
“Biodiversity loss is well understood by ecologists. Satellite monitoring means land use changes can be tracked and wildlife losses quantified. Given the magnitude of the economic risks, the inclusion of nature in sovereign creditworthiness is inevitable.”
The research team was the first to use artificial intelligence to produce “climate-smart” credit ratings for states proposing global warming downgrades as early as 2030.
“Climate change has dominated the conversation, but it shows how biodiversity risk into market risk is the new frontier of environmental finance and the biggest challenge right now. This unique study begins this search for 26 countries,” said Simon Zadek, Chair of the Finance for Biodiversity Initiative.
subject of research
Loss-of-Nature and Sovereign Credit Ratings
Article publication date
June 23, 2022