Climate change could downgrade India's credit rating, study finds

India's sovereign credit rating could be downgraded due to the impact of climate change and the rise in temperature volatility by as early as the 2030s, according to a study.

The team, led by researchers at the University of East Anglia (UEA) and the University of Cambridge, UK, found that deferring green investments will increase costs of borrowing for nations, which will translate into higher costs of corporate debt.

The study, published on Monday in the journal Management Science, is the first to anchor climate science within real world financial indicators. It suggests that 59 nations will experience a drop in sovereign credit rating in the next decade without emissions reduction.

Sovereign ratings assess the creditworthiness of countries and are a key gauge for investors. Covering more than USD 66 trillion in sovereign debt, the ratings and agencies behind them act as gatekeepers to global capital.

The researchers used artificial intelligence (AI) to simulate the economic effects of climate change on Standard and Poor's (S&P) ratings for 108 countries over the next 10, 30 and 50 years, and by the end of the century.

This research contributes to bridging the gap between climate science and real-world financial indicators, said Patrycja Klusak, from UEA's Norwich Business School, and an affiliated researcher at Cambridge's Bennett Institute for Public Policy.

We find material impacts of climate change as early as 2030, with significantly deeper downgrades across more countries as climate warms and temperature volatility rises, Klusak said.

From a policy perspective, the findings support the idea that deferring green investments will increase costs of borrowing for nations, which will translate into higher costs of corporate debt, the researchers said.

Ratings agencies took a reputational hit for failing to anticipate the 2008 financial crisis. It is imperative that they are proactive in reflecting the much larger consequences of climate change now,Klusak added.

The researchers say the current mix of green finance indicators such as Environmental, Social, and Governance (ESG) ratings and unregulated, ad hoc corporate disclosures are detached from the science and this latest study shows they do not have to be.

The ESG ratings market is expected to top a billion dollars this year, yet it desperately lacks climate science underpinnings, said Matthew Agarwala, a co-author from Cambridge's Bennett Institute for Public Policy.

As climate change batters national economies, debts will become harder and more expensive to service. Markets need credible, digestible information on how climate change translates into material risk, Agarwala said.

The team, including former S&P chief sovereign ratings officer Dr Moritz Kraemer, found that if nothing is done to curb greenhouse gases, 59 nations could be downgraded by over a notch on average by 2030.

Chile, Indonesia, China and India would all drop two notches, with the US and Canada falling by two and the UK by one, the researchers said.

By comparison, the economic turmoil caused by the Covid-19 pandemic resulted in 48 sovereigns suffering downgrades by the three major agencies between January 2020 and February 2021, they said.

The study suggests that adherence to the Paris Climate Agreement, with temperatures held under a two-degree rise, would have no short-term impact on sovereign credit ratings and keep the long-term effects to a minimum.

Without serious emissions reduction, however, 81 sovereign nations would face an average downgrade of 2.18 notches by the century's end, with India and Canada among others falling over five notches, and Chile and China dropping by seven.

Just additional interest payments on sovereign debt caused by the climate-induced downgrades alone a fraction of the economic consequences of unrestrained emissions over the next eight decades could cost Treasuries between USD 135 and 203 billion.

The researchers call their projections extremely conservative, as the figures only track a straight temperature rise. When their models incorporate climate volatility over time extreme weather events of the kind we are starting to witness the downgrades and related costs increase substantially.

The research suggests there will be long-term climate effects for sovereign debt even if the Paris Agreement holds and we reach zero carbon by century's end, with an average sovereign downgrade of 0.94 notches and increases in annual interest payments of up to USD 67 billion globally by 2100.

The team also calculated the knock-on effects these sovereign downgrades would have for corporate ratings and debt in 28 nations. They found that corporates would see additional costs of up to USD 17 billion globally by 2100 under the Paris Agreement, and up to USD 61 billion without action to reduce emissions.

The research team say they were guided by the overarching principle to stay as close as possible to both climate science and real-world financial practices.

AI models to predict creditworthiness were trained on S&P's ratings from 2015-2020. These were then combined with climate economic models and S&P's natural disaster risk assessments to get climate smart credit ratings for a range of global warming scenarios.

While developing nations with lower credit scores are predicted to be hit harder by the physical effects of climate change, nations ranking AAA were likely to face more severe downgrades, according to the study.