The lack of proper assessment of the impact of climate shocks on economies may lead to a debt crisis in low- and middle-income countries, Oxford University researchers have warned. The risk is even higher now that they have borrowed billions to fight the spread of COVID-19 spread, they state.
During the COVID-19 pandemic in 2020, low- and middle-income countries borrowed US $783 billion in the form of sovereign bonds with maturity terms of 30, 50, or even 100 years. However, this research shows that they may not be able to repay their debts. Despite the fact that upcoming climate shocks may severely impair the ability to repay debts as by their nature they generate huge costs, 77% of all sovereign bond prospectuses included no assessment of climate-related risks.
Poorer countries are more prone to the extreme weather events caused by global warming. Thus, for instance, hurricane Maria, which hit Dominica in 2017, caused damage worth as much as 220% of the GDP of this tiny island country.
The authors of the research note: “The gaps we found suggest that governments do not understand the economic impacts of climate risks or are unwilling to report them. Both explanations are troubling. Without rigorous climate disclosures, investors and governments are flying blind.”
They estimate that in 2060, when the sovereign bonds issued by Saudi Arabia mature, the country’s GDP may drop by 60% due to lower productivity driven by climate change. Indonesia is likely to see a 56% decrease in its GDP by 2070 – the maturity term of its bonds.
As the researchers indicate, the lack of climate disclosures means that states and creditors are unable to properly assess the risk related to indebtedness. In March 2021 the UN Secretary-General already warned that “we are on the verge of a debt crisis.”
To prevent the situation from escalating, countries should cooperate to better estimate climate risks, inform potential creditors accordingly and develop tools to address the uncertain nature of sovereign climate risk, the authors of the report suggest. Aside from this, governments must use COVID-19 loans to finance green projects aiming to mitigate climate risks and enabling them to build climate resilience so that the money borrowed is used to boost their economies. In addition, high-income countries and their development finance institutions should also financially support the poorest borrowing states while development finance institutions must buy back debt from highly indebted countries in exchange for climate investments.
