What is the relationship between climate change and the debt of the countries?

Could climate change affect the payment of interest on sovereign debt? Could climate change limit the capacity of developing economies? Let’s see why fighting this phenomenon is a real necessity.

Since the emergence of COVID in our lives, many have been the debates that have had to be postponed to address the health crisis that was putting the world in check, while paralyzing the economic activity that, as a whole, was developing. The need to combat the crisis, as well as the effects that were emerging from it, forced the different leaders on the planet to focus all their efforts on stopping what will go down in history as one of the greatest crises in our recent history.

However, once the pandemic dissipates, as the vaccines arrive in the different affected territories, and they are supplied to the population, it is necessary to take stock of how the planet is after this health and economic catastrophe that we have experienced. It is time to talk about the economic recovery that is being presented to us, with the challenges that it poses, while at the same time we are proposing the lines of action to repair the damages that are registered. However, in the same way, we must deal with other matters that, having gone unnoticed, must be addressed; and this is established by the UN agenda, in the SDGs.

Among these issues is the inclusive development of economies. And, what better time to talk about this matter, than in a scenario in which an unexpected crisis has erupted with force, generating negative effects that could aggravate the situation and widen inequalities?

The crisis, as always, is preying on the most vulnerable, widening the existing imbalances in these types of economies. We are facing a problem to which we must add the fact that, since the 2008 crisis, growth in these economies has been moderating. Emerging countries, which grew at rates close to 14%, began to grow at a rate of 7%. In this way, the growth rate of emerging economies, which was up to 4.5 percentage points apart from that registered by developed economies, began to distance by only 0.38 percentage points.

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However, to all this we must add another aspect: climate change. A climate change that has not only put the Central American economies in check with natural disasters; that it has not only endangered the entire industrial sector in the Mexican country with the blackouts caused by the snowfalls in Texas; Instead, according to the International Monetary Fund, we are talking about climate change that could even throw the finances of many of these highly vulnerable economies out of balance.

Climate change, a risk for investors

“The study carried out by the IMF shows a connection between climatic shocks and the yields offered by sovereign bonds in these types of economies.”

According to a recent study by the International Monetary Fund, the observation made by technical staff has determined that the vulnerability of a country, or its resilience to climate change, can have a direct effect on its creditworthiness, its costs in terms of of indebtedness and, ultimately, the probability that you will default on your sovereign debt. Those countries most vulnerable to climate change, in the same way, register a worse credit rating that seriously damages their growth, with higher associated financing costs.

If the financing costs for emerging and developing countries, due to their characteristics, were not high enough, this increasingly frequent threat ensures that they are. The study carried out by the IMF shows a connection between climate shocks and the yields offered by sovereign bonds in these types of economies. The lower capacity to apply response policies that try to combat this situation, due to the greater scarcity, increases a risk that ends up being reflected in the credit rating and, therefore, the cost of financing.

Using vulnerability indicators from the Notre Dame Global Adaptation Initiative, the agency selects a panel of 67 countries, in a period between 1995 and 2017. In this selected sample, after analysis, it is observed that said vulnerability produces negative effects on credit rating; in addition, all this after taking into account those conventional macroeconomic determinants. In the same way, it is observed in this analysis that those economies that suffer the most from this situation, as in the beginning, with COVID, are once again developing economies; those most vulnerable.

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In this sense, an increase of 10 percentage points in vulnerability to climate change in these emerging economies, after analysis, can be associated with an increase of more than 150 basis points in the yield spreads of long-term sovereign bonds ( 10 years) issued by these economies against the reference value of the United States. Likewise, an improvement of 10 percentage points in this vulnerability indicator directly produces a decrease of 37.5 basis points in these yield differentials. As we can see, a new complication that continues to limit the potential of these economies, at the mercy of events that are not being fought from the institutions.

Likewise, the analysis carried out concludes with another observation made on a sample of 116 countries, during the same period chosen above. This observation analyzes the link between climate change and sovereign default. An observation that shows that those countries that are more vulnerable to climate change also have a greater probability of defaulting on debt payments. A study that obviously recommends greater resilience in order to reduce this probability, reducing, in the same way, financing costs; all this, in order not to continue stifling its growth.

Less sustainable debt

“The IMF itself had to attend to the rescue of Ecuador, to clean up its public accounts, presenting debt levels close to 50%.”

We must know that the study released by the IMF is very worrying, since a higher cost of financing for these economies, so dependent on debt and so little capable of making it sustainable, ends up limiting their growth and, therefore, their development. Thus, if we look at the debt levels in Latin America, while we see the great disparity that some countries such as Argentina or Venezuela present with the rest of the member countries, we can also observe that the average debt in the group could be close to at 63% of GDP.

In other words, the levels of debt in Latin America, in contrast to countries such as Spain (117%), Portugal (130%), Italy (150%) or Greece (199%), are not excessively high. In this contrast, according to data from the International Monetary Fund (IMF), debt in countries such as Colombia accounts for 54.8% of GDP, while in other more liberalized countries such as Chile, debt levels are around 27%.

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This, a priori, is not a problem. However, the high levels of corruption in the country, where the informal economy represents a large percentage of the economy itself, the commitment to debt buyers, in a scenario where interest rates are higher than in other countries, represents a great trouble. In other words, the high costs of debt in Latin America, added to the fiscal weakness of the institutions due to the high levels of economic informality, end up compromising the government itself, which is forced to pay higher interest for the debt. own financing.

Specifically, the average cost of public debt in Latin America is 2.5 times higher than in the Euro Zone, taking the latest data available from the World Bank. And facing this situation, with institutions so weak due to their limited collection capacity, is an unattainable task. Countries like Mexico follow the tail in the rankings prepared by the OECD on tax collection over GDP. With institutions so poorly capable, a vicious circle is generated that, as it seems with everything, ends up limiting the capacity of these types of economies to develop.

For this reason, in addition to everything described throughout this article, the governments of those developing countries must show greater caution with debt levels, since we have been able to observe how a few months ago, the IMF itself had to attend to the rescue of Ecuador to clean up its public accounts, presenting debt levels close to 50%. To finish with the example of contrast, something that has not happened in Spain, for example, where with a debt higher than 100% of GDP, the country presents a much lower risk premium, as well as a much more stable better financial situation for Your condition.

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