Summary
Key takeaways
Physical risk refers to the potential damage caused by climate-related hazards. Physical risk can be acute if deriving from extreme weather events and hazards, or chronic if related to a more gradual effect of global warming. By affecting individual businesses, households and the broader economy, climate risks could translate into financial risks and affect sovereign debt’s pricing and sustainability.
Using models based on IPCC’s climate scenarios, it is possible to assess countries’ exposure to climate hazards at different time horizons. According to the scoring provided by our sovereigns’ ESG data provider Verisk, the regions most exposed to physical risks by 2050 are Africa, Asia and the Americas. Europe is comparatively less exposed than other regions but still faces significant risks, as it is currently the fastest-warming continent.
In Asia, climate hazard risks are more significant in south and south-east Asia than in east Asia. Verisk’s Climate Hazard index shows that Singapore, Thailand, India, Indonesia and Sri Lanka face the highest risks by 2050 and 2080. Meanwhile, Japan, South Korea, Taiwan and China appear less at risk, although a high temperature scenario would significantly increase their exposure to acute and chronic climate hazards by 2080.
To assess the medium to long term potential economic impact of physical risks in Asia, we use two climate scenarios designed by the NGFS that capture the lowest and highest levels of physical risks. These scenarios show that by 2050, Asia’s GDP loss could reach between 10 and 16% compared to a baseline scenario, with south and south-east Asia being most affected. The main climate-related economic impacts come from sea level rise, reduced labor productivity, increased energy demand and the impact of floods.
Beyond exposure and vulnerability to climate hazards, it is also important to evaluate countries’ capacity to adapt (readiness). According to the University of Notre-Dame’s Global Adaptation Initiative (ND-GAIN) Index, Singapore, South Korea, Japan, China and Malaysia have relatively low vulnerability and high readiness, while Afghanistan, Myanmar, Bangladesh, Pakistan, the Maldives and Bhutan are most vulnerable and least prepared.
Adaptation to climate change has a cost and could significantly impact public finances. Some of the countries combining relatively high vulnerability and low readiness also face constraints on the fiscal side. This is notably the case for the Maldives, Sri Lanka, India, and Pakistan. This could translate into lower credit ratings, as climate risks are being increasingly considered by ratings agencies, and could have an impact on sovereign bond yields and sovereign debt sustainability.
While there are risks for sovereign debt investors stemming from the physical impact of climate change, there are also investment opportunities linked to the necessary adaptation of countries.
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