Finance & economics | Costing the earth

Countries most exposed to climate change face higher costs of capital

Poor countries find themselves trapped in a vicious cycle

IN EAST AFRICA millions of people are suffering from a prolonged drought. Deadly typhoons are wreaking havoc in Vietnam. Honduran coffee-farmers are seeing their crops wither in the heat. Poor countries have less capacity than rich ones to adapt to changing weather patterns, and tend to be closer to the equator, where weather patterns are becoming most volatile. As the world heats up, they will suffer most.

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By 2030 poor countries will need to spend $140bn-300bn each year on adaptive measures, such as coastal defences, if they want to avoid the harm caused by climate change. That estimate, from the UN Environment Programme, assumes that global temperatures will be only 2°C above pre-industrial levels by the end of the century, which seems unlikely. Adding to the costs, research suggests that these countries face higher interest rates than similar countries less exposed to climate risks. This raises the prospect of a vicious cycle, in which the most vulnerable countries pay more to borrow, making adaptation harder and them even more exposed.

The research focuses on the V20, a group founded by 20 vulnerable countries whose membership has since grown to 48. The members are mostly poor, together accounting for less than 5% of global GDP. They include low-lying atolls, such as the Marshall Islands, and economies dominated by agriculture, such as Kenya. The researchers, led by Ulrich Volz of SOAS University of London and Bob Buhr of Imperial College Business School, examined sovereign-bond yields between 1996 and 2016 for 46 countries, 25 of them in the V20. After controlling for non-climate factors, such as income per person and levels of public debt, they estimate that V20 countries must pay interest rates 1.2 percentage points higher than comparable countries. That raises the V20s borrowing costs by about 10%, equivalent to an extra $4bn each year in interest payments.

Companies may also be charged more for loans if they are perceived as more exposed to climate-related risks. In a new paper researchers at SOAS looked at the cost of corporate debt for more than 60,000 firms in 80 countries. A fifth of the companies, holding about 3% of the total debt, were in the countries most vulnerable to climate change. They were charged interest rates on average 0.83 percentage points higher—again roughly a 10% premium.

High interest rates largely reflect a greater risk of default. So credit-rating agencies are looking at climate risks, too. Undiversified economies that are reliant on agriculture are particularly susceptible, says Marie Diron of Moody’s. In the 37 countries that the firm thinks are most vulnerable, farming accounts for 44% of employment on average. (Together they have issued $2.8trn of sovereign debt, about 4% of the world’s total.) Those relying on tourism could also be in trouble. And climate-exposed countries often have weak institutions, says Ms Diron. They struggle to plan for and respond to disasters.

Some of the smaller vulnerable countries have been attempting to build climate resilience by pooling insurance risk to make premiums more affordable. The first such attempt was the Caribbean Catastrophe Risk Insurance Facility, which has paid out $139m since it was founded in 2007. The payouts help alleviate cashflow problems after disasters, reassuring investors and credit-rating agencies. In the past five years similar insurance schemes have popped up in sub-Saharan Africa, Central America and the Pacific.

Others are seeking to reduce the interest-rate premium with “blended finance”, whereby multilateral institutions such as the World Bank and Asian Development Bank bear part of the risk for mitigation and climate-resilience projects. In April the V20 launched such a programme. Officials plan to apply to use $500m from the UN’S Green Climate Fund in the V20. Such schemes will help, but only a bit. In truth, climate-vulnerable countries can do little to offset the rise in the cost of capital.

This article appeared in the Finance & economics section of the print edition under the headline "Costing the earth"

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