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An Apocalypse Foretold: Climate Shocks and Sovereign Defaults

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Abstract

Climate change poses an existential threat to the global economy. While there is a growing body of literature on the economic consequences of climate change, research on the link between climate change and sovereign default risk is nonexistent. We aim to fill this gap in the literature by estimating the impact of climate change vulnerability and resilience on the probability of sovereign debt default. Using a sample of 116 countries over the period 1995–2017, we find that climate change vulnerability and resilience have significant effects on the probability of sovereign debt default, especially among low-income countries. That is, countries with greater vulnerability to climate change face a higher likelihood of debt default compared to more climate resilient countries. These findings remain robust to a battery of sensitivity checks, including alternative measures of sovereign debt default, model specifications, and estimation methodologies.

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Notes

  1. Climate refers to a distribution of weather outcomes for a given location, and climate change describes environmental shifts in the distribution of weather outcomes toward extremes.

  2. In a recent article, for example, Cochrane (2021) presented a skeptic view of climate-related risks to financial stability.

  3. In this paper, we focus on countries’ exposure to physical risks that correspond to the potential economic and financial losses caused by climate change. However, it should be noted that transition risks related to the process of adjusting toward a low-carbon economy, such as stranded asset exposures in the financial system, can also amount to a sizable burden.

  4. There is also literature on the recovery rate after a debt restructuring process. See e.g. Edwards (2015) for a study on the Argentine case.

  5. Tol (2018) provides a recent overview of this expanding literature.

  6. The list of countries is presented in Appendix Table 4.

  7. Since 1960, 147 governments have defaulted on their obligations—well over half the current universe of 214 sovereigns. Defaults had the biggest global impact in the 1980s, peaking at US$450 billion, or 6.1% of world public debt, by 1990. The scale of defaults has fallen substantially since then. Over the past decade, it has ranged between 0.3 and 0.9% of world public debt, and in 2019 it was an estimated 0.4%.

  8. The analysis of the determinants of sovereign defaults depends on the very definition of debt defaults. It is common in many empirical studies to use debt crises synonymously with debt defaults for simplicity. However, this can be problematic especially in the post-1990s period, as pointed out by Pescatori and Sy (2007). Ams and others (2018) suggest several other ways to define sovereign debt default, including the database used in this paper.

  9. The ND-GAIN database, covering 184 countries over the period 1995–2017, is available at https://gain.nd.edu/.

  10. The ND-GAIN database refers to this series as “readiness” for climate change, which we use as a measure of resilience against climate change. In this context, it should also be noted that the ND-GAIN indices do not reflect fiscal insurance schemes for natural disasters that may occur due to climate change.

  11. For an overview of conventional determinants of sovereign default, see Catão and Kapur (2004), Reinhart and Trebesch (2016), and Kaminsky and Vega-García (2016).

  12. King and Zeng (2001) describe rare events as “dozens to thousands of times fewer ones […] than zeroes.”

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Acknowledgements

The authors would like to thank the editor, George Tavlas, and two anonymous referee for their insightful comments that led to marked improvements in the paper. An earlier version of this article benefited from comments and suggestions by Cristian Alonso, Pierre Guerin, Mick Keen, Yuko Kinoshita, Roberto Piazza, and Aleksandra Zdzienicka. This work was supported by the FCT (Fundação para a Ciência e a Tecnologia) [grant numbers UID/ECO/00436/2019]. The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management (Cevik) and the University of Lisbon’s School of Economics and Management (Jalles).

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Authors and Affiliations

  1. International Monetary Fund, 700 19th Street NW, Washington, DC, 20431, USA

    Serhan Cevik

  2. Instituto Superior de Economia e Gestão (ISEG), Universidade de Lisboa, Rua do Quelhas 6, 1200-781, Lisbon, Portugal

    João Tovar Jalles

  3. Research in Economics and Mathematics (REM) and Research Unit on Complexity and Economics (UECE), ISEG, Universidade de Lisboa, Rua Miguel Lupi 20, 1249-078, Lisbon, Portugal

    João Tovar Jalles

  4. Economics for Policy, Nova School of Business and Economics, Universidade Nova de Lisboa, Rua da Holanda 1, 2775-405, Carcavelos, Portugal

    João Tovar Jalles

  5. IPAG Business School, 184 Boulevard Saint-Germain, 75006, Paris, France

    João Tovar Jalles

Authors
  1. Serhan Cevik
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Correspondence to Serhan Cevik.

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Appendix

Appendix

Table 4 List of Countries
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Table 5 Summary Statistics
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Table 6 Climate Change Vulnerability and Sovereign Defaults—Type of Debt
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Table 7 Climate Change Resilience and Sovereign Defaults— Type of Debt
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Table 8 Climate Change and Sovereign Defaults: Rare-Events Logistic Estimator
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Cevik, S., Jalles, J.T. An Apocalypse Foretold: Climate Shocks and Sovereign Defaults. Open Econ Rev 33, 89–108 (2022). https://doi.org/10.1007/s11079-021-09624-8

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