Sovereign debt risks climate change

Climate change risks for sovereign debt: how the integrated assessment model gives us insights

The current decade requires bold (and costly) climate action, but at the same time, sovereign debt has reached levels not seen since World War II. Unprecedented central bank intervention during the epidemic has averted a credit crunch, but concerns have been raised that climate change is hampering countries’ ability to repay Covid-19 loans (Dibley et al. 2021). These concerns go to the center of Greta Thanberg’s speculative proposal, proposed by Kotlikoff et al. (2021) When they put his word for a bargain in the 2019 speech at the United Nations:

“Since we cannot rely on you to act morally, offer me a bribe to save the planet. Take the high global carbon tax. However, reduce other taxes so that, on a balanced basis, you stay well. My and future generations will pay higher taxes to cover your deficit. ”

But can the Greater Equivalents service inherited loans because of the impact of climate on debt?

The CEPR collection (Di Mauro 2021) provides “an interesting insight into the evolution of economic research on climate change over the last decade”. At the climate risk center level for financial stability, next to carbon pricing and green financing. Climate risk for financial stability attracts very little attention, only Persaud (2021) works with debt. A 2019 survey by the EU National Council of Revenue found that their quantitative analysis does not cover climate risks. A Google trend search since the Paris Agreement has an average rating of 92 for “climate risk + financial” and 36 for “+ financial”. Google Scholar lists 1.94 million documents on the former and 0.3 million on the latter. Aware of the challenges ahead, the European Fiscal Board has recently called for a holistic view of climate risks in financial planning (Thygesen et al. 2022).

Zenios (2022), I suggest developing such an holistic approach by capitalizing on advances in climate risk and debt sustainable analysis (DSA). Combining the descriptive scenarios of climate analysis (Climate Change 2014) with the Stochastic DSA scenario, I argue that we can integrate the Integrated Assessment Models (IAM) introduced by Nordhouse to inform our understanding of climate impact on debt.

Sovereign debt channels from climate change

Climate change affects sovereign debt through multiple channels: economic growth, rapid and long-term losses, and costs from low carbon emissions (Figure 1).

Figure 1 From climate change to public finance

Let’s look at the index level. A Tol (2014) meta-analysis found that a 5 ° C temperature rise could adversely affect the global economy by 3 to 15% of GDP. Under 2.5 degree Celsius growth the effect will be 2.5%, although some regions are more affected (15% for tropical regions). Damage is recorded in the International Disaster Database but extrapolated from history devalues ​​future damage because the number and severity of extreme events are accelerated; EM-DAT reports a doubling of events in recent years since 1985 Severe weather damage for European countries is estimated at € 170 billion per year (1.4% GDP).1 Sovereign assets are valued as a result of the shift from fossil fuels, where assets worth $ 12 trillion (3% of capital) are projected to be trapped by 2050 (Banque de France 2019).

Bond markets are valuing climate risk (Cevik and Tovar-Jalles 2020), and rating agencies are predicting that climate change will affect ratings in the coming decades. Klusak et al. (2021) see that 55 sovereigns face lower grades with an increase in loan service costs, below 2 ° C growth and below 80 4.2 ° C.

Combining pieces suggests that uncontrolled climate change may induce a ‘climate-debt doom loop’. Rising debt service costs add to losses and the cost of climate policy, and complex impacts can become a first-order problem for some sovereigns. Indeed, countries with greater exposure to climate risk have more uncertain public debt positions: the climate-preserved EU tertiary averages 78% for the least vulnerable compared to 133% of GDP. If the climate raises concerns about the ability to repay costs, the sovereign is reduced and its financing rate increases. Sovereign is trapped in a debt trap that could make it harder for growth to slow down due to climate change. Greater team will be tied.

Debt sustainability analysis with climate risk

The DSA, including climate modules, can assess the risk of such traps. It tells us whether a sovereign can sustainably finance his debt or estimate the available financial space if the debt is sustainable. These answers go to the heart of Thanberg’s speculative proposition. To assess whether future generations can repay debt, we need to weigh the debt caused by climate impact on today’s policy and debt. Linking IAM to DSA allows structured dialogue on this complex issue.

DSA of Genius et al. (2021) Scenario trees are used to represent future uncertain GDP growth, government initial balance, and interest rates. The debt-to-GDP ratio is a tree stochastic variable. A tail risk measurement tells us that debt is on a non-growing path with high potential so that it is considered sustainable with high confidence. If debt declines, we can estimate the space available to run further deficits to ‘save the planet’.

Currently, DSA situations ignore climate risks and extend to the medium horizon while expert estimates are reliable, the probabilities are calibrated in market data. Beyond that, scenarios turn into long-term trends, such as historical average growth or inflation targets. On the other hand, climate risk analysis is complicated by deep uncertainty. There is ambiguity where the results can be known, but they are unlikely, and there are incorrect specifications without any consensus on the models.

This complication can be dealt with even if not with high accuracy. Climate scientists predict the possible future states of the world, but they cannot pinpoint the possibilities because the future situation depends on an unknown policy path. To integrate climate risk into the DSA, we calibrate the scenario trees on IAM economic projections under future states. To address the ambiguity of the future situation, we created the work of the Integrated Assessment Consortium (IAC).2

The IAC has developed a Narrative Scenario Architecture (Climate Change 2014) that combines the representative density pathways (RCPs) of atmospheric greenhouse gases with descriptions of shared socio-economic pathways (SSPs). Table 1 illustrates the architecture of the scenario. For each cell, the number of available IAMs can be estimated and using the model’s ensembles, we deal with incorrect model specifications.

Scenario architecture provides a transparent state of the world for what-if analysis. For each SSP-RCP pair, the existing IAM provides visionary estimates of mitigation and adaptation costs, losses, GDP growth, and other outcomes to integrate climate risks into the DSA.

Table 1 Descriptive Scenario Architecture of Climate Risk

I am presenting a case study for Italy, using growth estimates from two prominent IAMs to demonstrate the climate impact on debt and the challenge of incorrect specification.3

Figure 2 shows 25/75 quintals of debt dynamics, including climate-free DSA, using estimates from the IMF World Economic Outlook and the ECB, with volatility and correlation matching their historical values. Intermediate debt is stable with significant upward risk. I then introduced climate effects compatible with the Paris Agreement (RCP2.6-SSP2) using the WITCH model (Emmerling et al. 2016) and RICE50 + (Gazzotti et al. 2021). Both models project downward adjustments for Italian growth, and I use these assumptions to rearrange the trees. Climate-compatible DSA results are overlaid in the fan chart in Figure 2 and we observe the dynamics of declining debt. With RICE50 +, the effects begin in 2050, where WITCH changes are noticeable from the mid-2030s. We notice an accelerated trend after the mid-century due to the growing adverse climate effects and the nonlinear growth of risk premiums as manifestations of the Doom Loop.

Figure 2 The dynamics of Italian debt stocks, including the impact of climate on growth

Climate-proofing public finance

The government needs to prepare public finances for climate change:

  1. Climate challenges are global (or regional) and need Adjustment. An integrated modeling effort using scenario architecture will provide transparency and ensure the acceptability of the situation for financial planning. A Climate-proofing network for public finance Can play a coordinating role.
  2. Financial authorities should Mainstream climate risk analysis in public finance. Budget plans should include losses and mitigation and adaptation costs, including social costs, perhaps as an incidental liability, and look for risk-sharing mechanisms that provide financial space during weather shocks (Demartzis and Genius 2019).
  3. Financial authorities should Reveal their exposure Follows the task force on climate-related financial disclosure guidelines. Debt resilience of a country is essential for climate change, the country is contributing more or less to climate change.

Climate change mitigation is not a matter for any single country. But financial stability depends on the organization to ensure that the budget position of the sovereign is resilient.


Bank de France (2019), “Criteria for the Financial Sector in the Face of Climate Risk: Information and Recommendations”, Financial Stability Review 23.

Cevik, S and J Tovar-Jalles (2020), “It Changes Everything: Climate Shock and Sovereign Bonds”, worksheets of the International Monetary Fund.

Climate Change (2014), “Special Problems: A Framework for the Development of New Socio-Economic Situations for Climate Change Research”, Climate change 122 (3).

Demertzis, M and SA Zenios (2019), “State ancillary debt as insurance for euro area sovereigns”, Journal of Financial Regulation 5 (1): 64-90.

DeBeli, A. T. Weitzer and C. Hepburn (2021), “National Cowid Debt: Climate Change Happens Countries’ Repayment Ability”, Nature 592: 184-187.

De Mauro, BW (2021), Fighting Climate Change: A: CEPR CollectionCEPR Press, 6 November.

Emmerling, J, L Drouet, LA Reis, M Bevione, L Berger, V Bosetti, S Carrara, E De Cian, GDM D’Aertrycke, T Longden and M Malpede (2016), “The WITCH 2016 Model-Documentation and Implementation Share The socio-economic path “, Fundagione Annie Enrico Mattei Working Paper.

Gazzotti, P, J Emmerling G Marangoni, A Castelletti, K van der Wijst, A Hof and M Tavoni (2021), “Sustainable inequality in economically favorable climate policy”. Communication with nature 12 (1): 1-10.

Klusak, P, M Agarwal, M Burke, M Kraemer and K Mohaddes (2021), “Rising Temperatures, Falling Rating: The Impact of Climate Change on Sovereign Debt”, Cambridge University Working Paper.

Tol, RSJ (2014), “Corrections and Updates: The Economic Impact of Climate Change”, Journal of Economic Perspectives 28 (2): 221–226.

Zenios SA, A Consiglio, M Athanasopoulou, E Moshammer, A Gavilan and A Erce (2021), “Risk Management for Sustainable Sovereign Debt Financing”, Operations research 69 (3): 755–773.

Zenios, SA (2022), “Sovereign Debt Risk from Climate Change”, Climate Change 172 (3): 1-19, First Published Bruegel Policy Contribution No. 16/21, July 2021, Bruegel, Brussels.


1 PESETA IV project (

2 This is a scientific consortium that was established in 2007 in response to a call from the Intergovernmental Panel on Climate Change (IPCC), see

3 Warning Importer: This case study should not be construed as a complete debt sustainability analysis for Italy. This explains what is possible, and in Zenios (2022) I discuss the need for additional work and the possibility of combining DSA with IAM.

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