Loss of Natural Capital a Risk to Countries’ Credit Ratings
The sovereign debt crises in countries around the world has preoccupied the financial markets. But there is another emerging challenge to the health of various nations’ credit ratings: the rising price of commodities. And those commodities, from timber to fish to wheat and of course, energy, could surge in price even more because of environmental degradation and other problems. Municipalities such as Atlanta have had their credit ratings threatened because of water scarcity; eventually similar problems this could spread to national governments.
To that end, the United Nations Environment Program Finance Initiative (UNEP FI) studied five countries: Brazil, France, India, Japan and Turkey–and found that environmental factors could harm the financial long-term health of these nations in the long run–notably those treasured credit ratings. All five of these nations, according to UNEP, are pushing their ecological resources to the limit and in the near future will be more sensitive to price shocks due to their import of more commodities.
Some of the findings include trends that should worry everyone, from financial analysts on Wall Street, large bondholders and pension funds, and bureaucrats in government trade and financial ministries:
Exhaustion of natural resources can hit a nation’s GDP. According to the study, a 10 percent reduction in the capacity of renewable and biological resources can cause a trade balance that is equivalent from one to four percent of a country’s GDP.
The demand for natural resources will cause fierce global competition and credit risks: The demand for natural resources is 1.5 times more than the rate at which the earth can naturally replace them. As countries deplete resources within their own borders, their import bills for all resources will increase. Those resource constraints, in turn, could have a negative impact on a country’s economic performance, subjecting these countries to credit risk because they will face greater challenges in repaying or refinancing sovereign debt.
The bond markets could become just as volatile as the equities markets: Investors have long considered bonds to be a much safer long term investment than equities. But the $95 trillion bond market has long overlooked data related to environmental, social and governance (ESG) performance because they were not seen as material to the bond markets’ performance–not to mention the fact that ESG data until recently has been difficult to quantify. Now more financial institutions are purchasing third-party ESG data to augment their sovereign credit risk analyses. As commodities spike in price due to growing global demand as well as resource depletion, more countries will be subjected to increased volatility. According to the report, the flow of financial capital outside a country, due to the growing scarcity of natural capital causing demand of more imports, is a cause of concern. A scenario where more businesses flee countries for others where natural resources are more abundant–and the net affect on a company’s tax revenues–could drive some nations to their own fiscal cliff.
The UN has therefore called on credit rating agencies to find a standardized way of linking ESG data with traditional financial metrics. Starting with the calculation of of a country’s ecological footprint of consumption, production and its net ecological footprint of trade, these three components provide a start from which financial institutions can rate countries’ various ESG performances. Standardization on this front will take some time, but one trend is clear: sustainability and financial data can no longer be tucked into individual silos–and together the numbers make for a worrisome decade as countries continue to kick the proverbial financial–and sustainability–cans down the road.
Photo of Place de la Bastille courtesy Leon Kaye.