Climate change costs

Ratings agencies, which often hold the fate of high-debt countries, may incorporate climate change into their credit ratings, which means that governments may have to pay more attention to how they will deal with climate change risks.    

Bloomberg recently reported that coastal communities from Maine to California have been put on notice by one of the top credit rating agencies: start preparing for climate change or risk losing access to cheap credit.

In a report to its clients last Tuesday, Moody’s Investors Service Inc. explained how it incorporates climate change into its credit ratings for state and local bonds. If cities and states don’t deal with risks from surging seas or intense storms, they are at greater risk of default.

In its report, Moody’s lists six indicators it uses to assess the exposure and overall susceptibility of US states to the physical effects of climate change. They include the share of economic activity that comes from coastal areas, hurricane and extreme-weather damage as a share of the economy and the share of homes in a flood plain.

Based on those overall risks, Texas, Florida, Georgia and Mississippi are among the states most at risk from climate change. Moody’s didn’t identify which cities or municipalities were most exposed and no mention has been made if the ratings agency plans to roll out this measure to countries it rates around the world. But it gives an interesting viewpoint on the evolving challenge states, cities and even countries may face down the road. Sri Lanka, with 44% of its loan portfolio being held by the market, is extremely sensitive to any ratings changes made by agencies. 

Bond rating agencies such as Moody’s are important both for bond issuers and buyers, as they assign ratings that are used to judge the risk of default. The greater the risk, the higher the interest rate municipalities pay.

If repeated storms and floods are likely to send property values - and tax revenue - sinking while spending on seawalls, storm drains or flood-resistant buildings goes up, investors say bond buyers should be warned. 

The approach to dealing with climate change is at times so complex that governments prefer to think in silos. Therefore they separate disaster management from other aspects of dealing with climate change, which on the surface appears to make things less complicated but can result in huge problems in the future.  

Tying climate risk to the ratings of states will change how governments evaluate climate risks and tackle issues such as climate resilient infrastructure and financing. The usual route of simply compensating people who have died in extreme weather disasters will have to evolve to encompass complex financial outcomes over long periods of time and states will need to begin preparing for these sorts of global changes, even though their first signs are far away from small countries like Sri Lanka. 

This also demands a different way of thinking about capital and investment. The lifecycle of infrastructure projects should be built into the cost considerations and this should be a positive consideration when banks or states lend for infrastructure projects.

Climate vulnerable countries will find that they have to evolve faster to understand and make use of these new categorisations to keep their economies growing.