How AI is being used to show how climate change will hit nations’ debts
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Researchers at the UEA’s Norwich Business School based at Norwich Research Park have used artificial intelligence (AI) to work out the financial cost that climate change will have on public finances if countries do not reduce their emissions.
Climate change will increase the cost of sovereign and corporate debt worldwide according to a new report from the University of East Anglia (UEA), the University of Cambridge and the School of Oriental and African Studies (SOAS). ‘Rising Temperatures, Falling Ratings: The Effect of Climate Change on Sovereign Creditworthiness’ is the first such research to assign climate science to ‘real world’ financial indicators.
A team of economists from the three universities used AI to simulate the economic effects of climate change on Standard and Poor’s (S&P) ratings for 108 countries over the next 10, 30 and 50 years, and by the end of the century.
Credit ratings are hugely important to the financial system. They determine how much it costs for Treasuries, and ultimately taxpayers, to borrow money. They are a key gauge used by investors, be they companies, pension funds or other nations, to decide where to commit their capital. The research suggests that 63 nations will experience a drop in sovereign credit rating in the next decade if emissions aren’t reduced.
The importance of these ratings cannot be underestimated because they act as gatekeepers to global capital – worth over $66tn in sovereign debt!
The study found that many national economies can expect ratings downgrades in the future unless action is taken to reduce their emissions.
UEA is already globally recognised as a leader in climate science and economics and its work is one of the key parts of Norwich Research Park’s world-leading proposition. Dr Patrycja Klusak, from UEA’s Norwich Business School, said: “Ratings agencies took a reputational hit for failing to anticipate the 2008 financial crisis. It is imperative now that they are proactive in reflecting the much larger consequences of climate change.”
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Whilst there are a number of green finance indicators already in existence, they have been accused of being detached from the science.
Dr Matthew Agarwala, from the School of Environmental Sciences at UEA, explained: “As climate change batters national economies, debts will become harder and more expensive to service. Markets need credible, digestible information on how climate change translates into material risk.”
“By connecting the core climate science with indicators that are already hard-wired into the financial system, we’ve shown that climate risk can be assessed without compromising scientific credibility, economic validity or decision-readiness.”
The research found that if nothing is done to curb greenhouse gases, then 63 nations could be downgraded by 2030. Germany, India, Sweden and the Netherlands would see a serious drop with the US, Canada and the UK also falling, albeit it a little less.
Encouragingly, the study suggests that adherence to the Paris Climate Agreement, with temperatures held under a two-degree rise, can substantially reduce the downward pressure of climate change on ratings.
Without serious emissions reduction, 80 sovereign nations could face significant downgrades by the century’s end, with India, Canada and China faring particularly badly.
The additional interest payments on sovereign debt caused by these climate-induced downgrades alone could cost Treasuries around the world between $137-205bn per year.
The research suggests even if the Paris Agreement holds and we reach zero carbon by the end of the century, the increases in annual interest payments will be up to $33bn globally.
It would also affect companies. The calculated knock-on effects of the downgrades in 28 nations found that organisations would acquire additional costs of up to $12bn globally by 2100 if they adhere to the Paris Agreement, and up to $62bn without action to reduce emissions.
“AI has the potential to revolutionise how we carry out climate risk assessment but we must ensure the evidence base is ‘baked-in’,” said Matt Burke, a researcher at UEA’s Norwich Business School.
While developing nations with lower credit scores are predicted to be hit harder by the physical effects of climate change, nations ranking AAA were likely to face more severe downgrades. Economists say this fits with the nature of sovereign ratings: those at the top have further to fall.
Lord Davies of Abersoch, chairman of LetterOne, that is supporting the research, said: “This much needed breakthrough will allow the financial community for the first time to understand the impact of long-term climate effects on sovereign and corporate debt.”