Climate Change and Sovereign Risk in Southeast Asian Countries

Climate change is inflicting social and economic damage on Southeast Asian countries. Increasing global warming is exposing these countries to physical, transitional, and sovereign risks. According to a new World Meteorological Organisation (WMO) number, extreme weather, climate, and water-related events caused 11,778 documented disasters between 1970 and 2021, resulting in little over 2 million deaths and US$ 4.3 trillion in economic damages. More than 90% of all recorded deaths occurred in underdeveloped nations. To explore sovereign risk, countries have adopted the original least square method models to measure their susceptibility and resilience to climate change. Greater climate vulnerability has hurt sovereign bond yields, which increases the investment cost of climate change adaptation, leading to more debt and thereby delaying the development of Southeast Asian countries. 

Thus, urgent steps need to be taken to mitigate climate-related risks and leverage emerging opportunities. The COVID-19 pandemic brought home the pressing need to focus on adaptability for climate-related risks. Countries exposed to higher climate risk will likely have a greater premium for sovereign debt to scale up their resilience to climate change; this premium is expected to increase as the climate change risk (physical and transition risks) becomes more pronounced in the years to come. In other words, the cost of the sovereign premium is driven by susceptibility and adaptability to climate change. Additionally, climate-related natural disasters can have a fiscal impact, which can be attributable to macroeconomic and/or specific fiscal effects. Macroeconomic effects include disruptions to economic activity, which can hurt tax revenue and public revenue. Demand and supply shocks are also possible, which can increase the use of fossil fuels. Even physical assets and state-owned enterprises may be damaged, prompting governments to infuse significant capital to recover these assets.

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The effect of climate change on Southeast Asian countries varies from country to country. The economic impacts of global warming are found to be the largest and are vulnerable to climate change. As per the Asian Development Bank institute climate risk index (CRI), four ASEAN countries feature among the 10 countries most impacted by climate disasters. This index is based on the number of floods, storms and landslides. The table below shows the acute risk people are exposed to from weather changes. 

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10 ASEAN countries (Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam), with a population of approximately 630 million, experienced harsh weather during the period 1993-2018 which resulted in a loss of about US$125 million, of which 27–28% was insured. Investments towards climate change adaptation and mitigation should be increased, as global warming will likely be on the rise. Else it will likely create a fiscal burden. Moreover, economic activity will likely be hampered, as Southeast Asian countries may face worsening heat, water scarcity, and rise in sea levels, among others. For instance, 7% of the land may be lost because of a 1-meter sea level rise. 

Around 22% of the Indonesian government’s revenue in 2011-2016 was derived from fossil fuels such as oil, natural gas, and coal. As most ASEAN countries are export-dependent, the transition risk will likely increase. ASEAN will need to change/intensify its measures by 2030, and then again by 2050, to stay on track towards the climate targets for adaptation and mitigation. This can be accomplished through an integrated set of actions such as mitigation with air pollution prevention, RE promotion via the ASEAN Power Grid, green recovery via business innovation, finance and carbon pricing, afforestation programs, technology development and diffusion, and workforce reskilling (just transition) towards net-zero GHG emissions.

Conclusion

Sovereign bond yields will be affected positively in ASEAN countries that are more vulnerable to climate change, resulting in a higher premium for sovereign bonds. These countries may face a vicious circle, as conditions continue to deteriorate. This will likely lead to material sovereign credit risk, culminating in poor investments in climate adaptation measures and climate-resilient infrastructure. To avoid such a situation, ASEAN countries need foreign investments and support. Even governments need to incorporate climate risk analysis in public financing to understand the potential impact of climate change over the medium and long term and the steps required to mitigate these risks.

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