Impact of Climate Change on Sovereign Risk in Asia

Publication | February 2023
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Sovereign risk is influenced by climate variables such as vulnerability, resilience, economic, social, and governance indicators. 

More than at any time in the history, climate change is having an increasingly unprecedented effect on human lives. Economies are affected severely in terms of sovereign risk due to climate change variations influencing the macroeconomy. Asian countries are highly susceptible to economic downturn due to the consequences of climate change. We identify the relationships between sovereign risk and climate change in all Asian countries. Controlling for a range of macroeconomic and financial drivers of sovereign bond spreads, we applied a panel autoregressive distributed lag (ARDL) model to identify the effects of climate change on the sovereign risk. The panel ARDL included the pooled mean group (PMG) regression, mean group (MG) estimation, and dynamic fixed effects (DFE) regression for estimating the macroeconomic impacts. The results show that, in the long run, the DFE model, which was selected as the best model for all Asian countries, provides evidence for the existence of a cointegration relationship. These findings have implications for policy makers, both from a fiscal sustainability perspective and with regard to the influence of exposure to climate change.

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Subjects
  • Climate change
  • Finance sector development
  • Governance and public sector management