E-RISC demonstrated how importers and exporters of natural resources such as fossil fuel, timber, fish, and crops are being exposed to the increasing volatility that accompanies rising global resource scarcity. Indeed, we estimated that a 10% variation in commodity prices could lead to changes in a country’s trade balance amounting to more than 0.5% of GDP.
Meanwhile, the economic consequences of environmental degradation can be severe. The report estimates that a 10% reduction in the productive capacity of soils and freshwater areas alone could lead to a reduction in the trade balance equivalent to more than 4% of GDP.
Of the five countries featured, Brazil has the most biocapacity of any country and scores in the top quartile of nations in the E-RISC score (with lower numbers representing less risk). Even so, as natural resources constitute key export products for Brazil, the economy is fairly vulnerable to changes in commodity prices: a 10 per cent price change could lead to a change in the country’s trade balance equivalent to 0.38 per cent of GDP.
This effect is less for countries like France whose relatively balanced trade reduces vulnerability to price volatility, although fuel prices do present risks. France also ranks in the top quartile in its E-RISC score. The small contribution of agriculture and agricultural employment to GDP reduces the impact that environmental degradation may have. Additionally, there is little evidence of degradation linked with overuse in France.
Turkey’s increasing dependence on imported resources has increased its vulnerability to trade-related risks, contributing to a higher risk score and its placement in the second quartile. Agriculture remains economically important in terms of output, exports and employment. As a result, Turkey is highly exposed to risks linked to the environmental degradation that is worsening in the country.
Japan’s very high rate of dependence on foreign natural resources, including fossil fuels, make its trade balance highly vulnerable to commodity price volatility. It also placed in the second quartile in terms of ecological risk. Over the past decades, an increasing share of this biocapacity deficit has come to be met by imports. Indeed, in biocapacity
terms, Japan has gone from meeting 73 per cent of its renewable natural resource needs from domestic sources in 1961 to only 35 per cent in 2008.
India had the highest risk score of the five case study countries and placed in the bottom quartile. In spite of its high self-reliance in agricultural commodities, India’s dependence on imported fossil fuels makes it highly vulnerable to commodity price volatility. Also, agriculture accounts for over half of all employment in the country. Loss of productive capacity due to overharvesting of resources may therefore have important adverse socio-economic effects.
Environmental risks are potentially large enough to affect countries’ economies in ways that could influence their willingness or ability to repay sovereign debt. In addition, these risks vary widely across countries, including countries whose similar current credit ratings mask this variability in a material contributor to sovereign risk.
The Way Forward
Incorporating these new risks into investment decisions will not only safeguard investments but also, because of the importance of credit markets to national governments, incentivize countries to protect their natural wealth. As financial markets incorporate these risks, a systemic shift in the way governments set policies and make investments could occur. Governments which take early action to address their environmental risks will be best placed to benefit from the changes in investment patterns that will occur when these risks are better quantified and integrated.
The time has come for a better understanding of the connection between environmental and natural resource risk and sovereign credit risk. Only then will investors, rating agencies, and governments be able to plan over the medium to long-term with the knowledge needed to ensure lasting prosperity and stability.
*This article was first published by Thomson Reuters on November 26, 2013.