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Resource degradation can impact upon countries’ sovereign debt repayments – UN report

Environmental Risk Integrationin Sovereign Credit Analysis.
Environmental Risk Integrationin Sovereign Credit Analysis.

Resource degradation can impact upon countries’ sovereign debt repayments – UN report

The degradation of natural resources negatively affects countries’ ability to repay their sovereign debts, a new United Nations report said today, stressing that sustainable resource management is needed to encourage medium- and long-term investments.

“We are seeing a paradigm shift due to natural resource scarcities with profound implications for economies and, thus, sovereign debt risk worldwide,” said the Executive Director of the UN Environment Programme (UNEP), Achim Steiner, at the launch of the report – E-RISC: A New Angle on Sovereign Credit Risk – in London.

“The time has come for a better understanding of the connection between environmental risk, and sovereign credit risk,” Mr. Steiner added. “Only then will investors, credit rating agencies and governments be able to plan effectively with the kind of insight aimed at ensuring long-term economic health and stability.”

Loss of soils, forests and fisheries, as well as rising resource costs, are becoming increasingly important to a nation’s economic health, affecting its ability to repay or refinance sovereign debt, states the report, issued by UNEP’s Finance Initiative (UNEP FI) – a global partnership between UNEP and more than 200 financial institutions, including banks, insurers and fund managers, which aims to better understand the impacts of environmental and social considerations on financial performance.

The E-RISC project, according to UNEP, investigates sovereign credit risk from an angle that has been largely overlooked by bond markets to date: natural resource risks and environmental impacts. The project explored to what extent natural resource risks can impact a country’s economy and thus, its ability to pay its debts.

At the moment, environmental risks remain largely absent from traditional models that determine sovereign credit ratings and other indicators of economic resilience. The report suggests that sovereign bond ratings should take into account the way a country manages its natural assets, to give investors more transparency when making investment decisions and encourage governments to manage their natural resources more sustainably.

Five countries – Brazil, France, India, Japan and Turkey – were analyzed as part of the report, highlighting major financial challenges due to a growing gap between rising demands for resources like freshwater, forests and soil, and the goods and services that countries can sustainably provide.

The report shows that India now demands 1.8 times more from its ecological assets than it is able to generate, while France demands 1.4 more resources than it can produce. Meanwhile, Japan met only 35 per cent of its renewable natural resource needs domestically in 2008, and Turkey is facing major risks due to water scarcity and desertification. Brazil was the only country that, although its ecological footprint has tripled since 1961, still generates more natural resources and services than its population demands.

“More and more countries depend on a level of resource demand that exceeds what their own ecosystems can provide,” said Susan Burns, the founder of Global Footprint Network, which collaborated with UNEP in the production of the report.

“This trend is tightening the global competition for the planet’s limited resources and represents risks for sovereign bond investors as well as countries issuing such bonds. A more accurate description of economic reality is therefore in everyone’s interest,” said Ms. Burns.

To address the gap between demand and supply of natural resources, the E-RISC report puts forward a framework that aims to assess the likely risks connected to the planet’s depleting resources, and to allow for a more comprehensive insight into the stability of future national income.

Among its findings, the E-RISC report estimates that a 10 per cent fall in the productivity of natural resources, such as grazing land or forests, could force current trade imbalances to grow wider – equivalent to an additional four per cent of gross domestic product – due mainly to a need for more imported goods.

The framework takes into account a country’s ecological footprint and its capacity to generate resources and absorb waste, to connect natural resource risks and environmental consequences with mainstream macroeconomic indicators.