A new study published in the Nature journal suggests that financial markets are largely blind to the potential economic costs of biodiversity loss, which could have significant consequences for sovereign debt markets.
According to the study, which was led by economists from the University of Sussex, the University of Sheffield and Edinburgh Business School, sovereign debt markets currently lack an accounting mechanism for the economic consequences of environmental degradation, despite it being recognised as a serious financial risk.
This leaves as much as $83 trillion in assets exposed to potential mispricing, the researchers suggest.
‘Partial collapse’
As the study found, even a ‘partial collapse’ in the population of wild pollinators, marine fisheries, and tropical forests could add $162 billion to annual sovereign debt interest payments.
It would also potentially cause a GDP decline of $2 trillion annually, with India‘s sovereign credit rating falling by four grades, while China’s would decline by 5.5 grades on the 20-point scale. This would mean that India would have to pay an additional $49 billion a year in debt servicing costs, while China may be forced to stump up an additional $70 billion.
Other vulnerable countries such as Indonesia, Bangladesh, India, China, and Malaysia could face downgrades of between four and six grades under a partial biodiversity collapse scenario.
“It’s not just financiers who will lose out,” commented Professor Matthew Agarwala, at the University of Sussex’s Bennett Institute for Innovation and Policy Acceleration. “As nature loss reduces economic performance, it will become harder for countries to service their debt, straining government budgets and forcing them to raise taxes, cut spending, or push inflation even higher.
“The consequences could be grim. Governments face a stark choice – pay now, by investing in nature recovery, or pay later through higher borrowing costs.”
The study focused 23 countries representing a combined population of 5.5 billion people, with the researchers stating that biodiversity-driven downgrades would leave many nations at risk of sovereign debt default.
Biodiversity finance
“Environmental scientists and financial markets need to get better at talking to each other,” added Dr. Matt Burke, of the Sheffield University Management School. “Biodiversity finance is becoming a bit of a buzzword, but most of the research being published on this ignores the underlying science, the pace of nature loss, and the consequences for people and livelihoods.”
The study calls on regulators, central banks, and credit rating agencies to incorporate nature- and climate-related financial risks into mainstream risk assessments, noting that the costs associated with protecting ecosystems are significantly lower than those required to respond to biodiversity decline.
“Protecting nature costs far less than losing it,” said Arend Kulenkampff, innovative finance lead, NatureFinance. “Yet this simple truth rarely reaches the financial decisions that determine its fate. For sovereigns facing debt distress, the stakes are existential: stripping forests, grasslands, and watersheds to service today’s debt destroys the very foundations of future solvency. This research exists to make that cost visible before it is too late.” Read more here.
