Environmental Risks and Sovereign Credit Ratings: Evidence from Developed and Developing Economies

Ali, Amjad and Usman, Muhammad and Ahmad, Khalil (2025): Environmental Risks and Sovereign Credit Ratings: Evidence from Developed and Developing Economies.

Abstract

This study investigates how climate-related risks influence sovereign credit ratings on a two-dimensional scale, considering both the Climate Vulnerability Index and the Climate Resilience Index. Using a panel cross-sectional dataset covering fifteen developed and developing countries from 2020 to 2024, the research evaluates how the Climate Vulnerability Index and Climate Resilience Index, along with macroeconomic control variables such as gross domestic product per capita, debt-to-gross domestic product ratio, and inflation, affect sovereign creditworthiness. The results remain consistent across robustness tests, and neither the lagged indicators nor indices derived from principal component analysis demonstrate significant predictive power. These findings are supported by graphical data, including scatter plots and heat maps. Although the theoretical expectation is that higher climate vulnerability would lead to lower ratings, the data do not offer strong empirical support for this relationship within the study period for developed and, alternatively, for developing nations. The study concludes that current methods for assessing sovereign credit ratings do not necessarily account for climate-based risks, at least in developed countries over this time frame. Policy recommendations emphasize greater transparency and the integration of climate indicators into credit models, closing resilience gaps through national government action, and prompting international financial institutions to encourage the standardization of climate risk procedures, particularly for developing nations. This study contributes to the evolving discourse on sustainable finance by identifying compromises in climate-adjusted credit assessment and proposing methods and institutional reforms. Concrete policy recommendations include the integration of forward-looking climate indicators into sovereign credit models, the adoption of climate stress testing by rating agencies, and the promotion of standardized climate risk disclosure frameworks, especially in developing economies.

• Item Type: MPRA Paper
• Language: English
• Keywords: Climate Risk, Sovereign Credit Ratings, GDP per capita, Debt, Price Level
• Subjects: E - Macroeconomics and Monetary Economics > E0 - General; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q5 - Environmental Economics

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