Experts warn biodiversity loss could trigger sovereign debt crises

Financial markets are blind to the economic costs of biodiversity loss, leaving several countries at risk of defaulting on debt, according to new research published in Nature.

While environmental degradation is recognised as a serious financial risk, sovereign debt markets currently have no way of accounting for it, leaving US$83 trillion of assets open to mispricing. Adjusting S&P Global’s credit ratings to account for ecological damage, a team of economists led by the Universities of Sussex, Sheffield, and Heriot-Watt found that even a partial collapse for wild pollinators, marine fisheries, and tropical forests could add US$162bn to the annual interest payment on sovereign debt.

Biodiverse environments provide what economists call “ecosystem services”, valuable economic contributions like insects pollinating crops and oceans underpinning the seafood value chain. Losing these services carries hefty costs. The researchers’ conservative estimates demonstrate that even a partial collapses in fisheries, wild pollination and tropical timber would cause a global GDP decline of $2 trillion annually. This kind of biodiversity loss would see India’s credit rating falling 4 grades, while China’s would plummet by 5.5 on the 20-point scale. The implications for debt servicing costs are substantial with India having to pay an additional US$49bn a year and US$70bn for China.

The researchers warn that falling credit ratings and higher sovereign risk sees markets demand higher risk premia, meaning governments, and ultimately, taxpayers, pay more to borrow.

Professor Matthew Agarwala, of the University of Sussex’s Bennett Institute for Innovation and Policy Acceleration said: “It’s not just financiers who will lose out. 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."

Sovereign ratings assess the ability of countries to repay debt, directly affecting the price governments pay to borrow. This in turn affects taxpayers: 11 pence of every pound of tax collected in the UK goes to paying interest on the national debt. That’s more than is spent on Education (10.3%), Defence (5.5%), Public Order and Safety (4.4%) or the Environment (1.5%).
Sovereign ratings can also affect the cost of borrowing elsewhere in the economy, with implications for businesses, financial institutions, and pension funds. When economies struggle due to political instability, war, or unsustainable debt burdens, sovereign ratings offer investors an early warning system. But so far, these ratings have systematically ignored the consequences of ecological degradation.

Professor Pati Klusak, from the Edinburgh Business School said: “The 2008 global financial crisis was an example of what happens when markets and ratings agencies ignore new risks. By integrating ecological science with credit ratings models, our work reveals that the financial system risks once again sleepwalking into a catastrophe.”

For the past five years, the research team has been developing machine learning techniques to incorporate environmental science into credit risk assessments. The results show that Indonesia, Bangladesh, India, China, and Malaysia could all face downgrades of four to six grades under a partial collapse scenario.
Dr. Matt Burke, of the Sheffield University Management School explains: “Environmental scientists and financial markets need to get better at talking to each other. 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 23 countries captured in the study represent 5.5 billion people. Biodiversity-driven downgrades in these countries would increase annual debt interest payments by over US$162 billion a year, equivalent to nearly three-quarters global overseas development aid, and leaving many nations at risk of sovereign debt default – in effect, bankruptcy.

If the additional debt servicing costs were met through new taxation, they would absorb about 1.8% of after-tax income for median Indonesian, rising to 2.3% in Malaysia and 2.5% in India.

Compared to the UN Global Biodiversity Framework’s target of mobilising US$200bn annually across 196 countries, the study adds to a growing body of evidence that the costs of protecting nature are far lower than the costs of losing it.

The paper calls on regulators, central banks, and credit rating agencies to incorporate nature- and climate-related financial risks into mainstream risk assessments.

Arend Kulenkampff, Innovative Finance Lead, NatureFinance said: “Protecting nature costs far less than losing it. 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.”

The work was carried out by a research team spanning the University of Sussex, University of Sheffield, Edinburgh Business School, and SOAS.

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