Policy brief

The risks from climate change to sovereign debt in Europe

European Union institutions and national fiscal authorities should incorporate climate risk in debt sustainability analysis.

Publishing date
08 July 2021
Stavros Zenios

The author is a Professor at the University of Cyprus and Member of the Cyprus Academy of Sciences, Letters and Arts. Thanks are due to Roel Beetsma, Zsolt Darvas, Maria Demertzis, Demetris Georghiades, Barret Kupelian, Alexander Lehmann, André Sapir, Rolf Strauch, Guntram Wolff, Georg Zachman, Theodoros Zachariades and participants in a European Stability Mechanism Seminar on Debt Sustainability Analysis (April 2021) for comments. Andrea Consiglio carried out the debt sustainability analysis tests and Johannes Emmerling provided generous clarifications and access to WITCH and RICE50+. Research assistance by Klaas Lenaerts, Elena Papadiofantous and Vicenzo Martorana is gratefully acknowledged.

The exposure of European Union sovereigns to climate risks can be acute, from extreme weather, or chronic, from the productivity effects of gradual temperature increase, increased sea levels and the transition to a low-carbon economy that results in repricing of assets. Climate-related innovations can also spur growth. These risks are priced by investors and can affect sovereign credit ratings.

Governments and fiscal stability authorities have an interest in the sovereign-debt implications of climate change being transparent. To this end, we look at the exposure of EU sovereigns to climate risks, study international best practices, and describe the transmission channels from climate change to public finance.

European union institutions and national fiscal authorities should mainstream climate risk analysis in public finance. Stress testing of debt dynamic requires a link between regional climate scenarios and country debt dynamics. We argue for the adoption of an architecture of narrative climate scenarios, to guide national policymaking.

Narrative Scenarios can be generated using integrated assessment models. As an illustration, we apply two prominent models to generate rough bounds on the extent of the risk for Italian debt from climate change. This raises issues about the models used. Coordination by EU institutions to develop regional scenarios will ensure acceptability, raise ambitions in dealing with climate risks and encourage the fiscal authorities to think of solutions. A network for climate-proofing public finance will bring together EU and member-state institutions.

We also recommend budgeting for climate expenditures and contingent liabilities, and using risk-sharing instruments, with disclosure of the risks to public finance from climate change.

Recommended citation:

Zenios, S.A. (2021) 'The risks from climate change to sovereign debt in Europe', Policy Contribution 16/2021, Bruegel

About the authors

  • Stavros Zenios

    Stavros Zenios is a Cypriot citizen with a long career in the USA. His current research focuses on sovereign debt issues, especially in relation to the challenges posed by climate change and political risks. He is working on the development of stochastic dynamic models for debt sustainability analysis and risk management for sovereigns, on sovereign contingent debt, and on the asset pricing effects of political risks. He has published more than 150 articles in leading academic journals, encyclopedias, and handbooks, and edited numerous collected works. He regularly appears on national media discussing issues relating to the economy, transparency and corruption and is consulted by the international press on Eurozone crisis issues. He was Vice chairman of the Cyprus Council of Economic Advisors and served on the Board of the Central Bank of Cyprus.  He served two terms as President of UNICA-Universities of European Capitals and two terms as Rector of the University of Cyprus.

    He is a Professor of Operations Management and Finance at Durham University (UK), on sabbatical leave from the University of Cyprus, where he has been a Professor of Finance and Management Science since 1991. Prior to that, he was a tenured faculty member at the Wharton School, USA, where he remains a Senior fellow of the Financial Institutions Center.

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