The Economist - USA (2019-08-17)

The EconomistAugust 17th 2019 Finance & economics 57

I

n east africamillions of people are suf-

fering from a prolonged drought. Deadly

typhoons are wreaking havoc in Vietnam.

Honduran coffee-farmers are seeing their

crops wither in the heat. Poor countries

have less capacity than rich ones to adapt to

changing weather patterns, and tend to be

closer to the equator, where weather pat-

terns are becoming most volatile. As the

world heats up, they will suffer most.

By 2030 poor countries will need to

spend $140bn-300bn each year on adaptive

measures, such as coastal defences, if they

want to avoid the harm caused by climate

change. That estimate, from the un Envi-

ronment Programme, assumes that global

temperatures will be only 2°C above pre-in-

dustrial levels by the end of the century,

which seems unlikely. Adding to the costs,

research suggests that these countries face

higher interest rates than similar countries

less exposed to climate risks. This raises

the prospect of a vicious cycle, in which the

most vulnerable countries pay more to bor-

row, making adaptation harder and them

even more exposed.

The research focuses on the v20, a

group founded by 20 vulnerable countries

whose membership has since grown to 48.

The members are mostly poor, together ac-

counting for less than 5% of global gdp.

They include low-lying atolls, such as the

Marshall Islands, and economies domin-

ated by agriculture, such as Kenya. The re-

searchers, led by Ulrich Volz of soasUni-

versity of London and Bob Buhr of Imperial

College Business School, examined sover-

eign-bond yields between 1996 and 2016 for

46 countries, 25 of them in the v20. After

controlling for non-climate factors, such

as income per person and levels of public

debt, they estimate that v20 countries

must pay interest rates 1.2 percentage

points higher than comparable countries.

That raises the v20’s borrowing costs by

about 10%, equivalent to an extra $4bn

each year in interest payments.

Companies may also be charged more

for loans if they are perceived as more ex-

posed to climate-related risks. In a new pa-

per researchers at soas looked at the cost of

corporate debt for more than 60,000 firms

in 80 countries. A fifth of the companies,

holding about 3% of the total debt, were in

the countries most vulnerable to climate

change. They were charged interest rates

on average 0.83 percentage points higher—

again roughly a 10% premium.

High interest rates largely reflect a

greater risk of default. So credit-rating

agencies are looking at climate risks, too.

Undiversified economies that are reliant

on agriculture are particularly susceptible,

says Marie Diron of Moody’s. In the 37

countries that the firm thinks are most vul-

nerable, farming accounts for 44% of em-

ployment on average. (Together they have

issued $2.8trn of sovereign debt, about 4%

of the world’s total.) Those relying on tou-

rism could also be in trouble. And climate-

exposed countries often have weak institu-

tions, says Ms Diron. They struggle to plan

for and respond to disasters.

Some of the smaller vulnerable coun-

tries have been attempting to build climate

resilience by pooling insurance risk to

make premiums more affordable. The first

such attempt was the Caribbean Catastro-

phe Risk Insurance Facility, which has paid

out $139m since it was founded in 2007.

The payouts help alleviate cashflow pro-

blems after disasters, reassuring investors

and credit-rating agencies. In the past five

years similar insurance schemes have

popped up in sub-Saharan Africa, Central

America and the Pacific.

Others are seeking to reduce the inter-

est-rate premium with “blended finance”,

whereby multilateral institutions such as

the World Bank and Asian Development

Bank bear part of the risk for mitigation

and climate-resilience projects. In April

the v20launched such a programme. Offi-

cials plan to apply to use $500m from the

un’s Green Climate Fund in the v20. Such

schemes will help, but only a bit. In truth,

climate-vulnerable countries can do little

to offset the rise in the cost of capital. 7

High interest rates and climate change

trap poor countries in a vicious cycle

Adapting to climate change

Costing the earth

ofbillionsofdollarsofsecuritiseddebt.

Rating agenciesrespondedby down-

gradingmonolines’owndebt.Thatdidfor

someofthem,giventhatthebusinesswas

largelyaboutlendingtheinsurer’saaarat-

ingtothebonds.Ambacfiledforbankrupt-

cyandwasplacedinrehabilitation.mbia

avoidedgoingbustbutisa shadowofits

formerself.Bothfirmsremaininrun-off,

meaningtheycannotwritenewpolicies,

buthavebigbooksof existingbusiness.

Thesedays,mostnewpoliciesarewritten

byeitherBermuda’sAssuredGuarantyor

NewYork-basedBuildAmericaMutual.

Themonolineshadhopedthatless-rav-

agedmunicipalbondswouldshorethem

up.Buttheretoovolumetumbledasissu-

ancedwindledandinterestratesfell,erod-

ingmargins.JoshEsterovofCreditSights,a

researchfirm,reckonsthemuni-insurance

businessisa tenthofitspre-crisissize.

Moreover,asthepublic-financemarket

shrankit alsoconvulsed.Insurershavesuf-

feredbigger-than-expectedlossesonmuni

defaults,fromDetroittoPuertoRico.The

latter’s bankruptcy in 2017, designed to

helpitrestructure$120bnofdebtandpen-

sionobligations,hashitthemparticularly

hard.The$170mnetlossunderusgaap

madebymbia inthelatest quarterwas

largelydowntoPuertoRico.

The$720mmbiaisseekingfromCiti-

group,ubsandsevenotherbanksmatches

thevalueofclaimsit haspaidoutonPuerto

Ricancontracts.It accusesthemofcreating

“afinancialabyssofhistoricproportions”

byurgingPuertoRicotoissue“unsustain-

able”debt,andmakingfalseormisleading

disclosuresonwhich theinsurerrelied.

Thebanks’defenceislikelytofocusonthe

factthatbondinsurersarehardly unso-

phisticated;insurershavelongadvertised

theircredit-surveillanceskills.

Allofwhich suggeststhatpost-crisis

bondinsuranceisnotforthefaint-hearted.

LastyearDavidEinhornbecamethelatest

ina longlineofhedgefunderstopublicly

shorta bondinsurer,callingAssuredGuar-

anty“ameltingicecube”.Thefirmpooh-

poohed the critique, and many clearly

thinkithasnavigatedthemorasswell:its

sharepriceis50%aboveitspre-crisispeak

(and23%higherthanwhenMrEinhorn

weighedin);mbia’sisdownby88%.This

hasallowedAssuredtoswoopinonsome

ofthemoreattractivebitsofrivals’books.

Itisalsodiversifying:onAugust9thitac-

quiredBlueMountain,a fundmanagerspe-

cialising in collateralised loan obliga-

tions—securities backed by leveraged

loans,whichfaredbetterthanmortgage-

backeddebtinthecrisisandremainpopu-

larwithyield-hungryinvestors. 7

Correction:In last week’s story on faster payments

(“Overdue”, August 10th), we said that Chris Van

Hollen was a Democratic congressman. He is in fact

a senator.

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