Climate Risk Spillovers and Sovereign Financing

Climate change strains public finances through direct economic effects, yet interconnected economies also face indirect climate exposure via trade networks. These spillovers can amplify costs but are widely ignored. We systematically examine foreign climate risk transmission into sovereign financing conditions by mapping and quantifying local and spillover impacts through global value chain linkages. We use a simple static model of production networks to conceptualize climate effects on sovereigns via international spillovers. Deploying regression models for 75 countries (2000-2022), we exploit exogenous variation in temperature to estimate domestic and spillover impacts on financing conditions, measured by sovereign credit ratings. Results are threefold. First, local temperatures exhibit negative and heterogeneous impacts on ratings, with a 1°C anomaly implying an average 0.2 notch downgrade. Second, ignoring foreign climate spillovers underestimates total climate risk by 30%, most severely for cold and small open economies. Third, climate-driven rating changes imply a 36 basis point sovereign borrowing cost increase, of which 11 basis points are attributable to spillovers. Findings hold implications for investors and policymakers regarding asset valuation, climate adaptation and fiscal sustainability.